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Posts Tagged ‘delinquency rate

The U.S. economy and housing – part II

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foreclosuremapAug09               Foreclosure rates and Unemployment by state

Risky lending practices have led to a stellar rise in home prices and subsequent plunge when the housing bubble started to burst in the so-called sand states of California, Florida, Nevada and Arizona. It is no surprise that delinquency rates for missed or late mortgage payments have spiked strongly in those areas but also around the country.

In the second quarter of 2009 according to the Mortgage Bankers Association (MBA) delinquency rates for one-to-four-unit residential properties have reached a seasonally adjusted rate of 9.4 percent of all loans outstanding. These numbers set the record for highest late payments rates ever recorded.

Foreclosed properties are also at record high with 4.3 percent at the end of the second quarter, leading to a total combined 13.7 percent of loans past due, also the highest amount of non-current payments in the history of the MBA survey. A welcomed exception are loans 30 days past due which are still well below the record set in the second quarter of 1985.

A sure sign that mortgage problems are being driven by economic recession rather than non-conforming lending practices is the increase in foreclosure rates with prime fixed rate loans. Foreclosure filings are now spreading to areas hit by the economic downturn. The combined percentage of foreclosure filings in the sand states has decreased slightly to 44 percent from 46 in the first quarter.

The State of Oregon is a good example with its unemployment rate rising to 11.9 percent in July compared to last year, at the same time foreclosures in the state are up a whopping 84 percent. The problem seems to be unemployment rather than toxic loans. Many first time home owners who bought at the peak of real estate prices simply have not enough equity in their homes and cannot afford current mortgage payments due to the weak economy.

Of course the actual foreclosure rates are very hard to predict. Government moratoriums have effectively created a hidden backlog of foreclosures that one day have to be dealt with. There are also more warning sign of homeowners under duress emerging as fewer are catching up on lapsed mortgages.

A report from Fitch Ratings found that cure rates for prime loans collapsed to 6.6 percent in July from an average 45 percent for the years 2000 through 2006. Cure rates have also fallen dramatically for non-conforming loans of Alt-A and subprime category. Fitch looked only at a return to current payment for loans bundled into securities, excluding GSE and non-securitiezed loans. 

This dramatic shift in the recovery of delinquent loans towards current payment is partially caused by the economic recession and fall in home prices, which puts a significant number of homeowners under water with little hope of ever recovering their investments. With toxic loans from non-conforming lending practices on the one hand and economic recession on the other, it is no surprise the outlook for both the economy and housing remains highly uncertain.

Few signs of a turn around in housing are starting to emerge. According to Case/Shiller nationwide home prices are showing tangible signs of improvement month over month in June and May of this year. In some areas where prices have fallen dramatically investors are coming back to the market hoping to snap up properties on the cheap.

The Outlook remains uncertain and yet a recovery will by and large depend on the pace of turn around in the economy. While it is no secret that recessions caused by a slump in businesses of the financial services industry tend to last longer, on average almost five years, the depth of the economic trough and the pace of recovery is still unclear.

Key to answering the question whether we will have a V, W, U, or L shaped recovery lies with the American consumer. In the past abundance of credit fueled conspicuous consumption and a debt driven economy. No wonder many are fearing a new found admiration for frugality that is exemplified by an increased savings rate in the U.S. today.

Even though less consumption in the U.S. would almost certainly have implications reverberating around the global economy, the results of this dramatic shift in behavior would be felt most severely in the U.S. itself. While there likely will have to be some shift towards a more export driven economy it is hard to imagine that policymakers in the U.S. are willing to completely adjust to this new set of paradigms without recourse to pre-crisis conditions.

In fact strong signs of reoccurrence of pre-crisis behavior are starting to emerge. Reports of once-again record compensation packages among employees in the financial services industry have angered critics who see the industry at the center of the economic storm and would like to see more humbleness instead of the same old greed.

Even more daunting is another bad habit that many consider at the heart of the financial meltdown through its manipulative prowess in credit distribution behavior. Many banks still stuffed with risky mortgage loans from frothy days of real estate exuberance are once again engaging in what some call resecuritization of real estate mortgage investment conduits.

At the heart of Wall Street’s newest innovation is the re-remic, an impaired bond that does not necessarily have a natural buyer but by splitting it into two bonds may find a buyer for both of them. Investors who take on a really risky pool of securitized loans agree to lose money first if the deal goes sour. Investors in the safer pool of assets get paid first, therefore securitized loans in this category are slapped with a AAA-rating. Sound familiar?

The financial meltdown shooting out from non-conforming lending practices is in part credited to the failed securitization of mortgage loans deemed useful by false credit ratings. Yet, here we go again relying on financial repackaging of inferior securities dubbed suitable once again by rating agencies.

Sifma and the European and the American Securitization Forums (ESF and ASF) are ambitiously drafting new rules to rebuild confidence in structured credit markets reacting to a call from financial regulators to enhance transparency in this notoriously shrouded over-the-counter market. There is clearly a consensual desire to clean up the securitization markets, no wonder given its impact on the current financial crisis.

Initiatives aimed at standardizing issuer disclosure, facilitating and broadening investors’ access to transaction information and enhancing the usability of information are all welcomed but do they really justify the inherent risks purported by this form of financial engineering? Wall Street’s history and its future always has been and always will be abusive in nature, which should give everyone a moment’s thought, unless the crisis was for naught.

While this initiative has been started more than a year ago it does not seem to get into gears. The first drafts of reform were to be implemented at the beginning of 2009 but new rules are still in the workings and have not taken off ground yet. The MBAs proposal to standard procedures for servicing non-conforming residential mortgage loans and ASF’s Project Restart aimed at the securitization market are now trying to put the squeeze on regulators to let more players get sucked back into this ailing market.

So far the magic wand of enhanced transparency did not help to lift the freeze in in the securitization market. During Goldman Sachs’ second quarter the securitization powerhouse was only able to sell $12.9 billion in securitized loans, with meager $496 million outside of safe government agency bonds. That dwarfs in comparison to upwards of $30 billion at the beginning of 2007.

Inquisitive minds might argue that policy makers are not too successful in their attempt to hawk back to pre-crisis conditions. The emperors new clothes in the form of enhanced transparency seems not sufficient to once again resurrect bad habits from the dawn of the credit crisis.

Nevertheless much will depend on future success of the credit-distribution-lifter in form of securitized mortgage or other asset backed loans. Without it the American consumer might well be maxed out, with it the financial services industry and investors will probably once and for all loose their last shirt over it. Much like the Federal Reserve also Wall Street seems to be damned if they do and dammed if they don’t.

While these contradictions contribute to the overall uncertainty credit markets in general are still not healthy. Recently the Fed extended its Term Asset-Backed Securities Loan Facility (TALF) for another six months. It was scheduled to expire at the end of 2009.

In the UK, Bank of England governor King detonated a bomb last week when it became known that he voted for an even bigger increase in the bank’s quantitative easing policy. The minutes of the August meeting revealed King wanted to expand the program by 75 billion instead of 50 billion pounds.

In this apparent game of confidence policymakers are hitting the monetary accelerator full throttle to make sure the public can have trust in their abilities to revive the economy. Yet under these strange conditions a sustained recovery in housing, the economy and on Wall Street seems to be still ways off.

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MBS – then and now, analogy from a small mortgage REIT

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90-day-chart-big

Dynex Capital Inc. is a rather small US based real estate investment trust with its principal investments in securitized residential and commercial mortgage loans and non-agency MBS. The REIT’s portfolio is managed through a combination of short term debt, securitization financing, and equity capital. Dynax provides a glimpse into the current state in short term financing of mortgage backed securities.

This type of financial wizardry in combination with a deterioration in loan underwriting standards has driven the financial industry and the world economy to the brink of disaster. The subprime debacle has forced private capital to flee securitization markets of residential and commercial mortgages.

As of June 30, 2009, Dynex Capital had carrying assets of $245.1 million in non-Agency MBS, that contrasts with $531.5 million in Agency MBS. During the most recent episode of credit contraction, which is still ongoing, impairment of government guaranteed Agency MBS was less severe than of non-Agency MBS.

In the quarter $245.1 million of non-Agency MBS portfolio was associated with $192.5 million securitization financing and short term debt repurchase agreements. Shareholders’ equity amounted to $52.6 million or 21.5% of the total portfolio. In the non-Agency MBS portfolio leverage of equity capital was about 5 times in the end of the second quarter.

Chairman Thomas Akin commented on the quarter, “The story of this quarter is the performance of our Agency MBS investment portfolio. We earned a net interest spread of 3.70% on Agency MBS as our borrowing costs continued to decline (thanks to Bernanke)….Our highly seasoned non-Agency investments continue to generate solid earnings and cashflow for the Company.”  (() emphasize added)

Net interest spread between annualized yield and annualized costs of funds was a record 3.70% in the quarter ended June 30, 2009. In the year earlier quarter the spread was much smaller, only 1.45%. The conditional prepayment rate (CPR) also decreased from 27.3% a year earlier to 19.9% during the last quarter.

Thanks to Fed chair Bernanke’s monetary easing borrowing costs for the financial services industry are almost zero, yet lending rates remain high causing the spreads to widen. According to CEO Akin the joint venture in $6.1 million non-Agency CMBS may be eligible for financial assistance from the government’s TALF program.

There is something suspicious about this joint venture. Could this be a bad bank with potentially impaired investments taken off the REIT owner’s and ultimately its shareholders hands? Akin obviously expects to get help from the government.

In bank land many financial institutions are still getting sicker. At the end of the first quarter the FDIC had still 305 of them (could be less by now) on its problem bank list with about $220 billion in combined assets. Investors in the financial services industry are abandoning their free market principles and line up for a multitude of accommodative government support, yet their commitments to regulation and prudence in compensation are nothing but lip service.

A revealing report by NY Attorney General Cuomo showed that many of the banks which lost billions in 2008 continued to reward its employees with generous bonuses. Financial institutions of all sorts have adopted a motto of ‘heads I win, tails you loose’ . This attitude is rooted in the almost guaranteed government bailouts that have spread all over the Western hemisphere during the last two decades.  

An Icelandic bank lending huge amounts of money mostly to its biggest shareholders shortly before it collapsed, or governors of their states in Germany promising radical changes in compensation policy while asking for public funds to bail out the Landesbanken are just two examples of the prevailing bigotry in the financial services industry. Needless to say top management continued to receive lavish compensations to this day.

This kind of compensation and also lately the marked improvement in earnings for some institutions leave the overall financial health of the industry in doubt. Maybe things aren’t as bad as they seem?! Dynex Capital reported in its press release that delinquencies on securitized mortgage loans increased from April to June of 2009 to $15.0 million from $9.1 million at December 31, 2008, but the company incurred no credit loss during the quarter. That’s payments on about 6.1% of non-Agency MBS loans are 60 to 90 days late.

Finance blogger Calculated Risk has a nice monthly chart with historical data of 90+day delinquency rates for Orange County (CA), one of the hardest hit regions of the U.S. housing bust. The chart above shows 6+% delinquency rate of residential mortgages for June, 2009, and compares with what Dynex reported during the quarter (commercial and single family loans combined).

Interestingly, going back into the archives of financial statements from Dynex, revealed a similar delinquency rate of commercial loans with 5.15% delinquent 90 days and over in the June 2006 quarter. The single family loan portfolio performed much butter, only 2.68% of the loans were delinquent 90 days and over. The commercial loan portfolio is not unlike the non-Agency loan performance during the most recent quarter, although commercial and single family combined.

In general Dynex was substantially less invested in government guaranteed Agency bonds reflecting a more opportunistic environment before hell broke loose in the summer of 2007.  The securitized finance receivables were collateralized with $535.5 million of commercial loans and $136.9 million of single family loans. $487.4 million of commercial loans were financed with non-recourse securitization, and $113.4 million of single family loans were financed with monthly recourse repurchase agreements. The finance strategy was similar then and now, though different in the magnitude of dollar amounts invested.

Shareholder equity was $136.3 million during the quarter, or 20.2% of the $672.4 millions of the commercial and single family loan collateral combined. During the summer of 2006 non-Agency portfolio leverage of equity capital was therefore about 5 times, essentially unchanged to the most recent quarter.

Net interest spread between interest earning assets (average 7.55%) and interest bearing liabilities (average 7.54%) was substantially lower before the crisis, only 0.01% for all investments combined in the portfolio. Thanks to Bernanke, at last something he can be proud of, this margin has improved substantially. For Dynex it was a record 3.7% in the quarter ending June 30, 2009.

The portfolio is certainly more cautious today then it was before the crisis. Government guaranteed mortgage loans have significantly replaced more risky private sector loans. Yet, credit quality benchmarks have not changed that dramatically at all as one would expect.

The following table summarizes the allocation of the Company’s $154.6 million of shareholders’ equity as of June 30, 2009:

REIT-Dynex

Is CRE the next accident to happen?

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Commercial real estate is shaping up to become another causality of the financial crisis and CRE mortgage delinquencies and loan defaults are now starting to pile up on the balance sheets of US financial institutions. That is of course on top of losses from residential real estate, consumer credit and the securitization markets that sort of connect all the sore spots on Wall Street.

$817 billion of total CRE-loans are still outstanding in June, 2009, and about 29 billion have run into trouble. In the month of June loan delinquencies soared by $10 billion heating up the debate about future CRE losses by financial institutions.

But that’s not all. About $105 billion worth of troubled loans have been worked out. A majority of those loans experienced an averaged loss of almost 64 percent. Delinquency rates on CRE are up to 4.5 percent in the second quarter from 3.6 percent in the first quarter, 2009.

Similar to residential real estate CRE property prices have also collapsed. Moodys/REAL Commercial Property Price Index (CPPI) has not bottomed as of April 2009:

CREallPropertynationalindex

In CRE much like with residential real estate many loans have been securitized and actual losses to financial institutions and investors will therefore depend largely on two conditions. First, the total amount of loan defaults will be substantial given the collapse in prices. Second, FASB statements 166 and 167 will determine how big the losses are or if they can be deferred onto some future time horizon.

FASB statements 166 and 167 refer to securitized loans in special purpose entities, and require banks to consolidate insufficiently capitalized SPEs onto their balance sheets. Although this should foster more disclosure for investors its impaired with whims of possible rule-bending.

FASB determination to implement these rules is another uncertainty factor. In April, 2009 FASB halted fair value accounting to stop the hemorrhaging of impaired financial assets. Statements 166 and 167 are supposed to take effect in the first fiscal quarter beginning after November 15, 2009.

Some are already preparing for the worst. Bank of America now expects to bring about $150 billion back onto its balance sheet under the new FASB rules. This 150 billion off-balance-sheet assets comprise of $12 billion home equity conduits, $85 billion card securitizations, and other variable interest entities make up the remaining $53 billion. Maybe BofA is just lucky.