Weak October Retail Sales in California

From the California State Controller's Office:

The actual year-over-year increase [in California General Fund revenue was] $72 million (1.5%). Retail sales tax receipts were $94 million (-8.7%) below last October.

The General Fund revenue increase was clearly below inflation, so negative in real terms. October's year-over-year sales tax decline follows a 7% y-o-y decline in September.

California's GDP is larger than all but seven countries in the world. The last time California sales tax receipts dipped (2001), there was a recession in the U.S.

From a Census Bureau statistical brief (.pdf, July 1993):

The 1990-1991 recession was particularly challenging for State government finances. For fiscal year 1991, States experienced only a 3.3 percent rate of tax growth - the smallest rate of increase following the 1957-58 recession.

Now that SPF is all over but the crying (subordinated note is yielding 46.6%!), I am going to start shifting focus to weak retailers and manufacturers that cater to what Russ Winter calls "Joe Soccer Mom."

Downey Financial NPAs Continue Exponential Trend; StanPac Bonds Down

Downey Financial NPAs
Today Downey released another Thirteen Month Selected Financial Data report. The rate of increase of their non-performing assets increases every time it is reported:


Downey reports NPAs as a percentage of total assets. But not all of a bank's assets are loans. So, to make the NPA statistic more easily comparable, you can back out Downey's cash, investment securities, FHLB stock, and other assets that are not loans from the calculation.

The graph above shows NPAs as a percentage of only loans. It reveals that calculating NPAs as a percentage of total assets has been steadily understating the increase.

I have consistently maintained a "Sell" on Downey since March 15 when it was selling for $64.87. It is down 51% since then.

Take a look at this writeup from April 2007 on Downey's underwriting quality.

I have a prediction: Downey NPAs will be sharply higher in their next data release. You can confirm that using the first chart in this post.

Standard Pacific Troubles
Today we had four people come to Credit Bubble Stocks searching for "Standard Pacific bankruptcy," which has to be some kind of record. Ouch!

The StanPac subordinated note is now yielding over 35%. Take a look at the price action:


I continue be short DSL and SPF.

David Einhorn on Credit

David Einhorn's remarks from the 17th annual Graham & Dodd Breakfast. It's a must read but here are some quotes:

"[The] fear [among banks, brokerages, and hedge funds] is that the new prices [for mortgage-backed securities and other convoluted structures] are actually disclosed. This is the 'don't-ask, don't-tell method' of security valuation."

"...lenders of all sorts have lent too much money and did not demand enough interest to compensate them for the risks they took. There has been a colossal undercharging for credit across the board."

"Loans [were] based on the borrowers' ability to refinance rather than the borrowers' ability to repay."

"Advocates of securitization say it disperses risk. However, it does so by separating the loan originator from the eventual outcome of the loan."

Comment on Journal Register Post

From the author of off the beaten path investments:

"your post on JRC was especially interesting to me as I have been watching the larger newspaper stocks for over a year but was not aware of JRC and its problems .....based on your post i am going to do my own work on JRC ....i am thinking about a long short trade ...going short JRC and MNI and long BLC and NYT"

My comment on newspaper stocks:

JRC was definitely the worst of breed. I covered JRC last week in the low 2.20s. I wouldn't want to own it but I would rather be short BKUNA.

I am actually short NYT. You should look into how the dual classes of stock allow the B share holders to finance their propaganda by leveraging capital of the ignorant institutional A share investors. Morgan Stanley recently realized this.

I don't think I would pair newspaper stocks as the entire sector is obsolete. Imagine being paired on adding machine companies when it became clear that computers would replace them.

October Survey of Downey Financial Defaults and Trustee's Sales

Today I updated my Downey Financial (DSL) survey of defaults and trustee's sales for September and October 2007. It's based on a sample of San Diego, San Joaquin, and Solano counties only. See the footnote for more on how this data is collected. (1)

Survey indicates that Downey borrowers continue to default and go to trustee's sales at a high rate.

A "Default Notice" is the first step in the foreclosure process. It is a formal notice to a borrower that they are in default. Lenders typically send them after a couple months of missed payments.

Once the lender sends the default notice, the foreclosure clock starts ticking. In California, the borrower has 90 days from the Default Notice to become current on the mortgage. If not, the borrower receives a Sale Notice and shortly thereafter (unless the borrower pays up) the property is sold at auction/foreclosed. Then the trustee's deed transfers title to whoever buys it at auction (usually the lender takes it back as Real Estate Owned). This is coded as a "TTEE Deed" in most of the California recorded document systems, and on the chart below.

So, on this chart, the blue portion indicates borrowers who are in arrears, and the red is borrowers whose foreclosure is imminent or has already happened.



Key point: all of these borrowers in default were almost certainly in default prior to the credit market crunch in August. That means that, beginning next month, we will see the effect of the drastically worse post-August credit, mortgage lending, and real estate markets.

The following chart extrapolates results for Q4 based on data collected in October.



At current rates, 4th Quarter 2007 will be the worst quarter. However, I expect the rate of default to increase and be worse than this linear projection. Now that housing inventory in CA has swelled and mortgage lending has tightened, it will be even more difficult for problem borrowers to refinance or sell their homes.

Also, because Downey is an option-ARM lender, many of their borrowers are making artificially low, negatively amortizing payments. This may be temporarily allowing people to avoid defaulting. I expect Downey's default numbers to worsen as borrowers hit loan interest resets and/or max out their negative amortization caps.

(1) 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 and trustee deeds during the time period. I do not make any adjustments for notices of rescission of default. I have found this data to be an excellent leading indicator, but no warranty is made as to its accuracy.

Disclosure: Own DSL Puts.