Victory for Bears

With 125bp of rate cuts in 7 trading days, the Fed was able to lift only45 S&P points, and today the markets closed down. That's an important psychological defeat and everyone is going to hear about it when they watch the news tonight.

After today's Fed cut, 15 and 30 year mortgage rates are up. But, regardless of whether Fed cuts push mortgage rates up or down, the bigger issue is tighter lending standards. The real estate bubble was predicated on a near absence of lending standards. Unless those conditions come back, the only direction real estate prices are going is down.

The next (scheduled) Fed meeting (cut) isn't until March 18. That means 48 days without anything bullish to look forward to. (Except government intervention, but after three or four flops in a row, those are wearing thin.)

After a huge, insane rally, the mortgage and bond insurers are flopping again. Here's a great Bill Ackman interview re: MBIA on Bloomberg TV. The other great quote from Mr. Ackman is

"Does a company deserve your highest Triple A rating whose stock price has declined 90%, has cut its dividend, is scrambling to raise capital, completed a partial financing at 14% interest (now trading at a 20% yield one week later), has incurred losses massively in excess of its promised zero-loss expectations wiping out more than half of book value, with Berkshire Hathaway as a new competitor, having lost access to its only liquidity facility, and having concealed material information from the marketplace?"

The problem with these insurers is the correlated risks. The same event - a huge decrease in real estate prices - is going to cause unusually high numbers of simultaneous, unusually high claims. The risk that a $20T asset class decreases in value by say 20% is uninsurable.

I think there is currently no panic in the market and there never has been since the bubble started unwinding, in the sense that nothing has become systematically undervalued yet.

What have looked like "panics" in February, August, and last week have been prices beginning to approach reasonable levels only to have bull market conditioning cause people to buy the dips.

For example, I saw a spreadsheet of REO that a liquidating hard money lender was trying to pitch. It was being talked about at the "fire sale" price of 30 cents on the dollar. Except, none of the properties are worth that much.

However, when people are selling shares of weak financials, homebuilders, and insurers for under $1, I will view that as a fire sale price and cover my shorts.

You Walk Away

What do you do if you are underwater on your house? You walk away.

1. We will stop your mortgage company from calling you.
2. You will immediately know the exact amount of days you have to live in your house payment free. ... We also will notify you if the lender is taking longer than expected subsequently giving you more time in your home payment free.
3. You will be enrolled in our affiliate credit repair plan. They have removed thousands of foreclosures from their clients credit reports.
4. You get a personal consultation with one of our highly experienced Real Estate Attorneys making sure the lender followed the law perfectly. If they did not, you may have a case against them.

It's about to become "acceptable" to stop paying your mortgage simply because you are underwater.

People are going to realize that they can sell their credit score in exchange for their mortgage balance. It will be the trade of a lifetime for millions of people.

Bank United Non-Performing Loans Doubled in Fourth Quarter

BankUnited (BKUNA) Announces First-Quarter Results for Fiscal 2008: "BankUnited Financial Corporation today reported a loss of $25.5 million, or $0.73 per diluted share, for the quarter ended Dec. 31, 2007."

BankUnited non-performing loans more than doubled during the fourth quarter of 2007.

In this environment of rising delinquencies and falling collateral values, both Bank United and Downey are lowering their allowance for loan losses as a percentage of their non-performing loans.

BankUnited was a big option-ARM lender. Notice how more and more of their interest, and income, are coming in the form of non-cash negative amortization.


In theory, this could be OK. It all depends on whether the negative amortization balance will eventually be collected. I predict that it won't.

I think of them as the Downey of Florida, and you know how bearish I am on Downey. Florida has worse real estate markets than California.

Analysis of Downey Financial's (DSL) 2007 Earnings

Downey Announces Full-Year 2007 Results: "Downey Financial Corp. (DSL) reported a net loss for 2007 of $56.6 million or $2.03 per share on a diluted basis, compared to net income of $199.7 million or $7.16 per share in 2006."

I'm pressed for time, so I'll give you four very interesting charts, with a brief commentary on the fourth chart.



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.




Suppose that Downey was to go back to reserving 50% of their non-accrual loans. That would require adding an additional $114.9 million to the allowance for losses.

Doing that would have blown out their loss for 2007 from -$2.03 to -$6.16. (27.85M shares outstanding)

MGIC Provides Investor Update

MGIC Investment Corporation (NYSE: MTG) announced today that year-end 2007 delinquency inventory was 107,120 loans, an increase of approximately 16,000 loans from the end of the third quarter. Cure rates have continued to deteriorate, resulting in a higher percentage of delinquent loans that become claims, and average claim size has also continued to increase. As a result, the Company expects incurred losses for the fourth quarter of 2007 to approximate $1.3 billion. The Company said its insurance in force at year-end 2007 was $211.7 billion. The Company also said it is increasing its paid loss forecast for 2008 to $1.8 - $2.0 billion.

I'm still short MTG - it's one of my favorite positions. Used the rally in financials today to buy back BKUNA, MTG, MBI puts that I had sold last week.

Floyd Norris: A Bear's Questions

From a Floyd Norris post called A Bear’s Questions comes an excellent quote from David A. Rosenberg, a Merrill Lynch economist:

Finally, the question must be asked: if the first 7 percent downleg in home prices could manage to trigger …
1. Almost $100 billion in write-downs in the banking sector;
2. A 65 percent year-over-year surge in foreclosures;
3. The highest residential real estate loan delinquency rate in 20 years; and,
4. A 20 percent plunge in S&P financials …
… then what, pray tell, will the next 20-30 percent have in store?

I think this is dead on. There are tons of people out there catching falling knives.

I added new shorts since January 1 as a recession play: HOG, M, F, TIF, CROX. Short the consumer and long SHY and BIL is a great trade in my book.

Downey Financial Restates Non-Performing Assets

From an 8-K filed today by Downey Financial.

"As required for all loans classified as troubled debt restructurings, loans modified as part of our borrower retention program must now be placed on non-accrual status but interest income will be recognized when paid. If borrowers perform pursuant to the modified loan terms for six months, the loans will be placed back on accrual status and, while still reported as troubled debt restructurings, they will no longer be classified as non-performing assets because the borrower has demonstrated an ability to perform..."

More detail at Calculated Risk.

For me, the most interesting thing is not the effect of this restatement, but simply the continued, sharp increase in plain-vanilla non-performing assets (NPAs) from November to December.

Of course, I had a pretty good indication of that last week, thanks to my tri-county survey.

Here's a restated chart showing NPAs before and after the change.


Here's the kicker: "As yet, we have not determined the impact this reporting change may have on previously reported financial statements, if any, but we expect to complete this analysis soon.”

December 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 December 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.

(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.

CBS Year End Review: Downey Financial (DSL)

Downey Financial was down 52% for 2007 from the time that I initiated coverage on March 15, 2007. (Red S indicates blog posts where "sell" was reiterated.)

In my first Downey post I pointed out how Downey had put together a mortgage portfolio with multiple layers of risk including: limited verification of borrower income or assets; concentration in California; concentration in bubble years; use of mortgage brokers; negatively-amortizing Option-ARM loans.

On April 1, when people were still convinced that problems were limited to "subprime," I noted:

"M&T Bank - which is partially owned by Warren Buffett - is being forced to markdown and repurchase its Alt-A loans. Does anyone think that a bank owned by Buffett does worse underwriting than Downey? What does this imply about the value of Downey's portfolio of Alt-A loans?"

On April 12, I reported on an interesting conversation I had with an Arizona real estate agent:

I asked, "Did you ever have any garbage paper you couldn't push through Downey?" He just laughed.

It is amazing that we both set out, for different reasons and at different times, to find the loosest mortgage lender and independently found Downey.

This April 22 comparison of Downey and New Century illustrated that Downey's portfolio was, in some ways, riskier than a subprime lender's.

On June 12, I found out that hedge funds viewed Downey as a good buy. I pointed out that stated income loans made questionable economic sense for normal borrowers.

During the first week of every month, I release my Survey of Downey Financial Defaults and Trustee's Sales (see October and November). This has proven to be a great leading indicator of the Thirteen Month Selected Financial Data report that Downey releases mid-month.

I'll have the December survey posted in the next few days.

Here are the rest of my Downey-tagged posts. I still own Downey puts.

Astonishing Inventory in Palm Beach County

From the Palm Beach Post:

In Palm Beach County, the supply of unsold homes - called "inventory" in real estate-speak - has risen to astonishing levels as the housing boom continues to go bust.

"Fifty-five months!" McCabe said.

Actually, there's a 57-month supply - nearly five years - of single-family homes in Palm Beach County, based on the current pace of sales, according to Illustrated Properties Real Estate. The South Florida brokerage tracks listings in the Regional Multiple Listing Service.

Does anyone know what the record is for a market that size?