"The most valuable truths are the ones most people don't believe. They're like undervalued stocks. If you start with them, you'll have the whole field to yourself. So when you find an idea you know is good but most people disagree with, you should not merely ignore their objections, but push aggressively in that direction." Paul Graham
He makes a lot of assumptions in this analysis, but if he’s right about the increasing number of foreclosures and the slim number of non-REO sales taking place, the California housing market will continue to be a scary place for quite some time.
Take a look at the debate going on at his Web site if you want to see other people’s perspectives on his video.
On May 29, the FDIC issued a press release indicating concern that more loan losses are accentuating the credit stress already felt in the market.
Restatements of fourth-quarter 2007 profits by a few institutions, primarily reflecting additional charges for goodwill impairment, reduced industry earnings for that quarter from the $5.8 billion previously reported to $646 million. That is the lowest quarterly net income for the industry since insured institutions posted an aggregate net loss in the fourth quarter of 1990….
Noncurrent loans are still rising sharply. Loans that were noncurrent (90 days or more past due or in nonaccrual status) increased by $26 billion (or 24 percent) to $136 billion during the first quarter. That followed a $27 billion increase in the fourth quarter of 2007. Almost 90 percent of the increase in noncurrent loans in the first quarter consisted of real estate loans, but noncurrent levels increased in all major loan categories. At the end of the first quarter, 1.7 percent of the industry’s loans and leases were noncurrent.
Earnings remain burdened by high provisions for loan losses. Rising levels of troubled loans, particularly in real estate portfolios, led many institutions to increase their provisions for loan losses in the quarter. Loss provisions totaled $37.1 billion, more than four times the $9.2 billion the industry set aside in the first quarter of 2007. Almost a quarter of the industry’s net operating revenue (net interest income plus total noninterest income) went to building up loan-loss reserves.
The industry’s “coverage” ratio — its loss reserves as a percentage of nonperforming loans — continued to erode. Loan-loss reserves increased by $18.5 billion (18.1 percent), the largest quarterly increase in more than 20 years, but the larger increase in noncurrent loans meant that the coverage ratio fell from 93 cents in reserves for every $1.00 of noncurrent loans to 89 cents, the lowest level since 1993. “This is a worrisome trend,” Chairman Bair said. “It’s the kind of thing that gives regulators heartburn.”
The early 1990’s were an optimum time to buy loans and discounted real estate. That time will come again soon.
She added, “The banks and thrifts we’re keeping an eye on most are those with high levels of exposure to subprime and nontraditional mortgages, with concentrations of construction loans in overbuilt markets, and institutions that get a large share of their revenues from market-related activities, such as from securities trading.”
The FDIC’s Deposit Insurance Fund (DIF) reserve ratio fell. The DIF increased by $430 million (0.8 percent) during the first quarter, ending with a balance of $52.8 billion. The growth in the DIF, which was restrained by loss provisions of $525 million, did not keep pace with the quarter’s $140.5 billion (3.3 percent) increase in insured deposits. As a result, the fund’s reserve ratio declined from 1.22 percent to 1.19 percent during the quarter. Total deposits of FDIC-insured institutions increased by $150.4 billion (1.8 percent). Deposits in domestic offices rose by $156.2 billion (2.3 percent), while deposits in foreign offices declined by $5.8 billion (0.4 percent).
In particular:
The FDIC cited higher provisions for loan losses as the primary reason for the drop in industry profits….
Almost a quarter of the industry’s net operating revenue (net interest income plus total noninterest income) went to building up loan-loss reserves.
With banks’ money tied up in this way, the money to refinance poorly performing loans is becoming even less available.
It will be time to buy when there is blood in the streets. The wounds are getting harder and harder to bind.
We are now undergoing a self-reinforcing cycle of default, foreclosure, home price declines, and mortgage credit contraction, the likes of which we have not experienced since the 1930s. The annual number of U.S. foreclosures nearly doubled between 2005 and 2007 to more than 1.5 million, and some private forecasts project 2 million foreclosures or more during 2008 if action is not taken now. Beyond their immediate costs, which include hundreds of thousands of displaced families and tens of billions of dollars in financial losses, these defaults and foreclosures are now resulting in wider problems for our communities and our economy.
When this happened in the early 1990s, the FDIC helped shut down banks and liquidate their assets. Now it says we’re facing a crisis that’s even worse. If bank failures begin again in earnest, the FDIC will have a lot of work on its hands.
Home prices in ten large U.S. cities fell on average by 13.6 percent in the year ending in February, and home price declines of more than 15 percent were registered in major metropolitan areas of California, Nevada, Arizona, Florida, and Michigan. A large inventory of unsold homes points to a protracted oversupply of homes. Of the net 6.6 million homes added to the U.S. housing stock since 2004, more than half are currently vacant. The problem is made worse by the difficulty of securitizing mortgage debt outside of the government-sponsored enterprises. The data show that private MBS issuance in the fourth quarter of 2007 was down 80 percent from the same quarter the year before, and originations of nonconforming loans financed by private mortgage backed securities (MBS) declined by similar amounts.
More than half of the unsold homes are vacant. That’s 3.3 million empty houses. Empty houses are eventually attacked by weather, vandals, and squatters. What will happen to property values then?
Because of the high costs associated with foreclosure (which can range up to 40 percent of the value of the property), it is in the interest of both borrowers and lenders to avoid this remedy whenever possible. But the progress of loan modifications to date has been too slow. A recent study indicates that seven out of ten seriously delinquent borrowers are not yet in any loss mitigation process, and that new loans are becoming delinquent faster than the servicers can modify them on their own.
Loan modifications are going to be an important part of bringing the housing market to a recovery point. I don’t think it’s the government’s job to make sure that these modifications take place. Rather, lenders have every reason to preserve themselves financially by increasing the efficiency of their loss mitigation efforts and by selling their problem loans to investors who are skilled at dealing with delinquent loans.
Subsidizing lenders who are unable to do this simply subsidizes their irresponsible lending choices and business practices. Subsidizing homeowners who put nothing down and are now in distress has the effect of penalizing homeowners who used substantial down payments to buy their properties but have lost most or all of their equity. (See Richard Martens’ post on homeowner bailouts.)
Investors are already responding to lenders’ needs by doing short sales, buying REOs, and purchasing pools of unwanted mortgage paper. Profits exist where lenders need help, and the strength of that need is going to increase through the coming recession.
Delinquencies for Alt-A mortgages rated between 2005 and 2007 are climbing, with total delinquencies rising as high as 17 percent in some cases, more than 6 percentage points higher than previous estimates, the ratings agency said in a report.
Alt-A mortgages are considered higher-quality than subprime ones because Alt-A borrowers have high credit scores, often better than 700. However, most of these loans were made with little or no documentation of the borrowers’ income. Now the market is beginning to show what a risk these loans really are.
Lower-quality subprime mortgage delinquencies soared as high as 37 percent for mortgages originated in 2006, 4 percentage points higher than previous estimates, S&P said.
Subprime mortgages originated in 2007 saw delinquencies climb to almost 26 percent, 6 percentage points higher.
That’s a staggering delinquency rate. Banks’ loss mitigation departments are overwhelmed and understaffed.
“The 2007 issuance year continues to be the worst-performing vintage in terms of cumulative losses,” S&P said, regarding subprime mortgages. “Serious delinquencies” of payments 90 days late or more and foreclosures also are rising, S&P said.
Things may be bad now, but the Alt-A crisis hasn’t even fully begun. The housing market is going down before it comes back up.
Investors who are prepared for this will profit. Everyone else will get slaughtered.
Fannie Mae has reported a loss of more than $2 billion in the first quarter and expects severe weakness in the housing market throughout the rest of the year….
The government has increasingly looked to Fannie Mae to restore stability in the market by buying up mortgages and selling them as securities. Three-quarters of mortgage-backed securities are issued by Fannie Mae and its smaller sibling, Freddie Mac.
To raise capital, the company said it would cut its dividend and offer $4 billion in an immediate share offering. It intends to raise another $2 billion later in the year.
The government is relying on Fannie Mae to reduce the problems we’re facing on the mortgage market. In order to help Fannie Mae do this, investors will have to buy Fannie Mae’s stock.
The company (1) reported a loss of more than $2 billion last quarter, (2) cut dividends, and (3) is planning to package up and sell more loans in a troubled secondary market. In addition, the company is (4) lowering its down payment standard to 3 percent in areas with falling home prices.
(5) Fannie Mae’s stock is down 25 percent this year, and (6) its own chief executive doesn’t think the U.S. housing market will recover until 2010.
If you were considering purchasing its stock, what would you do?
Some people say it’s impossible to make predictions about the economy.
I disagree.
I moved to Oklahoma City in September 2006 expecting its housing market to remain stable through the coming recession. The market is beginning to confirm that expectation.
Forbes recently made a list of America’s top ten recession-proof cities (out of the fifty largest cities).
Oklahoma City is #1 on that list.
Nationally, home prices are falling, unemployment is on the rise and the economy is expected to grow slowly–or even contract–in the first half of the year.
But some cities are doing just fine.
Take Oklahoma City, Okla. With falling unemployment, one of the country’s strongest housing markets, and solid growth in agriculture, energy and manufacturing, it looks best positioned among the nation’s largest metropolitan areas to ride out the current crisis.
Oklahoma City, Okla.
Median home price: +8.2%
Unemployment: 3.5% (from 4.7% in February 2007)
Key growth: Leisure and hospitality, +6%; construction +11.5% from 2007
Did someone say something about a recession? With falling unemployment, one of the strongest housing markets in the country, and strong growth in agriculture, energy and manufacturing, Oklahoma City might not have received the recession memo, and it looks best positioned of the nation’s metropolitan areas to ride out the current crisis. Booming valuations of Oklahoma City’s largest companies, like Devon Energy and Chesapeake Energy, suggest the energy sector is the right place to be.
The price of oil may fall in a recession as it has in the past. That would hurt Oklahoma City’s housing market. Despite this, our cost of living is so low that housing doesn’t have much room to fall before bottoming out.
We all make predictions about the economy, whether we realize it or not. Someone who chooses to live in San Jose, CA is inadvertently betting that housing prices won’t drop there - or he is willing to accept whatever decline occurs. His neighbor, who moves to Oklahoma City or Houston, is also making a bet. It’s simply a more conscious one.
Can a Florida real estate brokerage still make money? Ed Bonkowski, a Fort Myers-based broker, says “yes”, but he’s waiting for certain market conditions.
One recent attendee [of foreclosure auctions] was Kim Hardin, a real estate agent with Century 21 Sunbelt Realty # 1.
She didn’t bid on any properties but was interested in buying foreclosed houses from the regulars.
Hardin said she’s looking to buy in bulk for clients interested in holding houses and leasing them out.
But that could be difficult, Carney said. “We can’t get the houses” in large numbers from the banks.
Ed Bonkowski, a Fort Myers-based real estate broker, did a lot of business in foreclosed properties in the early ’90s in the last major downturn but said he hasn’t lately because good deals are “few and far between.”
He expects that will change eventually, as foreclosure sales accelerate and bank-owned homes pile up.
“Our decision to buy’s going to be when the banks are ready to bulk sale a bunch of them, then it’d make some sense,” Bonkowski said.
But prices will have to drop steeply for that to happen, he said.
“At 15 cents on the dollar, all those properties will be gobbled up, investors will come out of the woodwork and buy them and everybody will go back to work,” Bonkowski said.
Rentals are worth buying, even in Florida, but only if the prices are right.
People who buy right are not scared of this market. They’re excited. That’s worth remembering.
Last week, we went to a seminar hosted by the Oklahoma City Real Estate Investors’ Association. Justin Gentry, a local real estate investor, showed us a strategy that will allow him to eventually collect an income of a million dollars a year.
Here is the basic outline of his strategy:
Buy a house at a large discount that needs minimal repairs to be put in rentable condition. The gross rent per month should be at least 2% of the purchase price of the house.
Fix the house up and rent it out.
Borrow against the house at 50-65% LTV to pull all of the acquisition and repair expenses back out of the house. Small, local banks will lend based the overall cash flow of Justin’s housing portfolio.
Use the money to buy the next house. Do this once a week.
Use the rents to pay the loans down as quickly as possible.
If Justin continues buying one house per week, he’ll have two hundred houses after four years. Once they’re paid off, each house will throw off about $5000/year in net cash flow. For two hundred houses, that’s a total income of a million dollars a year.
That income will rise each year as rents increase. If Justin ever needs to, he can borrow against his free-and-clear homes and have quick access to several million dollars of cash.
You can do this too. One of the challenges will be finding one house a week to buy that will give you enough cash flow to follow Justin’s plan.
There are ways to do this in many areas of the country. Stay tuned as we continue to post profit-generating strategies that take advantage of a buyer’s market.
One of the members of our team ran across this article from the Bank Wage-Hour and Personnel Report (No. 7, Vol. LVIII). My emphases are in bold.
The FDIC is warning banks to prepare for the increased workload that will come as more and more loans default. It’s advising banks to bring on the staff necessary to work these problems out with the borrowers.
The banking crisis is not going away. Don’t be caught off guard.
Shore Up Loan Workout Staff, FDIC Advises
April 15, 2008
The Federal Deposit Insurance Corporation (FDIC) is urging insured financial institutions with significant commercial real estate (CRE) concentrations, including concentrations of construction and development (C&D) loans, to immediately undertake a number of risk management actions. Such actions include bolstering the institution’s loan workout infrastructure and staffing to handle the increased workload associated with problem loans….
According to the FDIC, institutions with CRE and/or C&D concentrations should ensure that they have sufficient staff with the appropriate skill sets to properly manage an increase in problem loans and workouts.
Staffing decisions may involve hiring, making internal staffing changes, and training. Human resources strategists may also entail entering into arrangements with third-party experts on a temporary outsourcing basis. The FDIC suggests that management should develop a ready network of legal, appraisal, real estate brokerage, and property management professionals to handle additional prospective workouts.
If your institution’s management is currently adopting risk management strategies to contain the damage from subprime loan losses and the associated financial repercussions, you should insist on a place at the planning table. No risk management strategy can be successful without adequate staff who are appropriately trained to handle the potential wave of problem loans.
The bank lost seven billion euros due to its positions in the U.S. real estate sector.
UBS is selling 14 billion euros of its subprime mortgages for 9.7 billion. That’s 69% of face value. Black Rock, the U.S. investment fund buying the loans, is going to make a killing.
The United States is like a concrete block tied to the legs of a hapless swimmer. We’re dragging the world with us, and there’s only one direction we can go.
UBS is to cut 5,500 jobs, 7% of the people who work there, and this comes on top of 1,500 previous layoffs. The Swiss bank is Europe’s biggest casualty of the subprime mortgage debacle, and most of the job cuts involve its US and UK investment banking sectors.
UBS reported a first-quarter loss of just over seven billion euros -…
