CBS Year End Review: Standard Pacific

Standard Pacific is down 84% since I initiated coverage on March 30, 2007. (Red S indicates blog posts where "sell" is reiterated.)

In my first SPF post, I talked about how the assets on the balance sheet were greatly overvalued, and would require significant further writedowns. I also brought up the issue of the two layers of financial leverage thanks to the joint-venture deals.

Also, this observation proved to be an understatement:

And when land values fall, they fall hard. They are a bet on home prices and builder profit margins.

I grant that the old JV land, and the old land owned (if any), are undervalued on the books. But my suspicion is that the amount of that land is dwarfed by the way overpriced land.

On October 3, I questioned the reasoning behind a huge homebuilder rally sparked by Citigroup analyst Stephen Kim. Sure enough, that was not the bottom for the homebuilders.

This is an industry suffering from huge over-investment, and it needs a restructuring.

I am still short Standard Pacific, and I believe that their common stockholders will be wiped out within one year from today.

Joe Lewis and Bear Stearns

I haven't seen this mentioned in most of the articles about Joe Lewis continuing to buy shares of Bear Stearns.

Take a look at the Schedule 13D filed by Joe Lewis and his apparently related companies.

Scroll down to item 5. You can see that almost all of the shares were "acquired pursuant to exercise of options by option counterparty."

In other words, those shares got "put" to him, at prices between $90 and $110. Bear closed today at $88.

It's possible that he meant to acquire the shares that way - so that he collects a premium and then buys the shares. But it's also possible that he thought that the stock had bottomed.

Any way you slice it, selling those $110 puts was a losing trade.

Are Financials a Good Buy Yet?

I think this WSJ article answers that question.

Warren Buffett agreed to pay $4.5 billion to buy the majority of an industrial conglomerate from Chicago's Pritzker family, choosing to invest in products like plumbing pipes and railroad tank cars as Asian investors pour billions into U.S. financial institutions.

Who is the smart money?

With more than $45 billion in cash on its balance sheet and a triple-A credit rating, Berkshire could easily buy a stake in a big bank, brokerage or other hard-hit financial firm. But so far, Asian and Middle Eastern investors have been at the forefront of financial deals.

The Marmon investment doesn't mean Mr. Buffett has written off the U.S. financial industry. As he did with high-yield telecom bonds several years ago, Mr. Buffett typically waits until prices fall to rock-bottom levels and until few other buyers are on the hunt.

Florida Sales Tax Revenue Weak in November

From the Florida Department of Revenue, Revenue Collection Report for November 2007:

• November 2007 sales tax collections were 5.18% below the November 2006 levels.
• If you look at the report, FY07-08 tax receipts have been lagging FY06-07 receipts for several months now.
• The only category of sales tax collections that is holding up is consumer non-durables.
  
• Auto, construction, other durables, and business investment have been getting killed.
  

See my earlier post on Weak October Retail Sales in California. Almost 18% of the U.S. population lives in California or Florida.

Sea Change in California REO Pricing

This is a bad sign for loss severity at our California Savings and Loans:

Banks and other mortgage lenders are starting to deeply discount their “owned” properties – the homes they have foreclosed on – says a report Thursday from ForeclosureRadar...

“A notable sea change occurred in November. Lenders are starting to aggressively discount properties” says ForeclosureRadar founder Sean O’Toole. “We were surprised by the magnitude of the discount and even more surprised that most of the homes went back to the bank with no investor bidding in spite of the price cut.”

In one example cited by ForeclosureRadar, 8215 Shay Circle in Stockton, purchased new in January 2006 for $481,000, saw a precipitous decline in price. The loan defaulted in 2007 and the lender discounted the opening bid at auction in November to $240,000. But even then the home went back to the bank with no investor bids, the report says.

Here is some Credit Bubble Stocks background on default rates and loss severity.

Investors are increasingly walking away from houses:

“More than one-fifth of 6,557 Bay Area properties that fell into foreclosure from January through September this year were owned by investors, according to a Chronicle analysis of public records compiled by DataQuick. Of properties repossessed by lenders, 1 in 6 had been owned by people who had two or more foreclosures in their names. Eighteen Bay Area investors had five or more foreclosures.”

New Century Financial Common Stock is a Zero

NEW CENTURY FINANCIAL CORP filed this Form 8-K on 12/14/07:

"Based on a preliminary review of the claims against the Company received by the claim bar date, the Company currently believes that there will be no recovery in respect of the Company’s outstanding common stock under the Debtors’ plan of liquidation."

You've come a long way, baby!

Downey Financial (DSL) Non-performing Loans Jump Sharply

Last month, I predicted that Downey Financial (DSL) Non-performing assets (NPA) would be sharply higher in their next data release.

Today Downey released another Thirteen Month Selected Financial Data report, and the jump in NPAs surprised even me.


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 52% since then. Take a look at this writeup from April 2007 on Downey's underwriting quality.

BankUnited (BKUNA) Negative Amortization Update

Here are some quick notes I took regarding negative amortization at BankUnited (BKUNA) during the past couple quarters.




I'll write more on this later - I just wanted to post these statistics before I forgot.

I don't have as much anecdotal experience with BKUNA as I do with Downey. Please comment if you have anything to add.

Disclosure: Author is short BankUnited (BKUNA).

MGIC Investment Corp (MTG) to Become More Conservative

I just read an article about MGIC Investment Corp (MTG), the biggest mortgage insurer. This was published last Friday, December 7th:

But MGIC, going forward, will no longer insure loans for borrowers with credit scores below 575.

The insurer also is putting in some geographic restrictions in places like California and Florida -- two areas hard-hit by the mortgage crisis. MGIC will insure loans up to 95 percent of a home's value, meaning they won't insure homes with no equity...

Another change will limit the insurance MGIC offers people who have Alt-A loans, which generally require only limited verification of income.

So, if they aren't insuring those types of loans starting now, can I infer that they were insuring them up until this week?

And, if so, what were they thinking?

Disclosure: Author owns MTG puts.

Bankruptcies Up, Home Sales Down in Phoenix

Bankruptcy filings are way up this year-to-date, says the Arizona Republic:

Through November, the Phoenix area recorded 6,484 total filings, up 60 percent from 4,054 filings through the first 11 months of 2006. Statewide filings came to 9,577 through November, up 61 percent from 5,940 over the same span last year. Chapter-7 filings predominate both in the Valley and statewide, but Chapter-13 filings are growing at a faster clip.

Arizona's homestead exemption protects up to $150,000 in equity for homeowners, but that assumes there is equity.

"So many people (contemplating bankruptcy help) got into homes with a negative-amortization loan," said [Tempe bankruptcy attorney John] Volin.

There are two sources that I use to watch home sales in Phoenix/Maricopa County.

• Number one is Bubble Markets Inventory Tracking (BMIT) which does a great job presenting inventory and sales data every month. (He gets his data "from The Arizona Real Estate Center and [it] includes only SFR and Condos.")
• Number two is Melissa Data, which supposedly comes weekly from the County Recorder. I sample 59 metro ZIP codes.
  

Monthly residential sales in Phoenix metro:


We may be looking at two years of residential inventory in Phoenix right now.

I like to watch the "Tax Facts" releases from the Arizona Department of Revenue, but their newest release is August data.

• General fund revenues for August YTD were up an anemic 0.4% and down 2.7% vs August 2006.
• Transaction Privilege and Severance Tax Collections were up 3.3% year over year, but retail was flat.

It would be nice to see the October and November data. We do know the state is worried about the budget:

The Legislature’s budget staff now puts the state’s worsening shortfall at nearly $1 billion, aggravating an approaching confrontation between Democratic Gov. Janet Napolitano and the Republican-led Legislature on how to keep the treasury in the black.

Napolitano has offered a $600 million plan to borrow, spend from the state’s rainy day reserve and temporarily reduce agency spending to protect funding for important programs, such as education and children’s services.

A year after a massive economic boom the state has to start borrowing?

Backlog and Market Cap to Debt Ratios for Major Homebuilders

Following up on posts One and Two about homebuilder ratios.

Debt-to-backlog. Having debt that is a higher multiple of backlog (the dollar amount of outstanding orders for homes) is troublesome. Consider that the amount of cash for paying down debt is going to be a fraction of the backlog

Debt-to-market cap. A measure of the amount of financial leverage.


One thing to keep in mind is that the data not consider off-balance sheet debt, so the amount of debt is understated. The understatement is not necessarily equal - certain builders use more joint ventures to control land. Also, certain builders have more contingent liability for their off-balance sheet debt.

Also, significant numbers of orders in the backlogs will probably cancel. Some builders are better than others at converting the backlog into cash.

Homebuilder Ratio Analysis

In September, I put together a ranking of public homebuilders by their debt to backlog, enterprise value to market cap, debt to market cap, and Altman Z-Score ratios.

I am going to update that ranking, but first I wanted to measure its efficacy at predicting changes in stock prices.

This is a scatter plot of the relationship between the debt to market cap ratio on September 18, and the decline in price since then.


Similar scatter plot showing the relationship between price decline and debt to backlog ratio.

November Survey of Downey Financial (DSL) Defaults and Trustee's Sales

Today I updated my Downey Financial (DSL) survey of defaults and trustee's sales for November 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)

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.

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.

Here's a projection for the 4th quarter based on October and November.


(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.

Lennar Sells 11,000 Lots to Morgan at a 60% Discount

Lennar Corp said on Friday it formed an investment venture with Morgan Stanley Real Estate and sold the venture $525 million in properties.

The properties acquired by the new entity consist of about 11,000 homesites in 32 communities across the United States, it said.

As of September 30, the acquired properties had a net book value of $1.3 billion, it said.

The land portfolio includes a mix of raw land as well as partially and fully developed homesites in both active and future communities. The communities are located in California, Colorado, Florida, Illinois, Maryland, Massachusetts, Nevada and New Jersey.

Why I'm Not Covering

Another violent bear market rally. The market should have tanked instead after the awful news this week:

• Citadel bought a portfolio of E*Trade's residential loans. "Citigroup investment bank analyst Prashant Bhatia said E*Trade actually received 11 cents on the dollar for its portfolio, if you factor in that the brokerage received $800 million in cash minus 85 million shares it issued."
  
• E*Trade operated a bank, and these were relatively high quality loans. "...73 percent of the assets were backed by prime mortgages, or loans to people with solid credit." Downey and BankUnited have arguably lower quality loans, but the market is pricing them much higher than what E*Trade sold their loans for.
  
• Florida municipalities invest cash in a state-run investment pool. It seems that they were invested in low quality securities, and now Florida Halts Withdrawals From Local Investment Fund. There was a run on the fund, and some lucky cities got out in time. But not Jefferson County - their CFO says "I might not be able to pay our employees tomorrow."
• The Treasury's scheme to have lenders restructure loans has been on the news constantly. Russ Winter points out:
  
• "How exactly does the New Hope Alliance secure the agreement of ten or fifteen MBS holders to lower coupons and terms. ... Credit insurance is also put on against default and against altered conditions. If somehow some MBS were restructured under new terms this would in turn trigger a wave of claims against the credit insurance written against this securities. Would the insurers (if even still around) agree to pay these claims? This scheme as it applies to the mountain of MBS in the marketplace is just too much of a tangled web to ever be seriously implemented."

Ever calm and rational, Gary North wrote a good explanation of the rally:

On Tuesday, November 27, the Dow Jones Industrial Average rose by 215 points. The next day, it rose by 330 points.

Why? ... The news had broken that morning of the offer by the government of Abu Dhabi to pay $7.5 billion for 4.9% of America's largest and most prestigious bank, Citigroup.

The stock fund managers started buying as soon as the news hit. The official interpretation: "This decision by Abu Dhabi indicates that America's largest bank is in good shape. This is the end of the subprime crisis."

Here is my interpretation: A small percentage of a gigantic pool of oil-generated capital, which is managed by government bureaucrats in a city-state whose nation did not exist as recently as 1970, was used to buy 4.9% of the largest bank in the United States because this purchase was perceived as a better deal than buying T-bills denominated in a falling dollar.

Another reason for the rally is the eager anticipation of another cut in the Fed Funds rate. Bespoke did a post showing the reaction of various sectors to the last three Federal Reserve interventions in our markets:

Oops! Similar results in the homebuilding sector, of course. Rate cuts aren't going to keep the lights on if you're a real business that made bad investment decisions.

I put together a chart showing the performance of the Credit Bubble Stocks from this blog. Each data series begins on the date the stock was first mentioned on the blog.

(Click for larger version.)
S&P and cash are included for comparison.
You can see that Fed interventions and mistaken bullishness have caused sharp rallies, but they are fleeting and reality quickly catches up with the market.