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Wednesday, February 24, 2010

Unexpectedly, Again

Nobody 'spects nuthin', these days. It's like living in a nursery school full of economists.

Unexpectedly consumer confidence fell, unexpectedly the MBA mortgage purchase index fell, and unexpectedly new home sales for December fell. Mortgage rates were back up a touch over 5% last week, so refis are subdued.

The talk about CPI and deflation kind of obscures the fact that consumers have only so many truly disposable dollars. When their costs for basics go up (medical, food, energy) then spending retracts on all non-essentials. If you look at the actual release, a troubling pattern becomes clear:
                                Seasonally adjusted changes from            
preceding month
July Aug. Sep. Oct. Nov. Dec. Jan. ended
2009 2009 2009 2009 2009 2009 2010 Jan.

All items.................. .1 .4 .2 .2 .2 .2 .2 2.6
Food...................... -.2 .0 -.1 .0 .1 .1 .2 -.4
Food at home............. -.5 -.1 -.3 .0 .0 .2 .4 -2.0
Food away from home (1).. .1 .1 .1 .1 .2 .1 .1 1.6
Energy.................... .5 3.7 .6 .6 2.2 .8 2.8 19.1
Energy commodities....... 1.0 6.7 1.1 .4 3.0 1.6 4.9 46.6
Gasoline (all types).... 1.1 6.9 .9 .3 2.7 2.3 4.4 51.3
Fuel oil (1)............ -.3 5.0 -.3 2.2 7.4 .0 6.1 19.3
Energy services.......... -.2 .1 -.1 .8 1.1 -.3 .0 -4.7
Electricity............. -.4 -.1 .3 .8 1.2 -.2 -1.1 -1.9
Utility (piped) gas
service.............. .5 .5 -1.5 .7 .9 -.7 3.5 -12.2
All items less food and
energy................. .1 .1 .2 .2 .0 .1 -.1 1.6
Commodities less food and
energy commodities.... .2 -.2 .3 .4 .2 .1 .1 2.9
New vehicles............ .5 -1.0 .3 1.4 .5 -.2 -.5 4.1
Used cars and trucks.... .0 2.0 1.7 3.1 1.9 2.2 1.5 11.5
Apparel................. .4 .0 .2 -.3 -.3 .4 -.1 1.7
Medical care commodities
(1).................. -.1 .5 .6 .2 .1 -.1 .7 3.5
Services less energy
services.............. .1 .2 .1 .1 .0 .1 -.2 1.0
Shelter................. -.1 .1 .0 .0 -.2 .0 -.5 -.1
Transportation services .5 .5 .7 .5 .5 .3 -.3 3.3
Medical care services... .3 .2 .3 .2 .3 .2 .5 3.5

1 Not seasonally adjusted.
Consumers who are trying to live tight are being pushed again.... A very bad sign for debt repayments and retailers over the long term. Shelter is pushing down that aggregate index, but real aggregate shelter costs are probably increasing now (an increasing number of people who were living rent-free and not paying their mortgages are having to deal with rents). The rent give-backs come slowly, and if you own your property a lot of localities are increasing property taxes because of the fiscal problems.

I don't think anything more is required to explain consumer confidence and diminishing expectations; both medical costs and insurance costs are rising, food at home is now rising, fuel is rising. While CARS goosed the economy, just look at the effect on used car prices. The stimulus is being slowly retracted there.

Retail sales for January showed a YoY gain, but when you look at it, about 2/3rds of the gain was squarely in gasoline, which tells an ugly tale of its own.

Q4 charge-off rates (link to SA numbers) were published for banks, and they rose again. Credit card charge-offs were slightly down, though. Residential charge-offs rose to 2.71% and commercial mortgage charge-offs rose to 3.05%. Total loans and leases was an awe-inspiring 2.93%, although not hugely increased from Q3's 2.85% (with the seasonal adjustment).

But I'll tell you something - if the fuel price trend continues, the trend in consumer loans is going to reverse. That category is very sensitive to increases in the cost for basics.

If you are wondering, with charge-offs on residential mortgages running over 2%, and 10 year T-bills hanging in the 3.60-3.70% range, writing mortgages at 5% makes NO sense whatsoever. It's sort of like playing Russian roulette with all the chambers loaded. The pattern of recent defaults has shifted from being strongly funny-money related to being much more related to the basic economy. You've probably got a 1% charge-off baked in for years on these new loans (appreciation is not going to save you, and Q4 delinquencies rose again to 10.14%), and future interest rates are going to rise, so pass the ammo and praise the Fed?

For those who don't get it, charge-off rates are expressed as annual percentages of the total portfolio, so they are directly convertible to interest rates. Because of the high delinquency rate, your servicing costs are higher too. We are figuring 45 basis points for five years on prime mortgage portfolios.

100 basis points (=1%)
+45 basis points = 1.45% + 3.70% = 5.15%. Then add rate risk at 75 basis points. Hell yeah! Hoo-hah! I'll take the 3.70% return on the T-bills rather than the prime mortgages at 5%, Alex.

So this explains why almost all mortgage origination is going through federal programs.... To write prime mortgages I want 5.9-6%, and I really want it NOW, and no, I'm not swimming in these waters. Also, they have to be prime. I want 10% down, I want it in cash from the borrower, I want a housing inspection and MY appraisal, I want very good credit aside from exigencies, I want employment stability, I want housing stability, I want the borrower to have savings on hand for two months mortgage payments after closing, I want a record of the borrower saving, I want owner occupied, I want total mortgage payments 38% or under, and not out of range with comparable rents, I want mortgage insurance to 80% - in short, I don't want to write any mortgages in this market. I do not approve of screwing borrowers, and why should such a borrower pay me 6% for money when he can get it for 5% on the GSE market? The only ethical thing to do is pack my borrowers a lunch and send them down the road to inflict the losses on the taxpayers. As a taxpayer, I have mixed feelings about that....

I really don't worry about financing for small businesses in the market. There's no other place for the small banks and CUs to deploy their money in this market. The problem is that many small businesses are already maxed on credit at current revenues, and there are continuing worries about what health care reform proposals and energy will do to them. So I need a lot of collateral, which I can only usually get from hard assets (savings, real estate, land, stock, etc). Many of these people don't have it.

The structural problem here is pretty huge. The only place for lending to really pick up is in corporate expansion, which appears to be, ahem, waiting on consumer sales for the most part. Ag loan delinquencies, as predicted, have shot up. Q4 08 was 1.43%, Q4 09 was 3.24%. There is nothing at all to do but form a bank band which can sing a banking version of Joan Jett's "Love Hurts" after hours while preparing for the bank examiners. It really lightens the mood.
Loans hurt, loans scar, loans wound and mar
Any bank not tough nor strong enough
To take a lot of pain, take a lot of pain
Lending like a cloud holds a lot of rain
Loans hurt, loans hurt.

I may be slow, but even so
I know a thing or two, Ive learned from you
Ive really learned a lot, really learned a lot
Lending like a flame, burns you when its hot
Loans hurt, loans hurt

Auto commercials are either zero down with 60 and 72 month payments underwritten by taxpayers via GMAC or flashing low monthly payments through some lease program neither have much chance of being a long term option for the auto industry. The idea that citizens with household incomes stretched to the breaking point can afford 25K and up auto loans is more D.C. dreaming.
Been to Waco TX? A good example of what has occurred in small to medium size towns..the downtown shops and business are gone. One finds there replacement out by the nearest freeway strip mall with a Wall Mart store and a collection of fast food driveups. Small business has literally been run out of town.
M_O_M, I agree about loans to small companies. As far as I can tell, there's no difference between the availability of credit now vs. before the crash. It's never been easy for small companies to get credit, and that hasn't changed for the worse or for the better. Every time I hear a politician running his mouth about increasing bank loans to small business, I think "what, with MY bank deposits?"
Neil - the difference between then and now is that after 2003, an increasing number of small businesses were relying on credit cards for working capital. Not a good idea, and one that was doomed to fail. Nor can we "fix" that; the fix was failure.

But that's the difference - that and poor sales. If anything, I would say that the traditional type of small business credit is easier to get now than it was, as long as a bank can tell that the borrower has his own skin involved somehow, and is not just desperately borrowing.
Ronald - and oh, yes, we extended more money to GMAC just recently....

As for the small towns, I agree. The large cities aren't necessarily better, though.

About a month ago I drove around some mixed office/commercial development space (somewhat mature) in central PA. Vacancy signs everywhere, and nearly whole buildings empty.
M_O_M, good point. I'd forgotten about the credit cards. I've no excuse really, as my wife and I did some "5% for the life of the balance" deals when starting out. There seems to be a dearth of that kind of offer at the moment.

But if you can demonstrate to a bank that you have sales or collateral and need capital, there seems to be loans available. The problem is so few small businesses have either.
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