Residential Lending Credit Losses Worsen as Unstainable Government Support Proves... Unsustainable

By: Reggie Middleton | Mon, Dec 21, 2009
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As many people focus on commercial real estate exposure, they forget that we are only about halfway or so through the residential crash. The $8k homebuyer tax credit did serve to support the lower end of the residential market (from my anecdotal observations), but did very little to solve the problem. Basically, prices must fall, credit must be loosened or incomes must rise in order to stabilize home prices. With 10% plus unemployment (incomes have actually dropped since the initial bubble burst) and banks holding on to cash tighter than Fido grips his steak bone, you know what prices really need to do to reach equilibrium. Click the graphs below to expand.

Unsustainable government policies prove.... Unsustainable, with very transient results

Most people, including so-called professionals don't get it. We are still very much in a protracted housing bubble.

Yes, housing prices collapsed. Yes, it hurt - a lot! Remember, housing prices are a function of supply and demand. We have gobs of supply from overbuilding - See "Who are ya gonna believe, the pundits or your lying eyes?" and "Who are you going to believe, the pundits or your lying eyes, part 2". for a clear understandng of how bad off this vital urban and suburban market actually is. We have decreased demand due to stingy banks (tightened credit) and high unemployment. In terms of unemployment, we are already breaching the worst case scenario projection of the government's stress tests - two years into the future!

As you can see, the major driver of future bank credit losses has been woefully underestimated, and thus the capital requirements of said banks have been woefully underestimated, among other things. Now, what happens to home prices when you have lower income? Well...

Yes, we are still very much in a bubble!Once you come to the realization that we are still in a bubble that has yet to finish bursting, you can come to grips with the realization that we are already following in the Japanese "lost decade" footsteps, lockstep even.

Reference "They ARE trying to kick the bad mortgages down the road, here's proof!" and "More on kicking that housing can down the road...". We have government complicity in the purposeful opacity of the values of the mortgage assets. See the FDIC "Prudent Commercial Real Estate Loan Workouts" guidance issued Oct 30th, as reported by the WSJ: Banks Hasten to Adopt New Loan Rules and the new FDIC guidance that states performing loans "made to creditworthy borrowers" will not require write downs "solely because the value of the underlying collateral declined"). It really does appear that many have adopted this false sense of security even as I tried to warn about in such a bombastic fashion in "You've Been Bamboozled, Hoodwinked and Lied To! Here's the Proof. What Are You Going to Do About It?".

Now, for those of you who believe that the government's "pretend and extend" policy has any chance in hell of working (the prevailing logic is that we hide the losses long enough for banks to earn their way out of the hole) let's see how well that EXACT SAME tact worked for Japan. There are nearly no Japanese banks in the top 20 bank category on global basis by 2003 - NONE (save potentially Nomura, which arguably survived in name, alone). As you can see, they literally dominated 90% of the space in 1990!


Source: Cap Gemini Banking M&A

With the government's explicit consent, we are doing exactly what the Japanese did with their banks. Hiding losses and failing to take the proper writedowns, hence condemning our stature as global banking leaders. Our only saving grace is that this time around, the rest of the world is in a very similar boat. We are definitely going to fall, it is just that much of the other global banking centers are going to fall with us!

There is little wonder that as Moody's is set to downgrades (belatedely) $143 Billion Of Jumbo RMBS, as reported by Zerohedge, they are actually quite late to the party - as usual. The pure mortgage insurers are getting creamed by claims and losses, and the hybrids (Fannie, Freddie, etc.) are ready to ask for a couple of hundred EXTRA billion from the taxpayer. I am at a loss to see the improvement.

So, how far do we have to go? Well...

Recall "The Truth! The Truth? Banker's Can't Handle the Truth!!!"

CNBC comes out with "US to Push Mortgage Lenders To Modify More Home Loans: The US Treasury announced plans to push lenders to modify more loans after the administration's $75 billion housing rescue plan, called Making Home Affordable, fell short and foreclosures continued rising."

Hmmm... $75 billion is a lot of money. Mayhap the problem is that the banks know how useless pushing on a string is, or mayhap $75 billion is not enough to stem $304 billion (and counting) in Alt A and subprime losses that are still in the pipeline (see graphic below).

It gets worse though. Let's glance at the non-conforming loan losses that have already occurred in comparison to the SCAP projections that justified the return of TARP in many cases. Recovery rates had the illusion of increasing ever so slightly due to an increase in prices as illustrated by the Case Shiller index. I have expressed my doubts about this housing price recovery for several reasons, the least of which is the construction flaws in the index itself which fail to capture the nature of the transient price increases, namely the activity of short term investors and flippers (see On the Latest Housing Numbers). There are some areas that have witnessed some firming of pricing though, but that firmness is the result of the Fed and Treasury trying to blow another bubble within a bursting bubble and is more than outdone by the rampant deterioration in credit quality of loans that result in the dumping of foreclosures -> REOs -> short turnaround sales/flips (via investors, which are not captured by Case Shiller, hence the illusion of a firming market in the lower end of housing prices) all over the place.

Subprime delinquency, charge-off and foreclosure rates are still flying through the roof - with many other categories rushing to keep up. This is as I described from the beginning (2007) through the Asset Securitization Crisis series - there was an underwriting induced crisis and never a true "subprime crisis". As such, there is a very strong chance that many other loan categories may outstrip subprime loans in terms of aggregate losses. It hasn't happened yet, but the Alt-A category is hot on subprime's heels (see below). Construction and CRE will follow up the rear with unsecured consumer (ex. credit cards) and commercial loans fighting to get into the race.

Below, you see the loss trend as of October 2009. These are losses that have most likely NOT been claimed by the banks, and they are significant. In addition, the credit deterioration trend is climbing, not falling. If I am correct in my assumption on the validity of the Case Shiller index in capturing true inventory price depreciation across investor related sales and bank "hold outs", then prices will soon start dropping again, killing recovery rates and causing losses to spike even further.

The mainstream financial media has led many to believe that the "subprime crisis" has passed. FRB and FDIC data actually show that subprime credit deterioration is increasing in the face of lowered interest rates through QE/dollar debasing and HAMP government efforts. This is also despite certain bank policies that mask delinquencies, such as lagging the time it takes to mark a loan delinquent. We found Wells Fargo doing this last year with its HELOC portfolio.

As you can see, every reprieve seen since the crisis started has been followed by a spike in delinquencies. I expect the same to occur for 2010.

As can be expected, ARMs sport more than twice the delinquency rate as fixed rate loans. The drop in rates has caused a leveling of ARM delinquencies, but it is clear that rates can't remain at zero forever, and the bulk of these loans are close to if not passed the underwater mark. Literally any move by interest rates in the direction of equilibrium (read as the cessation or failure of the Fed's direct intervention in the interest rate markets) will cause a flood of delinquencies and foreclosures that are bound to overwhelm the banks. This is an inevitable occurrence. It is not a matter of if, but a matter of when. The interesting issue is that all of the categories are at currently a level that scream solvency alert!

As excerpted from Thoughts on the June 2009 Case Shiller report: Are prices really improving?

Well, the Case Shiller index has finally produced a positive print. Again, I will probably sound like a permabear, but this may not be all that it is cracked up to be. I have warned readers two years ago that the Case Shiller index, although an econometric marvel, is far from perfect in terms of determining the state of residential housing in the real world.

The primary suspects are:

  1. It ignores investment inventory which, when combined with poorly underwritten easy credit loans, was the catalyst for the housing bust in the first place. Investors simply walked away or were foreclosed upon, en masse.
  2. It ignores multi-family housing, which is a significant portion of the stock in urban areas such as NYC. It is also a much higher risk loan that shows more defaults in mortgage portfolios.
  3. It ignores condos and coops. See "Who are ya gonna believe, the pundits or your lying eyes?" and "Who are you going to believe, the pundits or your lying eyes, part 2". for a clear understanding of how bad off this vital urban and suburban market actually is. The recent Case Shiller condo numbers show a statistical uptick, but as can be seen from the ground (reference previous links), the inventory story is simply atrocious, and their is plenty of additional inventory being built as I type this, which just adds to the foreclosure and existing sales inventory issues.My assumption is the government stimulus (which ends right about now) offering $8k tax breaks, seasonality (as this uptick occurred in the strongest historical selling season, the coming to market of larger apartments as inventory is completed (remember, it appears as if this index tracks gross prices, and not prices per square foot, which can be quite misleading in terms of actual price appreciation), combined with the GSE occupancy waiver (which very well may backfire as it brings back the easy money credit days of lax underwriting) is responsible for the trend. Will it last? We shall see, but the laws of supply and demand will apparently have to be suspended.

 


 

Reggie Middleton

Author: Reggie Middleton

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