Sunday, February 25, 2007

The Subprime Meltdown and You

Normally, I focus my postings around pricing and inventory analysis, but every once in a while, it’s a good practice to poke our heads up and see what’s going on in the world around us. Today were going to have a look at the apparent collapse sub-prime mortgages and discuss the implication on the housing market in OC.

I think that everyone who frequents real estate blogs has heard from at least one source or another that the subprime mortgage business is in dire straights as of late. In one sign of weakness, no fewer than 24 subprime lenders have gone bankrupt, closed doors or are no longer operating independently since December of last year. The news gets worse.

In the
Faber Report on CNBC, David Faber refers to subprime lending market as being in a state of meltdown and shows how the stock prices on subprime lenders have been plummeting over the last several weeks and days.

Now, I don’t have an accurate total at this point, but based on the earnings reports, realized losses have to have crossed well into the low billions by this point and certainly, they are in the hundreds of millions. I can’t see how lenders in the face of losses like these can go about business as usual. Certainly they will have to make changes in lending policy in order to stem the flow of red ink. An article in the Washington Post offers some insight into how this might play out.

“Higher interest rates and less access to cheap mortgages lie ahead, particularly for young people…with shaky credit who are seeking to buy their first homes…”, said Joseph P. Mason, a Drexel University finance professor..

In that same article, Joshua Rosner, managing director at Graham Fisher & Co., said the credit crunch could be worsened, ironically, by new rules from banking regulators requiring banks to tighten lending standards. The crackdown is likely to make it more difficult for hard-pressed borrowers to refinance, while further pinching home sales to first-time buyers, he said.

But do these professors and study authors know what they’re talking about? Will the default of some of the sub-prime lender really lead to a tightening of credit? The answer is yes and it’s already happening:

In a memo to its lending partners, First Franklin, a subprime lender advised: “Effective Monday (2/26/07), our minimum score for 100% Full Doc Owner Occupied Purchases and refinances will be 620 [up from 580-619 minimum]” They go on, “Also effective Monday, our minimum score on Stated 100% Purchases will be 660 [up from 640-659], and W2 stated borrowers that are 1st time buyers will be maxed @ 95%.”

Act Mortgage Capital is a bit more direct, and in a corporate e-mail it states “…Effective Februrary 28th, 2007, ACT Mortgage Capital will no longer offer any Subprime products.” None Period.

These are just a couple of examples of lenders tightening their lending standards. Clearly other banks, acting in the interest of the shareholders and themselves will follow suit leading either to the complete or nearly complete removal of “toxic” loan products from the market. The removal of “easy credit” mortgages from the market is going to leave many borrowers and future home buyers with few options.

To reiterate what our experts are saying and to elaborate a bit, I see the situation in the subprime market leading to a decrease in demand and an increase in supply here in OC. Here’s why:

1. Sadly, many borrowers bought their homes on subprime credit will not be able to refinance their homes under the new, stricter guidelines, leading to greater rates of default and foreclosure for some and the reluctant sales of their home for others, leading to an increase of housing inventory.

2. Many future owners who would have liked to buy a house are now going to be unable to get their first purchase financed, leading to a reduction in demand.

3. In order to cover the losses incurred by the subprime portions of their portfolios, banks may choose to raise their mortgage interest rates, leading to a decrease in affordability accompanied by a decrease in demand.

4. I think that some percentage of fence-sitting sellers will recognize what’s going on with credit availability and put their homes on the market to try and beat their neighbor’s to the punch.

Weak demand and strong supply are key ingredients in the classic ECON 101 recipe for increases in inventory and decreases in prices--good news for us bears. But remember it takes the RE market a lot longer to digest information than the stock market, we may not see any material effects of this “subprime meltdown” for a couple, maybe a few, months. In my opinion, If prices or sales have a little recovery, don’t panic it’s likely a dead cat bounce, there’s too much too wrong for prices to recover any time in the new future.

So my advice to you:

1. Stay the course, bide your time. It is NOT the right time to buy a house here in OC.

2. Do all you can to improve your credit score. When this market does recover, you’re going to need a good FICO in order to finance your purchase.

3. Save all you can toward a down payment. There are already indications in the market that lenders are going to require some/larger down payments than in the past.

For complete coverage over the subprime meltdown visit what I consider to be one of the best and most robust blogs on the topic,
The Mortgage Lender Implode-o-meter.

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