Standard Pacific Joint Ventures

How about that preposterous rumor (from CNBC, of course) that Buffet would buy part of Hovnanian? The giveaway was that they chose the builder with the highest short interest.

My trade was to fade that rally (17%!) by sellling stock into it and also picking up the August 17.5 puts. Worked great and I'm looking for HOV to slump further. Ditto SPF.

The housing bottom is not going to come until inventory adjusts to normal (the market starts clearing again). That will happen when sellers give up on their wishing prices and hit the bids.

This article by Mish is helpful in understanding what kind of land the builders were buying and putting in joint-venture deals.

Meanwhile, I'm looking further into SPF's JVs:

We enter into land development and homebuilding joint ventures... [We] typically obtain secured acquisition, development and construction financing, which reduce the use of funds from our revolving credit facility...

At March 31, 2007, our unconsolidated joint ventures had borrowings outstanding that totaled approximately $1,245.3 million that, in accordance with U.S. generally accepted accounting principles, are not recorded in the accompanying condensed consolidated balance sheets, and equity that totaled $816.4 million.
We and our joint venture partners generally provide credit enhancements in connection with these borrowings in the form of loan-to-value maintenance agreements, which require us under certain circumstances to repay the venture’s borrowings to the extent such borrowings plus, in certain circumstances, construction completion costs exceed a specified percentage of the value of the property securing the loan.

At March 31, 2007, approximately $658.6 million of our unconsolidated joint venture borrowings were subject to these credit enhancements by us (of which $155.0 million we would be solely responsible for and $503.6 million which we would be jointly and severally responsible with our partners). During the three months ended March 31, 2007, we were not required to make remargin payments under any loan-to-value maintenance agreement. However, subsequent to the end of the 2007 first quarter, we made an additional investment to one of our Southern California joint ventures totaling $9.7 million, which represented our 50% share of the venture’s project loan remargin requirement. [We] expect that, over the next several quarters, we and our joint venture partners will be required to make additional remargin payments with respect to certain joint venture loans and will be required to restructure or extend others.

If our joint venture partners fail to make their required capital contributions, in addition to making our own required capital contribution, we may find it necessary to make an additional capital contribution equal to the amount the partner was required to contribute. Making capital contributions on behalf of our partners could result in our being required to consolidate the operations of the applicable joint venture into our consolidated financial statements which may negatively impact our leverage covenants. Also, if we have a dispute with one of our joint venture partners and are unable to resolve it, the buy-sell provision in the applicable joint venture agreement may be triggered. In such an instance, we may be required to either sell our interest to our partner or purchase our partner’s interest.

Another issue for SPF is the performance guarantees that they and the JV's have given:

We and our joint venture partners have also agreed to indemnify third party surety providers with respect to performance bonds issued on behalf of certain of our joint ventures. If a joint venture does not perform its obligations, the surety bond could be called. If these surety bonds are called and the joint venture fails to reimburse the surety, we and our joint venture partners would be obligated to indemnify the surety. At March 31, 2007, our joint ventures had approximately $130.0 million of surety bonds outstanding...

I realized that I have been neglecting a category of capital mis-allocator besides the crazed flipper: people who only needed a 2000 square foot house but bought a 3500 sf one, because, of course, the more money you spend on real estate, the more money you make in appreciation.

This was perhaps the more pernicious type, because it was an enormous misallocation of capital.

As with any bubble, it will take a while for the effects of that misallocation to ripple through the system. See this chart for more about that.

Downey has Terrible Quarter, As Predicted

The Wall Street Journal is finally getting it:

Most of the attention surrounding sub-prime and high-risk lending in recent months has focused on lower-income or high-risk borrowers who didn't realize they were taking loans that would be difficult to repay. But the Village of Penland project shows how the go-go climate of a real-estate boom, combined with an environment of easy borrowing, also infected well-off borrowers with healthy credit records -- many of whom now say they should have realized the deals were too good to be true.

Watch this video of Cramer "discussing" Downey on CNBC. Look how unhinged he is: "DON'T focus on the darn quarter!"

He's been making the ludicrous suggestion that WaMu should buy DSL for $100 per share. Cramer's thesis is that Downey is cheap, in a growth area, and has no loan loss problems.

If you believe that, I have shares of Downey to sell you.

Downey is cheap if you believe that they have a prayer of collecting on their loans. Negative amortization balances were up to 377M this quarter, which is 25.8% of stockholders equity (up from 320M and 23% in January).

Negative amortization is a debtor's death spiral.

Net income was 75.6M in 2007 YTD. Negative amortization balances increased by 57M. Fully 75% net income in 2007 has been non-cash negative amortization.

To believe that DSL is a buy, you have to believe that negatively amortizing borrowers are using it as a tool to prudently manage their household balance sheets. You have to believe they are not making the minimum payments just to stave off foreclosure a little longer.

Imagine that you bought a McMansion in California, in a far-flung suburb away from cool sea breezes. You paid $820,000 for it in 2006. It's been on the market since April this year, and there are no takers at $689,000. Your HOA and Mello-Roos are $1200 per month. This is a true story.

Downey is not in a "growth area," either. The types of loans they specialize in (Option ARMs) don't make sense for borrowers or lenders anymore. Not when real estate prices are declining.

And they most certainly are experiencing a problem with loan losses.

Their Real Estate Owned (foreclosed houses) increased by 12.7M from Q1 to Q2 - a low eight figure amount, just as predicted on this blog. It cost them $948,000 just in the second quarter to manage those houses.

[I wrote the above words over the weekend, and by the time I'm posting this, the market has started to catch up with Downey. At this point, I'll refer you to the post my friend Amit wrote about Downey.]

Comment on Downey

Don't know who this is or how they know this information (or whether it is accurate), but this comment was posted on the previous DSL post:

Just the tip of the iceberg. The real trouble comes from the MTA loans that don't have modification options because they have been sold.

Downey finally started offering modifications on the COFI loans in their portfolio, but they can't touch the MTA paper. The borrowers that are unable to refinance due to the increase in their loan balances and decrease to their values are facing payment increases of 130-150%. The sad part is some of their prepayment penalties aren't even up yet.

While Downey can begin to mitigate losses on the loans within their portfolio, they do not have the either the power or inclination to mitigate the losses on the loans they have sold. These borrowers are sitting ducks unless something happens to open up mitigation options to displaced borrowers. They know the loan product is defective, and that the underwriting guidelines at best were irresponsible.

What I can't understand is why they are still offering a 1% start rate and why they increased compensation to 3.75%?. Throw in doing away with their approved appraiser list while relaxing appraisal review procedures and I'd almost say they are doing it on purpose. I mean, you gotta think that these guys know how to do basic math and can grasp basic economic concepts.

Is Downey a rat in a trap or are they just a common rat?

The interesting thing about Downey is because of their 110% limit on Neg Am, they get to lead the industry in defaults. However, Countrywide holds the crown for putting equity lines behind their neg am stated product. Brilliant.

Downey Foreclosures Surge in Second Quarter 2007

Today I updated my Downey Real Estate Owned survey for Q2 2007. It's based on a sample of Alameda, Contra Costa, Kern, San Diego, San Joaquin, Solano, and Orange counties [last update: June 6, 2007]. See the footnote for more on how this data is collected.

Those 7 counties are only a fraction of the counties where DSL makes loans - DSL has at least one REO in over 40 different counties. However, the 7 counties did account for 40% of the REOs listed on DSL's website on June 6, 2007.



Downey REOs exploded in the second quarter, while NODs were down from the Q1 pace but still up substantially year over year.



Based on the historical contribution of 40% of REOs by these 7 counties, we can guess that Downey total REOs will increase by approximately 29/.4 = 72 for Q2 2007. That should be a dollar amount somewhere in the low eight figures.

From the Q: "Of the total non-performing assets, real estate acquired in settlement of loans represented $17 million at March 31, 2007, up from $9 million at December 31, 2006 and less than $1 million at March 31, 2006." An eight figure increase in Q2 2007 would more than double the dollar amount of REOs.

Grove Nichols, Communications Director at Indymac Bank, wrote an interesting response to the negative coverage they have been getting. I know that people from Downey, Corus, SPF, and BKUNA read this blog. If any of them wants to write a rebuttal, I would be glad to post and debate it here.

Make sure you see the Standard Pacific post. The inventory and foreclosure data in the Downey/SPF California markets is terrible. Downey's borrowers seem to be treading water, but for how long?

Footnote:
Not all counties make this data easily available online (especially in California). Los Angeles does not provide online access, and many of the counties that do have extremely cumbersome interfaces. My surveying method is to count all of the default notices and all of the notices of trustee's sale/trustee deeds during the time period. I do not make any adjustments for notices of rescission of default. Also, several of the counties do not show NODs on the county recorder website.

Know When to Fold 'em: Standard Pacific

"On June 21st, hedge fund Lone Pine Capital disclosed that it sold out of its entire 5.974M-share, or 9.23% stake, in the California-based homebuilder."

The other institutional holders should check out Bubble Markets Inventory Tracking to find out what is really going on in SPF's markets.

Inventory in Phoenix metro just hit 11.9 months of sales. Riverside County is 9.7; Las Vegas is 15.3 months! San Diego County has a "healthy" 6.6 months. Orange County is 7.2.

Note that SPF was a latecomer to the Las Vegas market, and land prices were astronomical when they started buying.

Check out the foreclosure stats for these cities as well: increasing exponentially.