Tuesday, August 15, 2006
RE: Credit Contraction, Baby
"Short-term losses" in the business "are now past a reasonable tolerance level," Doug Freeman, the Atlanta company's chairman and chief executive, said on a conference call Tuesday.NetBank, Inc lost 31.4 million in the second quarter, and took losses from its origination sector of 22.9 million. They are hinting at selling this line of business. Opteum, Inc. lost 3.7 million for the quarter, which it attributes to a 15.8 million decline in the value from the residuals from securitized credit that it holds. MortgageIT Holdings Inc. bailed from subprime earlier, and made a profit of 5.8 million this quarter. HomeBanc Corp. (Atlanta) squeaked out a profit, but was not celebratory:
"Correcting that situation" is "a top priority."
Patrick S. Flood, HomeBanc Chairman and CEO, said, "During the second quarter, we continued to focus on executing Phase II of our strategy. Our performance during the quarter reflects this focus, as well as the effects of a number of extremely challenging market conditions including a seventeenth consecutive Fed rate increase, industry overcapacity, aggressive pricing and credit practices, and of particular importance to HomeBanc, unusual and unfavorable real estate conditions in Florida. We currently expect that these market conditions will prevail throughout 2006. While these conditions are challenging, we maintain our focus on executing our strategic plan and are hopeful that conditions will improve by mid-2007."National City and KeyCorp are thinking of selling their non-prime business lines.
Repurchase costs (when sold loans are found to be in violation of guarantees somehow, and must be bought back) seem to be mounting rapidly in the nonprime business. NetBank's CFO said that excluding repurchase costs, its production margins for prime lending basically broke even, but the nonprime losses continue to increase. What it all boils down to is that the credit market will have to contract, because investors are becoming increasingly unwilling to buy these securities. No investors, no capital. In the end, someone has to advance the check for that 100% financing of the wonderful starter home that costs triple what it did four years ago and is unaffordable on a conventional mortgage to all but the top 25% of income earners in the local market. When investors stop doing that, funny money loans stop, and prices must fall significantly in certain areas.
S&P changed its rating policies for securitizations of nonprime at the beginning of July, which I believe was a decision in response to experience but will definitely cause caution among investors. As the need to tighten underwriting standards increases and the practice of "optimistic" property appraisals decreases, you will see an entire wave of borrowers unable to refinance their homes. Some of these people have been refi-ing every year or two as a strategy!
I think such figures explain why we seem to be seeing a national tipover into quite slow real estate sales. Conforming mortgages are a much, much smaller percentage of the market than they used to be, so a pullback in nonprime has a significant effect on the market. As prices drop, those who have been conservative will continue to emerge from the closet ready to deal. Now all things wait on them.
See this previous post about the FDIC's Summer Outlook.
"They are hinting at selling this line of business."
I get nervous when definitive moved to what is common sense, is 'hinted at.'
I'm tempted to buy condos at foreclosure or from the banks.
That said, where I am, office condo construction is at a frenzy. They're selling them starting at $160 a sq ft.
I'm buying older, better location units (closer in) for $85 sq ft- and they're all rented.
We're going to experience a big boom here.
I think buying the older units is a better deal for office condos, as long as you get careful appraisals for quality. Quality in some of this latest boom has been shaky, and with the higher building costs I wouldn't buy new construction now. Foundation problems take years to appear.
I haven't looked lately, but early this year the fundamentals in the Raleigh area looked to be excellent. The big thing there is that while median incomes in most of country had been falling since 2000, in that area they have been rising. Also the economy was relatively diverse with a decent mix of businesses and professions, and it had not gone through the big RE inflation.
Be sure of your locations and your demographics, though. Pockets of weakness are popping up all over. Even Texas is developing some problems.
You're not buying on spec and with loser loans, so you don't need to worry about returns year by year. But if a business downturn comes, what effects do you predict for your area? Who are the occupants, and what is their business?
A group of firms are all going to slide down the RE pole together. RE lawyers, mtg brokers, realtors, contractors and builders, appraisers in some markets, construction supply firms, etc. Also be very careful about import-export firms dealing with furniture, appliances, blinds etc. Quite a few stores will be closing in many areas.
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