Mortgage Liquidity du Jour: Underestimated No More
Tightening the Housing Food Chain
If you're in the real estate invsestment game, this is a GREAT article to get an understanding of what the heck is going on in the mortgage industry. Thanks to Ivy Zelman and Credit Suisse for the permission to reprint.
In response to the recent turmoil in the mortgage market, we surveyed our private homebuilders and their mortgage lenders to asses the new home market's exposure to mortgage products that are at greatest risk for tightening and increased regulation in the coming months --- it's not just a subprime issue.
We believe that 40% of the market (share of subprime and Alt-A) is at risk of significant fallout from tightening credit and increased regulatory scrutiny. In particular, we believe the most pressing areas of concern should be stated income (49% of originations), high CLTV/piggyback (39%), and interest only/negative amortizing loans (23%). The proliferation of these exotic mortgage products has been disproportionately weighted to former hotbeds such as California, Nevada, Arizona and Florida, which have accounted for the lion share of builder profits.
Major lenders such as Countrywide, Option One and Wells Fargo have already announced plans to discontinue certain high CLTV and stated income loan programs, and over thirty subprime lenders have closed shop since late 2006. In addition, Freddie Mac recently indicated it will cease buying subprime ARMs that qualify buyers at the teaser rate. We take these recent events and conversations with our industry contacts to estimate a total impact to incremental originations of 21%, or an approximate decline of 236,000 new home sales from December's annual pace to 887,000 units. Combining the reduction in demand from credit tightening with the excessive level of investor speculation in recent years and the risks of a softening economy/declining consumer confidence yields our total estimated peak-to-trough drop in housing starts of 35-45%. This compares to our previous forecast of a 25% decline as discussed in our September 2006 report titled "Data Masks Grim Reality," and the current 16% decline thus far on a trailing twelve month basis.
We remind investors that the headwinds from deteriorating credit will impact supply and pricing conditions, as well as incremental demand. With delinquency and foreclosure rates continuing to rise, we believe this will result in more supply hitting the market throughout the year. In addition, we estimate that current inventory figures released by the NAR could ultimately be 20% higher when homes currently in the foreclosure pipeline hit the resale market.
Finally, we believe that tightening liquidity and more stringent appraisals puts current builder backlogs at considerable risk for fallout, which should lead to another surge in cancellations and additional spec inventory on the market. As such, we believe the impact of these headwinds will be felt throughout the entire market (regardless of builder price point), and will likely contribute to the next tranche down in pricing, which in turn could lead to impairment risk surpassing our initial estimate of 20% of book as detailed in our "Wonder-Land" report.
Research Team:
Ivy Zelman
Dennis McGill, CFA
Justin Speer
Alan Ratner
http://credit-suisse.com
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