The Housing Bubble

Some housing bubble news from Wall Street and Washington. Bloomberg, “Centex Corp., the fourth-largest U.S. homebuilder, said it will have about $1 billion in expenses to write down property as the U.S. housing slump worsens. The charge, the second-largest announced by a builder in the past quarter, comes as Centex’s sales fell 13 percent in the fiscal second quarter and compares with $268.4 million in net income the company reported in the last fiscal year.”

“‘The housing market continues to be extremely difficult,’ CEO Timothy Eller said today in a statement. ‘These adjustments reflect the market’s further deterioration over the quarter and the significant effects of the mortgage- market disruptions.’”

“Five of largest homebuilders have recorded real estate writedowns and expenses of almost $4.7 billion in their most recent quarters. The 15 biggest companies have $7.75 billion in debt due through 2009 and are now selling homes at almost any price they can get.”

From MarketWatch. “‘The level of impairments was more than expected,’ said Morgan Stanley analyst Robert Stevenson regarding Centex’s announcement. ‘This news reaffirms our belief that book value is heading even lower as housing pricing declines escalate,’ he wrote.”

“Although Stevenson said that Centex’s sales, closings and backlog declines don’t appear as large as competitors, he pointed out the company didn’t release any pricing data. ‘We expect that many of these orders and closings were driven by aggressive discounting, and worry that the cancellation rate on orders will meaningfully reduce orders,’ he warned.”

“‘Continued oversupply and under-demand, coupled with book values that remain in a free fall, and few near-term catalysts (other than Fed rate cuts) keep us cautious on the homebuilders, and we expect further underperformance,’ the analyst wrote.”

From CNBC. “Moody’s Investors Service on Thursday cut its ratings on home builders Centex, Lennar and Pulte Homes to junk status, saying it expects bleak housing industry conditions to linger at least until 2009.”

“The downgrades affect about $9.4 billion of debt and $3.25 billion of commercial paper authorizations, Moody’s said.”

“Key problems facing homebuilders include rapidly declining orders, high housing inventories, disruptions in the mortgage market and heavy cancellations, Moody’s said in a statement.”

“Moody’s Investors Service lowered ratings on $33.4 billion of securities backed by subprime mortgages, the biggest downgrade yet, saying losses on delinquent home loans will continue to rise.”

“The 2,187 securities were issued in 2006 and represent 7.8 percent of the original dollar volume of the debt rated by Moody’s, according to a statement Thursday by the credit ratings company.”

“One percent of U.S. subprime mortgages with interest rates that began to adjust in January, April and July were modified to help homeowners avoid default, Moody’s said.”

“The company now expects losses from seriously delinquent loans will be 40 percent to 50 percent, up from a traditional level of about 35 percent.”

“‘It is very challenging to come up with an assumption for losses because we don’t have many yet,’ said Nicolas Weill, Moody’s chief credit officer for structured finance. ‘To come up with an assumption we talked to a lot of servicers and we do have some losses coming in. We know that some areas will have more than 40 percent and others will have less.’”

From Reuters. “Moody’s Investors Service said it may skip its typical process of putting debt ratings on review first and accelerate rating cuts of collateralized debt obligations tied to subprime bonds, a director said on Friday.”

“‘We feel this may be warranted,’ Yuri Yoshizawa, a managing director for Moody’s U.S. derivatives group, said during a conference call on Friday. Performance of underlying subprime bonds have ‘deteriorated at an unprecedented pace.’”

“On July 11, Moody’s placed $5 billion worth of debt comprising 184 tranches from 91 CDOs on review for possible downgrade.”

“‘We expect many of these tranches will be further impacted from yesterday’s rating action,’ said Yoshizawa, noting debt originated in 2006 and the first half of 2007 have the greatest level of exposure.”

“Bond insurer Ambac Financial Group said that it expects an unrealized loss of $743 million from marking its credit derivatives portfolio to market at the end of September.”

“Ambac insures municipal bonds and structured credit products such as collateralized debt obligations. They became popular in recent years and many invested in subprime mortgage-backed securities, helping to fuel the U.S. housing boom. But now that delinquencies and foreclosures are rising, some parts of CDOs have been downgraded and have fallen in value.”

The Buffalo News. “M&T Bank Corp. on Thursday reported a loan loss provision of $34 million during the quarter, twice the $17 million it reserved in the third quarter of 2006. Bad loans on its books more than doubled to $371 million, including so-called ‘Alt-A’ mortgages to borrowers with good credit who didn’t want to prove their income.”

“‘It’s a pretty tough environment,’ said Chief Financial Officer Rene Jones.”

“M&T is the first of the nation’s largest banks to report earnings, and as such represents somewhat of a bellwether for the industry. It’s also highly regarded for its conservative underwriting and operations.”

“‘M&T is first out of the chute for banks,’ said bank analyst Joseph Fenech. ‘I don’t really see much to get excited about in the quarter, but they’re going to look a heck of a lot better than a lot of other guys.’”

“Credit quality deteriorated, as $42 million in loans to mostly Mid-Atlantic home builders and developers went sour.”

“The largest single loan to go bad was a $32 million credit to a developer on the eastern shore of Maryland. M&T is now reviewing appraisals on all home builder loans every six months to ensure it still has enough collateral, he added.”

“Also, $26 million in ‘Alt-A’ mortgages with nontraditional terms were no longer performing. The bank tried to sell $883 million in such loans in January, but pulled them back to its own books when the mortgage crisis left it unable to get a good bid. It still has $1.3 billion in total Alt-A exposure, but is now only making loans it can sell.”

The Wall Street Journal. “Since the invention of the ticker tape 140 years ago, America has been able to boast of having the world’s most transparent financial markets.”

“These days, after a decade of frantic growth in mortgage-backed securities and other complex investments traded off exchanges, that clarity is gone. Large parts of American financial markets have become a hall of mirrors.”

“The hazards of this new age of uncertainty became clear at Dillon Read in March, when rising defaults by homeowners were hammering the value of mortgage securities. John Niblo, a hedge-fund manager at the firm, acted fast. He twice slashed his fund’s valuation of securities tied to ’subprime’ mortgages, knocking them down by about 20%, or nearly $100 million, say traders familiar with the matter.”

“But managers at UBS AG, Dillon Read’s parent company, were irate. The Swiss banking giant was carrying similar securities on its books at a far higher price, the traders say.”

“In conference calls, the UBS managers grilled Mr. Niblo on his move. ‘I’m marking to where I could reasonably sell them,’ Mr. Niblo responded during one call, according to the traders familiar with the conversations.”

“UBS later shut down the in-house hedge fund, and Mr. Niblo was let go in August. Last week, UBS announced a $3.7 billion write-down on $23 billion of securities with mortgage exposure, including securities from the shuttered fund.”

“Today, ‘way less than half’ of all securities trade on exchanges with readily available price information, according to Goldman Sachs Group Inc. analyst Daniel Harris. More and more securities are priced by dealers who don’t publish quotes.”

“Billionaire investor Warren Buffett advocates more transparency in pricing. ‘Some marks can be pretty imaginative,” he says. ‘They call it ‘marking to market,’ but it’s really marking to myth.’ He says that before funds publish financial statements, they should sell 5% of hard-to-value positions to gauge values.”

“During this summer’s credit crunch, more than 80% of investors in bonds tied to the mortgage market said they had trouble obtaining price quotes from their bond dealers, according to a survey of 251 institutional investors by Greenwich Associates.”

“Michael Vranos, a veteran mortgage-bond trader, recently told investors in his large hedge-fund company, Ellington Management Group, that he was suspending investor redemptions at the end of September because he couldn’t figure out values for some of the fund’s mortgage-related investments.”

“‘There is no way to determine [values] that would be simultaneously fair both to investors redeeming from these funds and to investors remaining in the funds,’ he wrote in a Sept. 30 letter.”

“J.P. Morgan Chase & Co. analyst Kedran Panageas estimates that 29% of lower-quality ‘collateralized debt obligations’ will eventually lose all of their value due to the recent mortgage shakeout.”

“In the case of quality CDOs, she estimated, 12% will be reduced to zero. The lost value, she says, represents roughly $85 billion of the $475 billion of such securities outstanding. So far, she believes investors have recognized only a fraction of those losses.”

“Mr. Niblo managed a portfolio of about $1 billion in CDOs and mortgage-backed securities. By February, rising mortgage defaults by homeowners with poor credit were taking a toll on the mortgage-backed market.”

“Mr. Niblo sought prices from more than a dozen Wall Street dealers, and in April marked down the portfolio of subprime mortgages by about $20 million, according to the traders with knowledge of the situation.”

“The mortgage-backed market continued to deteriorate. Again, Mr. Niblo sought prices from dealers and marked his portfolio down — this time by $75 million, the traders say.”

“Ramesh Chari, another UBS manager…asked Mr. Niblo to explain his decision. In response, Mr. Niblo asked how UBS could value the securities at a higher level ‘if we can’t sell them at these prices?’ according to traders.”

“In June, Mr. Niblo was put on administrative leave as UBS sorted out the losses and valuation issues at Dillon Read. Mr. Niblo had priced many of the mortgage-backed securities in the range of 50 to 80 cents on the dollar, while UBS valued similar securities in the 80s, the traders say.”

“Last week, when UBS announced its write-down, CEO Marcel Rohner said the firm had done the best it could. ‘We feel that we have applied a prudent valuation’ that ‘reflects the current expectation of what’s going to happen.’”

“Still, Mr. Rohner himself highlighted the bigger issue clouding the financial markets. The trouble, he said, arose because UBS had to mark a price on mortgage-related securities ‘where there is no market price, where there is no trading.’”