The Housing Bubble

Some housing bubble news from Wall Street and Washington. MarketWatch, “NVR Inc.’s second-quarter net income fell 52% from a year earlier, reflecting declining home prices as well as a land-related impairment charge, the residential builder’s financial results showed Friday. The company said orders for new homes fell 11% in the latest quarter, as sales and profit margins ‘continue to be negatively impacted by high levels of new and existing home inventories, affordability issues and declining home-buyer confidence.’”

“NVR said its cancellation rate held steady from the first quarter at 16%. Gross margin narrowed to 18.1% from 24.3% in the year-ago quarter. The company blamed the decline on lower home prices and land-deposit impairments of about $55 million.”

The Financial Times. “Beazer Homes will likely take a USD 100m-USD 200m impairment charge on land and land option write-offs for 3Q07, said two analysts.”

“Those charges should keep pressure on the company’s gross profit margin which have already shrunk to 5% for the second quarter ended March 2007 from 25% during the same period in 2006, said the two analysts and a buysider.”

From Reuters. “The chief executive of KB Home, the No. 5 U.S. home builder, said on Thursday he does not expect the overall U.S. home market to bottom out until the end of next year and that prices will not increase until well into 2009.”

“‘By the end of ‘08 it will start to stabilize,’” Jeffrey Mezger told Reuters. ‘Then it will start to go back up in ‘09. I think it will take a year.’”

The oversupply of existing homes on the market is thwarting efforts by U.S. home builders to spur demand by cutting prices, he said, adding that tightened mortgage requirements after the subprime mortgage crisis were not the chief reason for weakness in the U.S. housing market.”

“‘The bigger factor to me is how many of the markets have this huge resale inventory that has to clear and is going to keep pressure on pricing,’ Mezger said. ‘In a lot of the markets we’re in the new median price is below resale.’”

“He said that in Southern California, Las Vegas and parts of Florida, such as Orlando, the median price of a new home is less than that of an existing home.”

“‘In normal times in a market in balance, new homes carry about a 10 percent premium over resale,’ he said. ‘If today new homes are priced below resale and still not selling, and you have this huge glut of resale inventory, until those prices get back down and they could go low enough for new homes to go down again, we’re going to have an oversupplied market.’”

The Associated Press. “Bank of America recorded another profitable quarter yesterday, but gave investors reason to worry as it fattened its provisions for loan losses, an indication it sees lending risks growing.”

“Its provision for credit losses ballooned 79.2 percent to $1.81 billion, up from $1.24 billion in the first quarter and $1.01 billion in the second quarter of 2006. Net charge-offs, or bad loans, rose to $1.5 billion, compared with $1.43 billion in the first quarter and $1.02 billion in the year-ago quarter.”

“Like its peers, Bank of America’s second quarter results reflected the ongoing challenges in the loan environment. ‘(We) remain a little concerned about domestic consumption spending given the prolonged housing subprime issues and higher fuel prices,’ said Kenneth Lewis, Bank of America’s CEO.”

From Bloomberg. “Wachovia Corp., the fourth-biggest U.S. bank, said second-quarter earnings rose after the takeover of Golden West Financial Corp. Kennedy Thompson has tried to quell investor concern that Golden West, which focused on adjustable- rate mortgages, was purchased just as the five-year housing boom faded.”

“Today, Wachovia said its non-interest expense jumped 14 percent and predicted that net interest income will be at the low end of its 2007 forecast.”

“Wachovia’s total provision for credit losses rose to $179 million from $59 million a year earlier. Loans it couldn’t collect almost tripled to $150 million from a year earlier. They fell from $155 million in the first quarter.”

“JPMorgan Chase & Co. said so-called managed provision for credit losses doubled to $2.12 billion in the quarter from $1.05 billion a year earlier.”

The Journal Sentinel. “Profits rose for Marshall & Ilsley Corp. in the second quarter, but the bank missed Wall Street earnings estimates and boosted the amount set aside for loans that might go bad.”

“Loans and leases categorized as non-performing, those not being paid back according to the original lending terms, totaled $384 million in the quarter. That compared with $198 million in second quarter of 2006.”

“‘The largest increases came in the residential mortgage and construction and land development portfolios,’ Greg Smith, M&I’s chief financial officer, said of the non-performing loans.”

“The slowdown in the housing market led to ’stress for some borrowers in that segment,’ Smith told stock analysts.”

“Subprime mortgage defaults will increase this year and holders of securities linked to those home loans may record losses well into next year, JPMorgan Chase & Co. analysts said.”

“‘The worst is not over in the subprime mortgage market,’ analysts led by Chris Flanagan, the head of structured finance strategy at JPMorgan, said in a report. ‘We expect continued deterioration in subprime loan performance through the balance of this year, and it is likely to be well into 2008 before the problems in securitized portfolios begin to abate.’”

“‘Unfortunately I don’t think we have hit bottom’ in defaults, said Freddie Mac CEO Richard Syron, whose company is the second-largest source of money for home loans behind Fannie Mae. ‘Things are going to get worse.’”

“Flanagan, in a report titled ‘Subprime Meltdown, the Repricing of Credit and the Impact Across Asset Classes,’ said home price declines will lead to increases in defaults. Almost half of subprime borrowers won’t be able to refinance their loans when they reset in the next 18 months, JPMorgan predicts. Flanagan described conditions as ‘very bleak.’”

“The JPMorgan report said investors should not be optimistic that borrowers will forestall default through loan modifications.”

“‘Some borrowers may not qualify; for example, if the original loan was based on fraudulent reporting of income and the fraud is discovered when re-qualifying, modification would likely not be an option,’ the report said.”

“The increased risk of default prompted Moody’s Investors Service, Standard & Poor’s and Fitch Ratings to begin cutting credit ratings on hundreds of bonds last week. The ratings companies all warned that the housing slump is broadening.”

From Fitch Ratings. “CIT Group Inc. reported a 2Q007 pretax charge of $765 million in connection with the planned exit of the company’s home lending business. Although the decision resulted in a loss for the quarter, Fitch believes that exiting the residential real estate lending…may prove beneficial in the long run.”

The Australian. “Senior bankers have said the crisis enveloping hedge fund operator Basis Capital is serious, with warning signs flashing for local capital markets.”

“They have had their values slashed since May because of their exposure to the CDO (collateralised debt obligation) market, which in turn was partly exposed to the US sub-prime mortgage market.”

“Pictured is Mr Fowler collecting an award at the Asia Hedge Awards in 2006 at which the Basis Yield Fund was named Fund of the Year in the ‘fixed income, high yield and distressed’ category.”

“By an irony, the ‘distressed’ assets referred to are assets that have been acquired at reduced prices because their vendors have been financially stretched.”

“There are two main causes of the turmoil in the sub-prime market, and its increasing relevance for local investors. First, poor lending standards resulted in mortgage lending to risky customers with only a limited capacity to repay.”

“Second, and most important for Australians exposed to the crisis, the loans were repackaged through securitisation and sold throughout the world, finding their way into the portfolios of largely unsuspecting investors, according to Schroders.”

“This led to a complete disconnect between the originators of the loans and the eventual holders of the risk. The disconnect was further enhanced by complex structuring mechanisms, transposing the loan parcels into CDOs.”

“ANZ institutional boss Peter linked the cascading effect of turmoil in the sub-prime market to the wider debt market, particularly highly leveraged private equity deals. ‘Leverage is always the first thing that catches a cold first, and there’s probably been some pretty toppy multiples paid for some of those businesses,’ he said.”

“Foreign banks, including Lehman Brothers, Merrill Lynch, Citigroup, JP Morgan and Morgan Stanley, have the biggest exposure to Basis Capital.”

“The Basis Yield Alpha Fund (Master) has failed to meet margin calls and some of its lenders have declared the fund in default and are trying to seize its assets, Zenith Investment Partners, a research firm, wrote in a report on Thursday.”

“Basis warned that if its lenders seize assets of the Basis Yield fund and sell at ‘distressed sale prices,’ the net asset value of the fund could be halved compared to its May 31 level, Zenith’s report said.”

“Poor underwriting and investment decisions in subprime mortgage markets have led to the losses that are now even-handedly punishing lenders and investors, St. Louis Federal Reserve Bank President William Poole said on Friday.”

“‘I believe we should conclude that this year’s markets punished mostly bad actors and/or poor lending practices,’ Poole said in remarks prepared for delivery to a real estate group.”

“‘As is often the case, the market’s punishment of unsound financial arrangements has been swift, harsh and without prejudice,’ he said.”

“Poole said problems in subprime mortgage markets may have been unavoidable given the clash of new financial products and a cooling housing market. But while it was widely expected around 2004 that interest rates would rise, it was surprising that adjustable-rate loans were made so extensively to borrowers with shaky credit histories.”

“‘It is difficult to avoid the judgment that these ARM loans were poorly underwritten at the outset,’ Poole said. ‘It was imprudent for mortgage brokers and lenders to approve borrowers who likely could not service the loans when rates rose,’ he added.”

“Poole said the non-prime mortgage market, with originations in 2006 of about $1 trillion, is ‘clearly large enough to affect aggregate home-building activity and consumer spending.’”