Monday, August 11, 2008
Ah, The Smell Of Burning Credit
There is an excellent Tanta post on Alt-As that you should read. That whump, whump, whump in the background is the sound of banks imploding.... The Alt-A is where the real devastation lies in mortgage lending, and banks are just beginning to address that reality.
So now the builder bankruptcies will be rolling through hitting C&Ds, the CRE retail loans are going bust, and the Alt-A comes a-knocking in a manner reminiscent of those old horror flicks in which the dead started walking.
Anyone want to guess how much fun Bank of America's going to have from all those CW funny money loans that were rewritten and stuffed to Fannie? You can't fix loans AFTER they are written. You think Fannie isn't going to be diligent about shoving those babies back ASAP? They're ramping up to do it right now. The call of "Incoming" should be reverberating through WaMu about now. From Fannie Mae's press release on Q2:
Improving underwriting guidelines to eliminate higher-risk loans. Over 60 percent of our losses have come from a small number of products, but especially Alt-A loans. Through our recent underwriting changes, the volume of these products has declined more than 80 percent from their peak levels. We have already made underwriting changes to mitigate risk characteristics that drove those losses. After considered analysis, we will eliminate newly originated Alt-A acquisitions by year end.Fannie raised its provision for credit losses in the quarter to 3,700 million in the quarter, which brought credit-related expenses up to 5,349 million, as compared to 518 million in Q2 2007. Sweeeet, as Casey Serin would say. I mention Casey Serin because Rob at Exurban Nation kept insisting last year that fraud did cause real losses for real people. I think Rob's point is now made.
Ramping up defaulted loan reviews to pursue recoveries from lenders, focusing especially on our Alt-A book. The objective is to expand loan reviews where the company incurred a loss or could incur a loss due to fraud or improper lending practices. To achieve this, we are increasing post-foreclosure loan reviews from 900 a month in January to 4,000 a month by the end of the year, expanding our quality-control reviews for targeted products and practices, and are on track to double our anti-fraud investigations this year. We expect this effort to increase our credit loss recoveries in 2008 and 2009.
Fannie's estimate of eventual home price declines:
We estimate that average home prices declined by 0.6 percent on a national basis during the second quarter of 2008, which translates to an 8 percent total national decline since the beginning of the downturn in the second quarter of 2006. We have seen more severe declines in certain states, such as California, Florida, Nevada and Arizona, which have experienced home price declines of 25 percent or more since their 2006 peaks.The correlation between high levels of area Alt-A lending and subsequent price declines is quite powerful, and shows up in Fannie's overall book (1.36% as of June):
You know the best part? This isn't confined to the US. It crosses into more than half the nations. For example, a lot of Indian malls are running massive vacancies, the Spanish mortgage bonds (then vs now) are exploding in a dramatic fashion, and all those UK "investment" mortgages are turning from baskets of cute little fuzzy kitties into packs of Rampaging Saber-Toothed Lions. The really sad thing (if you've been following the US saga) is that the US came somewhat late to this party and did not get into it quite as deeply as many other countries. It's bad enough here, but it is going to be worse in a number of other countries. Even Dubai isn't a sure thing any more, no matter how much the authorities talk about the huge growth in population (because guess who is swelling the population?), and in Shenzhen, the question for many recent buyers is whether to keep paying the mortgage or not, now that the place is worth 25-35% less than when they bought. New Zealand? South Africa? Same story, different accent.
Loan loss severity has increased, with our average initial charge-off severity rate increasing from 19 percent in the first quarter of 2008 to 23 percent in the second quarter of 2008, driven primarily by losses on our Alt-A loans in markets most affected by the steep home price declines.
Performance of higher-risk loans. The deterioration in the credit performance of our higher-risk loans is especially pronounced in our Alt-A mortgage loans, with particular pressure on loans with layered risk, such as loans with subordinate financing and interest-only payment terms. As of June 30, 2008, our Alt-A mortgage loans represented approximately 11 percent of our total mortgage book of business and 50 percent of our second quarter credit losses.
And just wait until all those PE corporate loans in emerging Europe explode in correlation with a lot of their crappy corporate bonds.
By the way, among the dumbest proposals ever is the drive for the US to raise corporate income taxes. The US has the second highest rates in the world (among countries that count), just behind Japan. But the swell of support in Japan for cutting their rates is rising rapidly, and read why. US tax policy is really hurting US workers. Read the article.
If you haven't yet grabbed the concept of how serious the Alt-A problem is, see page 34 of Fannie's latest Investor Summary, which has breakdowns by state. MI, which has been in a depressed economic state for several years, ought to be leading credit losses far and away. But it isn't - MI is now improving, and compare that to the trend in credit losses for bubble states such as AZ, CA & FL. Note the correlation with Alt-A loans. Then go to page 36, and look at the five year trend. MI's dire state hasn't produced that bad a 5 year decline, but the one-year declines running around 20% in AZ, CA, FL and NV are so huge that it has knocked Fannie's five year HPA estimate down to 4-6% for those states. So there you have it - Fannie can handle an economic collapse better than bubble lending. Fannie's comparison of the characteristics and default rates of FNMA Alt-A vs private label Alt-A MBS shows that Fannie's is much better, so you can imagine how much pain is in store.
Someday, someway, the "subprime" meme will finally be laid to rest.
BOA's hit is not easily determined. Servicing is not directly related to having originated them, so this statement, without any additional evidence is nonsense.
I once listed to a bunch of lawyers explain how to win lawsuits. I explained to them that was all great and wonderful except for the ultimate defense in law suits, "Poverty".
Indymac is BKed and Countrywide is doubtful to able to take back mortgages. In addition, the mortgage insurers are in a delicate condition. So all in all Fannie is likely to get stuck with them.
Alt-A and Option-ARM resets don't peak until the 2009-2011 timeframe, so it's not one or two bad years that banks face; it's five years as bad as last year.
One of the reasons we refused to do these funky loans for Fannie was because this was going to happen, and it was an unknown but big risk. Fannie is in the driver's seat now really, because everyone needs to be able to sell to Fannie.
As for IndyMac, I think Fannie's going to find themselves in the line of the unsecured creditors. We'll see.
If you want to do business with the GSEs, you generally will find it hard to evade their requests on such matters, no matter how big you are. See The Bank Lawyer's opinion:
You just never know who's going to get stuck with the bill for loans that FNMA Mae buys, but it's rarely FNMA if there's any breathing body or inanimate object that Fannie can stick it to.
As for duration, the type of Alt-As that Fannie holds will probably go bust relatively early. They didn't do that much with the really funky stuff so most of it should hit by the end of 2010.
For example, if you look at FNMA's policy governing appraisal review in declining markets, you'll see that it is somewhat general but mandates extra levels of caution. If you write a bunch of these loans, and if two years later a bunch of them go bad, FNMA can and probably will come back to you noting that there appears to be a problem, and guess what, it is your problem.
When you do business with the GSEs, you generally agree to assume most of the risks of improper practice. You are expected to do due diligence on bought loans and maintain your own servicing standards. If you don't, it is your liability.
Seems like it would be hard for Fannie to put back Alt-A's. What would be the basis? Lack of income verification is out. Not tying income to job title is out (non-wage sources of income were entirely possible given gains on real estate).
Stated income is exactly what the name implies. So "due diligence" would not capture the most prevalent fraud.
Indy's put-backs peaked in '07 and were mostly EPD's. Another indication that anyone that wanted to put back after that probably had a hard time doing so.
Sure Fannie can throw its weight around, but given the lender concentration (BofA and Wamu) I think they would just be sinking their best customers and end up trying to collect from the FDIC. Its not clear, for instance, that BofA would stand behind Countrywide's buyback liabilities.
My guess is that the major mechanism will be appraisals. Fannie's declining market guidelines aren't new, for example.
Wow, those FNM guys a really on the ball! They're only go to buy this obviously toxic sludge for another 5 months! I am so fucking impressed.
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