Tuesday, March 27, 2007
Sunday, March 11, 2007
Part I - An INSIDE view (LITERALLY) of the subprime industry - New Century
Over the next week or so, I am going to show you...literally, why the subprime mortgage industry is imploding. I have known this was coming for a good 2+ years now. Those that have read this blog, and read my posts on Ben's blog, know that I have been saying these things for a long time. NOW, I am going to show you rate sheets and loan programs from various lenders. Some have already gone under, some are on their way, and others are still plugging along. You will be able to see what I was seeing on a daily basis in 2004, 2005, and 2006.
I saved a lot of mortgage hand-outs and flyers from my dealings in the mortgage industry. And now, I am going to share them with you. Some of you knew this stuff was crazy, some thought you knew, some of you had no clue. I am going to show you the 'paperwork' that was floating around every broker shop in the country. I am going to let you look at actual rate sheets and see if you think the 'risk' is priced into the loan. I am going to show you loan programs that were being marketed all day long by multiple lenders.
I will show you how competition drove standards into the toilet and how easy it was to get a loan the past few years. I am going to show you how mortgage lates, reserve funds, verifications of rent/mortgage, and other 'standards' were eliminated by the lenders to carve out their 'niche'. Unfortunately, about 30 companies have carved out their graves instead. Put a big 'W' next to the fundamentals...and a big 'L' (and some flowers) next to the companies that lost.
Before I get going, I will say this: Alt-A and the A-paper markets are next. Do not think for one second that the lax underwriting was only for the subprime borrowers. The booming market made 'everybody' feel good and risk assessment was no longer a priority or focus. Why would it be? That said, just because somebody has a high FICO score does NOT mean they have the income needed to afford their option-arm loan when it resets. You will see the alt-a and prime markets falter in the future. Probably not as bad as the subprime market, but you will see record defaults in alt-a and a-paper loans over the next 12-48 months. I will go into this more in depth at another time. Lets start by taking a look at a 'leading loser' in the subprime sector.
Of all the lenders out there, I will say that New Century was NOT one of the ones that was completely out of control, but they are in the news big-time right now, so I will start with them. Sure, they were doing the typical 'subprime' mortgage loans, but they were not doing some of the crazy stuff that I will show you over the next week or so. They might have had some funny accounting, but my point is, they are pretty representative of one of the top companies in the industry. Since we know where New Century is headed today, lets look at where they were a mere 27 months ago in December 2004: note that their stock price hit $65 a share in December of 2004 (closed at $3.87 on March 8, 2007...please pause while the 'shorts' cheer).
I know, I know....some familiar names on that list. Some of which are already gone. Look at the triple digit growth of some of those companies...and look where they are now. I have data from many of these companies which I will be sharing with you...just be patient. It actually takes quite a bit of work and time to put together good posts...that are informative and entertaining.
Now, lets take a look at a 'risk sheet'...I mean a 'rate sheet' from June 2005 and see how much of a risk premium most of these 'subprime' and alt-a borrowers were paying. Remember how the media always says that subprime loans have high rates in the 8's and 9's and are priced much higher than 'prime' loans. Well, now you can see and decide for yourself. There is nothing really shocking (for the subprime industry of the past 5 years) about this rate sheet, or any program that New Century had, but I will point out a few things.
I suggest clicking on the rate sheet below, and following along as best you can. The best way to read this rate sheet is as follows: you have full doc on the left, and stated income on the right. Then you have different levels of credit quality that make up the far left hand side. This looks at mortgage lates, as well at BK and foreclosures (NOD). Notice the 'Max D/R' or max debt ratio that is across the top. 50-55% debt ratios for most of these loans. That means that 50-55% of your pre-tax income is going to DEBT. Not just mortgage debt, all of your debt (car payment, credit card, etc). Don't forget that many people are in the 25-33% tax brackets as well. So you can easily 'qualify' to spend 70-85% of your gross income on taxes and debt...doesn't leave much to eat on, put gas in the car, and heaven forbid...'save'. Oh, and don't forget that if you don't meet these debt ratios, you can always 'state' your income so that you qualify. And you wonder why people are up to their eyeballs in debt!?!?!?
Be sure to look at the adjustments on the right hand side. Please note that a quarter point (.25) was SUBTRACTED from all loans in the $250k to $600k range. Look at the difference between full doc and stated income rates. I don't expect most people to be able to understand all of it, but post your questions and myself and others will try and help explain things.
I don't want to overwhelm everybody with a bunch of rate sheets and information on this first 'look' at the subprime industry. Every company has slight differences in their rate sheet. I am sure there will be questions on how to read a rate sheet and what things mean. Hopefully we can get a lot of questions answered early on, and focus on the fundamentals and have more discussion more on the coming posts. This post is just to give you a taste of what is to come. I have many more rate sheets and flyers to show you...look at these mortgage flyers as just a sample of what I have picked up along the way.
This first one is a CLASSIC!!! Don't just look at the loan program...look at the picture...and see if you notice anything else...
YUP! The company that is going to give you $750k can't spell the item you will be sticking in the master bedroom. But wait, got your eye on a 1.5 million dollar house, but don't have money for the downpayment?? No problem!
Yes, I know. They are a 'no name' lender that most people haven't heard about...and their stock price is about the same as a can of soda. But I will leave you with this flyer from a company you MIGHT have heard of:
Yup, you read that right...."1 day out of bankruptcy" you can get to 95% LTV with a 560 FICO score. But, at least it isn't a 'stated loan'. See, the lenders know what they are doing! I would be willing to bet this loan program probably isn't around anymore...but I have been wrong before.
Let me know what you think of this type of post. I have LOTS of rate sheets and flyers from a good 15+ lenders. Think Encore, Long Beach, Countrywide, Argent, First Street, Acoustic, Peoples Choice, Fremont, WMC, Meritage, Harbor Capital, Residential Capital, First NLC, BNC...and more!
I look forward to the comments and feedback.
Thursday, March 08, 2007
As bad as it is...the worst is yet to come
I know, I know....it has been too long since my last post. I have been busy with other business interests yet still keeping an eye on the industry and what is going on.
NOTHING that is happening should come as a surprise, especially to regular readers of this blog. I pretty much called how this was going to play out. Lets refresh and see where we are today.
We have had rising inventories for quite some time now...but people whined and whined that prices were not coming down. No, prices did not come down immediately, that takes time. But I think it is safe to say that most areas are definitely having a softening of prices. There is a great website that tracks this information: www.thebubblebuster.com
As we have seen the inventories increase and sales volume drop 20-40% in many areas, we have seen foreclosures skyrocket to all time highs. I received an e-mail last week from foreclosure.com that said they are tracking a record 155,671 foreclosures nationwide! That might not sound like much, but if you look at the increased foreclosure activity in many areas, and the fact that it is only going to get worse, you will see that this is only going to exacerbate the supply/demand imbalance that already exists.
Do not forget there there is still a good trillion dollars or so of loans left to adjust in 2007. Falling values is going to make refinancing many of these loans very hard if not impossible. This will lead to more people walking away from homes because they can't make the payment, or they don't want to pay on a decreasing 'asset'.
To make matters worse, the lenders that used to make these great 'you can afford the American dream' loans are either out of business or headed that way. I heard some intel that New Century is going to file for Chapter 11 here in the near future. Not only that, but like most of these other 'subprime' lenders, has some pretty major accounting issues to 'account' for. BUT, even if the companies were still around to make the loans, nobody is buying them!
I have discussed the MBS (mortgage backed securities) market many times before. I have a friend that is now in the corporate offices of a major lender. He told me that the secondary market is basically paying 'par' for most 'subprime' loan pools now. What does that mean?? It means that if a lender has a 500 million dollar pool of loans and they go to sell them, the secondary market will pay them 500 million for the loans. Dare I say it is hard to make money selling widgets that cost you $10...for $10. I am not including the expenses involved in making the loans either.
The way it should work is that the lender sells the $500 million of loans for say $520 million. Then goes back and lends that money...repeat cycle. Making money each time they sell the loans, which in turn gives them more money to lend out, and in turn sell for more money. Very simplified I know...but I'm not teaching an MBA class at Harvard, just trying to get people to understand the basics of what is going on here.
The main reason the lenders have been making these loans to begin with is because the secondary market would buy them and assume the risk! Remember the reference I have made several times about 'driving forward while looking in the rear view mirror'? Everything looks good when looking backwards, but you don't see the curve in the road ahead and the cliff to one side. That is how the mortgage market and the secondary markets have operated. The secondary markets kept buying debt and taking more and more risk, because they were not seeing the defaults yet (looking in rearview mirror). So they 'put the pedal to the metal' and would buy debt that was even lower quality and higher risk...but hey, all is well! The lenders will make 'stupid loans' if they are not assuming the risk AND can make money while doing it. BUT, now that the secondary market is seeing defaults and foreclosure activity rise higher than projected, they scale way back, and stop buying the debt.
Lets not even get into the fact that China used to be one of the largest purchasers of our mortgage debt, and that if the consumption/production relationship between the USA and China falters, we could see some tough economic times ahead. Here is a good article from the China Daily from back in October 2005. Then you have this article from a bloomberg.com analysis of the Chinese market taking a dip. I like this part the best:
China's slide affected markets around the globe for the simple reason that it reintroduced the long-forgotten concept of risk into the collective consciousness. Emerging markets don't go up forever. Junk bonds are called junk for a reason. Subprime mortgage loans are made to those with less-than-first-rate credit histories.
You have news coming out that 60% of Countrywide's ARM customers wouldn't qualify for the loan if new proposed measures were put in place that made sure the borrower had to quality on what the payment could be, not the beginning teaser rate. Countrywide rationailizes that only 25% of people refi at the end of the period into another ARM loan, but from my experience and the people I am talking to today, the rate is much higher than that. Either way, if you remove 25-60% of the potential borrowers from the market, guess what, 400-500K is no longer 'starter home' pricing.
I am going to be politically incorrect here for a minute. As a general rule, who do you think are 'financially smarter' people: people with good credit (700+), or people with bad credit (500's)?? The reason I ask, is that people with good credit for the most part make good financial decisions. And people with bad credit make bad financial decisions. So, wouldn't making loans that require some financial knowledge, to people that generally don't posess this knowledge, be a recipe for disaster?? You are making high risk loans to high risk borrowers, and NOT making them pay the risk premium anywhere close to the risk being assumed.
But don't think that 'prime' borrowers are exempt. Remember me saying that there was a distinct lack of good underwriting across the board? Well, it doesn't mean much when I say it, but apparently it does when Lehman Bros does. Here is the quote:
Lehman Brothers Holdings Inc. announced yesterday it is cutting the ratings of Countrywide Financial Corp., the largest mortgage lender, and other prime lenders as defaults surge.
"Prime loans will see rising default rates as subprime has, due to increasingly weak underwriting in recent vintages," analyst Bruce Harting said. "The rapidity, breadth and depth of the subprime sector meltdown has been extraordinary, even in the context of an environment in which most industry observers felt that major problems in the subprime space were inevitable and overdue."
If you think the nonsense in the lending arena was concentrated only in the subprime markets, you are mistaken. It has permeated all aspects of lending. Risk assessment has been shoved aside for the past few years...be it mortgages, car loans, credit cards, etc. With the massive consumption by most Americans being done on credit, look for trouble up ahead...but it will require you to stop looking in your rear-view mirror to see it.