Saturday, January 12, 2008

Countrywide Sale...Is This a Turning Point?

Whether you are a Bull or a Bear about the fate of the real estate market... the buyout of Countrywide by Bank of America will affect the mortgage markets as well as the housing markets today and in the future. It is possible that in two years we will look back at this buyout as the turning point in the housing crisis.

According to many sources the book value of Countrywide is well over the amount paid by Bank of America. The loan servicing portfolio alone is probably more then enough to cover the cost paid. This looks to be a good deal for BofA ..but who knows what the future will bring. Make no mistake the buyout will have long term consequences. The ever intrepid Brian Brady seems to think that the ultimate winner may just be Wells Fargo after the dust clears.

The imminent collapse of Countrywide and the impact that would have had on the financial community has been avoided. The pending demise of Countrywide seems to have been a wake up call for the FED. You can expect to see rates drop by a half point at the next meeting if not before. The FED appears to see a looming recession as a bigger threat then inflation fueled by rising energy prices. The hope is that lowering the funds rate will bring much needed liquidity back into the marketplace.

However Wall Street is still very skittish and is waiting to see what happens with Merrill Lynch and Citigroup next week. Citigroup is hoping for a partnership(bailout) by somebody and doesn't appear to be real fussy about who does the bailing. Merrill Lynch is expected to post a $15 Billion write-down of losses related to mortgage investments. It won't be pretty but it seems that Wall Street may be gentle with them as it could be an indication that the bottom of the mess is finally seeing daylight. Speculation is that WAMU could be the next to see a takeover as it appears JP Morgan has been holding some serious talks with the boys at WAMU

The major problem facing real estate markets has been a lack of liquidity. That meant higher rates that made it hard for potential buyers to qualify with stricter guidelines or for qualified homeowners to refinance properties. If investors view the players in the home mortgage markets as more stable the market may respond with lower rates on home loans and possibly for the whole consumer credit market.

The big question for many is how or if the takeover of Countrywide will affect our local Manhattan Beach and the Beach Cities market. It's possible that the FED lowering the fund rate along with BofA and possibly JP Morgan seeing value in the long term housing/mortgage market could be enough to bring a little confidence back to the credit markets. If this happens we may see a loosening of credit on jumbo loans which would definitely impact us.

A slightly better credit market doesn't mean that foreclosures are over or that markets that are in serious trouble will be saved. It also doesn't mean a return to the easy loans of the last few years. Nope...get used to it.. If you want to buy a house you will need good credit, a stable job and money in the bank in addition to the money for your downpayment.

Bad loans and non-qualified owners will still be in trouble. There will be opportunities to buy a home at a discount compared to prices a few years ago but a stable credit market may signal a flat or slightly downward price trend rather then a collapse in real estate prices for our area.

Much will depend on whether rumors of big inventories in foreclosure homes being held by banks prove true or false. If true we should see these homes hit the market in the spring. You have to have a lot of inventory to trigger a crash in our real estate market. If we see a huge increase in inventory then you can expect to see prices fall... a lot. So far inventory is still on the low side in the Beach Cities....for now our market may be slow not it's certainly not dead.


Anonymous said...

i work for a firm based in socal that is a very large investor in the secondary mortgage market. i can assure you that the problem facing the housing and mortgage markets is not a liquidity issue.

there is plenty of liquidity in the financial system. citigroup, merrill, wamu, etc would not be able to raise capital on such favorable terms (the wm cv came at a 7.5% yield with a 22% premium and was 4x oversubcribed) if liquidity was tight.

however, while there is plenty of liquidity to recap diversified institutions, there is very little interest in purchasing/investing in mortgages right now. this is reflected in the very wide OAS spread between agencies and treasuries, not to mention the persistent spread between jumbos and agencies. then there's the complete collapse of the non-agency market.

the reason the capital markets have pulled back has nothing to do with delinquencies in subprime. markets are, by nature, forward looking. for most of 06 and 07 when subprime was deteriorating, there was plenty of capital available for borrowers.

what has changed is the growing consensus among originators, investors, the rating agencies, and regulators that US home prices are going to decline at least 10-15% and that CA will drop 25-30% in nominal terms through 2010. the people that *run* these institutions (i'm talking about the syrons, killingers, bernankes, stumpfs, lewis, dimon's, gross's, ackermann's etc) generally all subscribe to this view. they aren't going to change their mind (and hence manage the organization a little more loosely) just because CFC got taken out. if anything, they are licking their chops that an "irrational" institution on the brink of liquidiation that was underpricing in an attempt to save itself, is out of the game now. that will allow the survivors to raise prices at the margin.

now, it's entirely possible that the consensus will be proven wrong and the drop won't be that steep. but, that will only be known after the fact. in the meantime, credit is going to be extremely tight for the next few years while the secondary market waits to see how this plays out.

in the meantime, california home purchases will be highly dependent on a small number of local thrifts and banks, many of which are grappling with multiple calls on their capital right now (deteriorating residential/consumer portfolios, leveraged loan books, etc). so mortgage finance will only be available for borrowers who fit the traditional guidelines employed by lenders (20% down, 3x DTI, 1 year of cash reserves, fully documented income, high FICO) at rates that are much higher (relative to benchmark treasuries) than what people have become accustomed to the past 7 years.

finally, i thought i'd offer a few comments on countrywide. the idea that the BofA takeover will loosen up the jumbo market is wishful thinking. if you know BAC, er Nationsbank, at all, you know that they are an extremely risk averse institution that tend to quickly put their stamp on acquisitions (e.g., BofA, Robbie Stephens, Fleet, Barnett Banks, MBNA, etc). they are going to take out a lot of cost at CFC ($1B in pretax synergies = 10,000 jobs, or 20% of CFC's workforce) and will eliminate a lot of production that CFC used to generate. on the call friday, ken lewis said CFC would be pulling back from subprime, alt-A, correspondent and wholesale lending. uh ... that's basically the entire CA market.

look, i don't think MB collapses 50%. but prices at set the margin and if the *marginal* buyer in MB the past few years was reliant on the capital markets to help finance their purchase, then that demand is gone. and if there's any surge in the number of homes in the market, prices will have to adjust accordingly. while i don't profess to have the same crystal ball steve legare does, i have a feeling that anyone who purchased a home from 2002-2007 would have been better off if they had rented and invested their equity in a diversified portfolio of stocks & bonds. housing prices moved so far above the long-term trendline in every CA sub-market that if there's *any* mean reversion in prices, people will have made a bad financial decision. (it's not without precedent - if you bought a home in the 20's, it took +20 years for you to break even.)

i invest for a living, and it seems to me that psychology in the *housing* market is still too optimstic for this to be the bottom (the providers of capital are already much more realistic, which means the stocks probably recover long before home prices). when the consensus among buyers and sellers is that prices are going to be down 20% in the coming years, THAT's the time to wade in. as long as people still think housing is a great long-term investment (it's not, people just confuse rent savings, inflation and leverage with "making money") it's too early.

Kaye Thomas said...

Anonymous 9:32,
Thank you for taking the time to comment.. You bring a new dimension to the discussion. As I work with buyers who are well qualified but in competition for the monies available I labeled this as a liquidity problem when it appears if you are right that it continues to be a risk issue.

The consensus about price declines among the major purveyors of loans is of interest because of the numbers they are using across the board and their time frame. If you are correct then we are looking at another 2 years for the market to stabilize.

Speculation has been that if the big boys step in.. perhaps at the behest of the FED.. that markets may look more favorably at the mortgage sector if they see it as not quite so dicey. Your comment views the situation differently...which helps to answer a question I have always had.. how did such a small segment of the market.. subprime loans .. cause such major devastation in the market.

As neither you nor I have working crystal balls... we will have to continue to monitor the national and local market. I do agree with your take on Nationsbank.. they are an arrogant bunch and the decision by BofA to pull out of the wholesale loan market could be an indication of where they are headed. But once again speculation is that their inability to compete in the wholesale market is one of the reasons they wanted CFC.. to provide them with an existing market tool that knows what's what so to speak.

My initial feeling is that you are right about the decline in home prices across the nation and in parts of Ca.. While I don't think MB or the Beach Cities will be spared I don't believe we will be hit as hard as other areas. Wishful thinking.. perhaps.. but we have historically fared better then other parts of the LA area.

However, as I noted I could change my mind very quickly if the rumors of vast numbers of foreclosure homes being held off the market by major lenders proves true. Markets generally don't "crash" unless there is a lot of inventory that goes unsold forcing the market downward to get rid of oversupply. If that happens we will see some hefty price declines..even in the new construction home market.

As always.. nothing is sure in the California real estate market.. only time will tell how the market will fare..