The Hutchens Blog

The rally among home-loan bonds without government backing is being fueled by errors made by “most market participants” in translating current prices to potential returns, Amherst Securities Group LP analysts said.

Investors are overestimating potential yields in part because they are failing to consider how many loans are becoming delinquent for the first time and partly because they are arriving at incorrect conclusions on how long it will take to liquidate seized homes, the New York-based analysts led by Laurie Goodman wrote in a report yesterday. Those issues can influence both the size of foreclosure losses and how quickly bonds get paid down.

“Do your homework, and sell securities which are being evaluated incorrectly by the marketplace,” the analysts wrote.

Non-agency home-loan bonds have soared from record lows or near-nadirs in March amid speculation that Treasury Secretary Timothy Geithner’s Public-Private Investment Program, or PPIP, will add as much as $40 billion of demand to the market, and that the longest U.S. recession and worst housing slump since the Great Depression are easing.

For example, the most-senior classes of 2006 and 2007 securities backed by prime-jumbo mortgages have rallied to more than 80 cents on the dollar, from as low as 55 cents, according to Amherst. So-called super-senior bonds backed by “option” adjustable-rate mortgages have jumped to about 48 cents, from the “low 30s,” the analysts wrote.

Insufficient Analysis

Investors also have been doing too little analysis of the differences, such as the level of home equity, among borrowers with currently non-delinquent mortgages backing non-agency bonds, which lack guarantees from government-supported Fannie Mae and Freddie Mac or U.S. agency Ginnie Mae, they said.

After correcting two of the three common mistakes by investors, the potential yield on a Countrywide Financial Corp.- issued option ARM bond now trading at 48 cents on the dollar would fall to 6.49 percent, from 12.67 percent, assuming the London interbank offered rate remains unchanged, Amherst said. Adjusting for all three reduces the yield on a Wells Fargo & Co. jumbo-mortgage note bought at 85 cents to 7.15 percent from 11.52 percent, the analysts wrote.

That is “much lower than most market participants believe they are receiving on the security,” they said. “Moreover, the yield must be evaluated in conjunction with the level of uncertainty about our assumptions” around whether borrowers will continue to refinance at the “fast” pace of recent months and how many borrowers with “negative equity” will default.

Third Point Profits

Scott Simon, mortgage-bond chief at Newport Beach, California-based Pacific Investment Management Co., the world’s largest fixed-income manager, told Bloomberg Television on Aug. 4 that “from a long-term point of view, a lot of this paper still will yield a lot after losses.”

A buyer last quarter of at least some kinds of home-loan bonds was Third Point LLC, the hedge fund run by Daniel Loeb, which entered the market amid lower prices after profiting from bets against subprime-mortgage bonds in 2007, according to a July 31 investor letter from the New York-based firm.

Third Point bought $160 million in mortgage bonds and made more than $20 million in profits from April through July, Loeb wrote. He estimated that under “severe economic distress” where all of the underlying loans default and home prices drop another 20 percent, the debt the fund held as of June 30 would return 10 percent based on the prices it paid. The debt would return 17 percent to 20 percent under “our base case economic assumptions,” he said.

Pleased Investor

Loeb may “eventually” increase his fund’s mortgage-bond investments to 10 percent to 15 percent of invested capital, up from a previous target of 5 percent to 10 percent, depending on other opportunities, he said.

“Although four months is certainly too brief of a period to ‘declare victory’ in the mortgage markets, I am pleased with our timing, security selection, and ability to obtain choice offerings from the Street,” Loeb said.

Goodman is the former head of fixed-income research at UBS Securities LLC whose team there was top-ranked for non-agency mortgage debt in a 2008 poll of investors by Institutional Investor magazine. Amherst is a securities firm specializing in trading and advising investors on home-loan debt.

The U.S. government announced July 8 that the PPIP would begin with nine managers raising as much as $10 billion, and receiving as much as $30 billion in taxpayer capital and loans to buy mortgage bonds originally rated AAA.

Option ARMs

Jumbo mortgages are larger than Fannie Mae or Freddie Mac can finance, currently $417,000 in most areas to as much as $729,500. Option ARMs allow borrowers to pay less than the interest they owe, tacking on the difference to their debt and creating the potential for bills to spike.

A Markit ABX index of credit-default swaps tied to a type of subprime-mortgage bond rated AAA when issued in the first half of 2007 climbed to 29 yesterday, up 18 percent from a June low, according to Markit Group Ltd.’s Web site. The swaps offer protection if the securities aren’t repaid as expected, in return for regular insurance-like premiums. Subprime mortgages went to borrowers with poor or limited credit or high debt.

Posted by Sandy Hutchens

A jump in oil prices helped widen the U.S. trade deficit in June, but a sharp fall in manufactured goods exports and imports appears to have stabilized, a Commerce Department report showed on Wednesday.

The monthly trade gap totaled $27.0 billion, up 4.0 percent from May. The shortfall was smaller than many analysts expected because stronger foreign demand for U.S. goods and services offset some of the impact of higher oil prices.

Both U.S. exports and imports remained sharply below records reached in July 2008, just before the global financial crisis began wreaking a savage toll on international trade.

But “the sharp decline in U.S. exports and imports of manufactured goods appears to be stabilizing,” said Frank Vargo, vice president for international economic affairs at the National Association of Manufacturers.

For the fourth month in a row, U.S. manufactured goods exports totaled roughly $67 billion and manufactured goods imports were roughly $93 billion, Vargo said.

The trade gap for the first six months of 2009 totaled nearly $173 billion, down more than 50 percent from the same period last year. Year-to-date exports were down 19.3 percent from 2008, while imports were off 28.8 percent.

The smaller-than-expected June deficit was, by itself, good news for the U.S. economy, which is beginning to show signs of emerging from a recession that began in December 2007.

“However, other data already released on construction and inventories point to a downward revision” of second quarter GDP growth to -1.6 percent from -1.0 percent,” said Nigel Gault, chief U.S. economist at IHS Global Insight.

Looking ahead, the monthly gap between imports and exports should widen in the second half of the year as producers and retailers restock currently lean inventories.

So, unlike the first half of 2009, “trade will become a drag on growth. But that would be a drag in a context where both exports and imports are growing, as the U.S. and global economies climb out of recession,” Gault said.

OIL PRICE UP

U.S. imports of goods and services rose 2.3 percent in June to $152.8 billion, the highest since January. Higher oil prices accounted for much of the increase, and imports of consumer products fell to the lowest since November 2005.

The average price for imported oil rose for the fourth straight month to $59.17 per barrel, helping to widen the U.S. trade gap with the Organization of Petroleum Exporting Countries to the highest since October 2008.

U.S. exports rose 2.0 percent in June to $125.8 billion, led by stronger foreign demand for industrial supplies and materials and capital goods.

Exports of foods, feeds and beverages were the highest since October 2008.

U.S. home loans failed at a record pace in July despite ongoing federal and state programs to avoid foreclosures, which have severely strained housing and the economy.

Foreclosure activity jumped 7 percent in July from June and 32 percent from a year earlier as one in every 355 households with a loan got a foreclosure filing, RealtyTrac said on Thursday.

Filings — including notices of default, auction and bank repossession — have escalated with unemployment.

“July marks the third time in the last five months where we’ve seen a new record set for foreclosure activity,” James J. Saccacio, RealtyTrac’s chief executive, said in a statement.

“Despite continued efforts by the federal government and state governments to patch together a safety net for distressed homeowners, we’re seeing significant growth in both the initial notices of default and in the bank repossessions.”

More than 360,000 households with loans drew a foreclosure filing in July, a record dating back to January 2005, when RealtyTrac started tracking monthly activity.

Notices of default, auction or repossession have reached nearly 2.3 million in the first seven months of the year — with more than half a million bank repossessions, the Irvine, California-based company said.

Making timely payments keeps getting harder for borrowers who have lost their jobs or seen their wages cut.

The unemployment rate is 9.4 percent and President Barack Obama has said he expects it will hit 10 percent.

Obama’s housing rescue is gaining traction in altering terms of loans for struggling borrowers, but slowly.

Earlier this month the U.S. Treasury Department detailed the progress of the top servicers in modifying loans and prodded them to step up efforts to stem foreclosures.

SUN BELT STILL SUFFERING

States where sales and prices surged most in the five-year housing boom early this decade remain hardest hit.

California, Florida, Arizona, Nevada accounted for almost 57 percent of total U.S. foreclosure activity in July.

Illinois had the fifth-highest total filings, spiking nearly 35 percent from June, in an example of how moratoriums often delay rather than cure an inevitable loan failure.

Default notices spiked by 86 percent in July, from artificially low levels the prior two months. A state law enacted on April 5 gave delinquent borrowers up to 90 extra days before foreclosure started, RealtyTrac said.

Michigan’s foreclosure activity fell 39 percent in July from June, mostly due to a 66 percent drop in scheduled auctions. A state law that took effect July 6 freezes foreclosure proceedings an extra 90 days for homeowners who commit to work on a loan modification plan.

Other states with the highest foreclosure filing totals last month included Texas, Georgia, Ohio and New Jersey.

Nevada had the highest state foreclosure rate for the 31st straight month, with one in every 56 properties getting a filing, or more than six times the national average.

Initial notices of default fell 18 percent in the month, with a new Nevada law taking effect on July 1 requiring lenders to offer mediation to homeowners facing foreclosure. Scheduled auctions and bank repossessions each jumped more than 20 percent, however, boosting overall foreclosure activity in the state by 4 percent from June.

California, Arizona, Florida, Utah, Idaho, Georgia, Illinois, Colorado and Oregon were the other states with the highest foreclosure rates.

The cost of fixed-rate mortgages rose to its highest level for ten months as more borrowers took out loans to buy new homes, according to figures published yesterday.

The Bank of England said that the average five-year, fixed-rate mortgage had risen from 5.54 per cent to 5.7 per cent between June and July, the highest level since October 2008, when the base rate was 4.5 per cent, compared with 0.5 per cent now.

Meanwhile, the number of homeowners taking out a mortgage to buy a home rose by 23 per cent to 45,000 in June, the highest for a year, according to the Council of Mortgage Lenders, after a rise in demand from new homebuyers.

Economists said that mortgage rates would continue to rise for the rest of the year, stifling the market at a time when demand for fixed-rate mortgages was increasing. Rate rises are a result of lenders passing on the higher cost of funding but also reflect bigger margins and a reluctance by banks to take on new business.

Paragon Mortgages, a lender, said that a record seven in ten buyers had applied for fixed rates in the three months to June as borrowers looked to capitalise on an historically low base rate. However, those opting for trackers, which follow the base rate, fared better: the average rate of these deals stayed the same at 3.81 per cent.

Separate government figures yesterday from the Department for Communities and Local Government showed that high demand relative to low supply had contributed to a 1.6 per cent rise in house prices in June to £191,423, bringing the annual fall from June to June to 10.7 per cent in England. The average price paid by first-time buyers rose by 2 per cent between May and June to £140,222.

Knight Frank, an estate agency focusing on the top end of the market, said that there were so few properties coming on to the market that some of its offices might run out of homes for sale by the end of the month. It said that the worst stock shortages were in parts of the country where there were few forced sellers of prime properties, such as Hereford. Some vendors were waiting until September before putting their properties on to the market.

Sandy Hutchens likes fixed-rate mortgages and would like to see them locked in at a reasonable rates.

Banks are pocketing extra cash rather than passing on lower interest rates to mortgage customers, a Daily Mail investigation revealed this week.

Homeowners are paying an average of £1,788 per year more than they should be as banks use the historically low base rate of 0.5% to shore up their ailing coffers.

Twelve months ago mortgage rates were just 0.5% above the Bank of England’s base rate. The margin has now increased to 2.61%.

Alistair Darling expressed “concern” at banks charging “more than is absolutely necessary”.

The Chancellor threatened to refer banks to the Competition Commission if they fail to pass on rate cuts soon.

In related news, mortgage lending in June reached its highest level since December, with £12.3 billion in mortgages granted.

Banks need to pass the profits through to the mortgagees, this kind of greed in the market can only make things worse.

Lets hope things will get better,

Sandy Hutchens

What is Interest?
Interest is the price that someone pays for the temporary use of someone else’s funds. To repay a loan, a borrower has to pay interest, as well as the principal, the amount originally borrowed.

Interest is the compensation that someone receives for temporarily giving up the ability to spend money. Without interest, lenders wouldn’t be willing to lend, or to temporarily give up the ability to spend, and savers would be less willing to defer spending.

Interest rates are expressed as percents per year. If the interest rate is 10 percent per year, and you borrow $100 for one year, you have to repay the $100 plus $10 in interest.

Because interest rates are expressed simply as percents per year, we can compare interest rates on different kinds of loans, and even interest rates in different countries that use different currencies (yen, dollar, etc.).

What are “APR” and “APY”?
“APR” stands for “Annual Percentage Rate,” and “APY” for “Annual Percentage Yield.”

The APR includes, as a percent of the principal, not only the interest that has to be paid on a loan, but also some other costs, particularly “points” on a mortgage loan.

Points (a point equals one percent of the mortgage loan amount) are fees that the mortgage lender charges for making the loan. In a sense, points are prepaid interest, or interest that is due when the loan is taken out.

Some lenders charge lower interest rates but more points than other lenders. The APR therefore provides a useful gauge for comparing the total cost of mortgage loans.

For example, a 30-year mortgage with an interest rate of 8.0% and four points would have an APR of 8.44%, while a mortgage with an interest rate of 8.25% and one point would have an APR of 8.36%.

The principal used in calculating the APR is equal to the amount of the loan the borrower actually has to use at any time. Consider two one-year loans of $1,000, each with an interest rate of 10%, or $100 in interest.

The second loan has a higher APR, even though the amount of interest paid ($100) is the same on both loans. The second loan has a higher APR because the second borrower, unlike the first borrower, does not have the use of the entire $1,000 for the entire year, because the second borrower repaid $500 of the loan after six months. (Another reason the second loan has a higher APR is that the borrower paid half of the interest after six months and half at the end of the year, rather than all the interest at the end of the year.)

“APY” is the effective interest rate from the standpoint of a person receiving interest. If you have $1,000 in each of two bank accounts, each paying the same interest rate, but the interest is credited more often (let’s say, every month, rather than once a year) on one of the accounts, that account will have a higher APY, because the interest will build up more rapidly than on the other account.

Why Does Interest Exist?
From the lender’s point of view:

* Interest compensates lenders for the effects of inflation, or rising prices. Prices go up every year, so lenders are repaid with dollars that can’t buy as much as the dollars they lent; the lenders must be compensated for that loss of purchasing power
* Interest also compensates lenders for the risks they take. One risk is that nobody knows for certain how much prices will go up during the time that the borrower has the lender’s money. Other risks are that the borrower won’t repay the loan fully, on time, or at all
* For a lender such as a bank, interest covers the costs of staying in business, including the cost of processing loans, and interest also provides the profit that a lender needs to stay in business

From the borrower’s point of view:

* Individuals are willing to pay interest to borrow money in order to be able to spend now, rather than later, on cars and many other items
* Individuals are willing to pay interest in order to be able to afford a large purchase, such as a home, for which they don’t have enough funds of their own
* Individuals are willing to pay interest on loans to pay for education, which can increase their earning ability
* Businesses are willing to pay interest in order to borrow to invest in equipment, buildings, and inventories that will increase their profits
* Some borrowers are willing to pay interest on certain loans because of the associated tax advantages. Mortgage interest, for example, is tax deductible. That means that in calculating how much income tax you have to pay, you can subtract the mortgage interest that you pay from your income
* Banks are willing to pay interest on their customers’ deposits because they can lend the funds at higher interest rates and make a profit
Interest: Cost to Some, Income to Others?
Interest is income to people willing to give up the temporary use of their money. When you put money into a bank account, or when you buy a U.S. Savings Bond, for example, you receive interest income.

Interest is a cost to borrowers. You pay interest, for example, if you don’t pay your entire credit card bill at the end of the month, if you take out a mortgage loan to buy a house, or if you own a business that borrows in order to invest in machinery.

Interest is a signal that directs funds to where they can earn the highest rates, or to where loans can do the most for the economy.

Interest is a measure of the cost of holding money. The rate of interest that you could earn by lending your money is the cost to you of holding your money in a way (such as in cash) that doesn’t earn any interest. Economists use the term “opportunity cost” to refer to what you give up by choosing a certain course of action. By holding money, you give up the interest that you could have earned, so the interest rate measures the opportunity cost of holding money.

Posted by Sandy Hutchens

Buying a mansion can be an exciting time in a person’s life, as it typically signifies wealth, success and the feeling of having finally “arrived.” Along with that celebratory attitude, however, also comes a great deal of stress in the form of mortgage payments, homeowners associations and sizable down payments. So think long and hard about if a mansion is the right real estate move for you and, if so, what type property you’re on the market for.

1. Visit a financial planner or adviser to determine your price range, including how much you’re able to put down, how much a 30-year mortgage would amount to and how much you can expect to pay in property taxes.
2. Find a real estate broker who specializes in luxury properties and upscale communities. These brokers can be easy to find because they are usually the top brokers or star players within their given company. Another way to find an experienced broker is to talk to residents of the community you are interested in.
3. Determine why you want to buy a mansion. Do you need a lot of space? Do you yearn for privacy? Do you have a lot of people under one roof? These questions will help you determine what neighborhoods to browse, what type of property to buy and if, in fact, a mansion will really meet your needs.
4. Set up appointments with your broker to visit some suitable mansions. Ask many questions based on your housing criteria (which will hopefully be established once the above-mentioned questions are fleshed out).
5. Ask the listing agent or homeowner about any custom or upscale amenities the property may contain. This will both help you realize the property’s value (or lack thereof) and determine if the home is likely to have many costly repairs. You should research the types of weather, acts of God and insurance that are common in those parts, which will also help you determine what incidental expenses you may incur.
6. Bring your family to view any properties that have met all of your criteria. Take them on an outing after viewing homes in different areas to get a sense of the community, what the neighbors are like, what they do for fun and how they behave to determine if that neighborhood would fit with your family’s lifestyle.
7. Hire a professional appraiser and handyman to do a walk-through of the house before determining whether it is a good investment. Remember, the property may appear to be everything you want at first glance, but a professional will be able to assess whether major, costly repairs will be necessary in the near future.
8. Place a bid on the mansion you decide on and play the waiting game with your broker. From here, it is up to you whether you want to enter in any counter offers should you be outbid.

After an early close on Friday, rates ended slightly higher than where they began the week. The week ahead will be abbreviated as the market remains closed on Monday in observance of President’s Day.  But even though it will be a short week, the economic calendar is still fairly active.  So what’s in store for rates?

Last week, rates edged lower before reversing course and heading higher as the Obama stimulus plan worked its way through congress.  It will be interesting to see if the President’s stimulus package actually stimulates anything as proponents of the plan claim the plan is nothing more than the largest pork spending bill ever.

One thing is for sure, the stimulus package in its current form is the largest sum of money ever spent in the history of the world in an attempt to stimulate the economy – So will it actually work?  Only time will tell, but if history is correct like it so often is, it will likely not accomplish its goal.  Considering to date, a government has never been able to spend its way out of a recession.  The last time it was attempted was a few years ago when Japan passed a massive spending bill to correct their recessionary heading.  But like all other past spending bills including Roosevelt’s “New Deal,”  the only thing Japan gained was moving their economy deeper into a recession and a massive debt for their children and grandchildren to payback.

The abbreviated week ahead boasts several high impact reports that can influence rates, but it will likely be political news that will continue to leave the market volatile as investors try and figure out where the market is heading.

As the jobless rate continues to rise in response to the recession, servicers are reminded that income and mortgage default levels are inexorably linked. According to NeighborWorks America, nearly 50 percent of mortgage default is income-related. Thirty percent of borrowers cited a reduction in income, and 19 percent a loss of income, as primary reasons for falling behind on their mortgage. Without transparency into a borrower’s current employment and income status, lenders and servicers are unable to proactively reach out to troubled borrowers and offer loan workout options. Insight into current borrower employment and income information enables servicers to make early contact with distressed borrowers, which is essential in successfully executing loan modifications.

Through the recently created “Making Home Affordable Act,” the federal government is planning to help up to 9 million homeowners currently at risk of default. In April 2009, HOPE NOW members and the industry at large modified 127,000 mortgages and completed 143,000 re-payment plans totaling 270,000 interventions, “the largest number in any month” since the alliance started to compile data.

In response to such programs, servicers need better insight into borrower financials in order to manage the level of predicted loan defaults for the remainder of this year. Rather than taking on the significant burden of additional staff, servicers should consider looking to efficient and automated data providers that can verify income and employment instantly and more cost-effectively. And, rather than taking on additional risk with loan modifications, servicers should better position themselves to manage risk through data and information by using providers that offer a deeper insight into the borrower’s employment and income situation, from data sources such as employer payroll or IRS tax transcripts (Form 4506-T).

Historically, the Government Sponsored Enterprises required lenders to obtain a credit score and verbal Verification Of Employment (VOE) to complete a borrower’s loan application. Many lenders were forced to dedicate call center staff to manually contact employers or work directly with the IRS to attempt to verify employment status for the borrower – an inefficient, expensive, and inconsistent process. Compounded upon this, some lenders and servicers managed loan data across multiple business units and service centers, with differing information being provided.

Unfortunately, when unable to reach the employer to verify income and employment, many loan officers chose to rely on the credit score as the sole indicator of a borrower’s financial health and risk. Today, lenders are no longer willing to base lending decisions on the credit score alone – they want an in-depth review of all information on a consumer’s credit file. In addition to credit information, lenders require transparency into other credit bureau information including real-time employment and income verification to predict future loan performance and delinquency.

Help Is On the Way!

Engaging a third-party for proof of documentation provides servicers with a strategic option to effectively streamline their existing workflow when it comes to employment and income verification, while simultaneously improving the quality of data on which lending decisions are made. Specific information servicers can access through a single, secure, third-party provider include: the borrower’s current place of employment, employment status (active or not), the longevity of employment, job title and salary (including pay rate, YTD income, past two years income). Armed with insight, servicers can determine the best course of action for each individual borrower and thereby improve the performance of their portfolio.

Additionally, a compliant and complete third-party provider can provide great comfort to investors, who wants know a lender is tapping the most accurate source of borrower employment and income for greater transparency into borrower financial health. And, through greater data transparency, investors and lenders can improve analytics on a significant percentage of their portfolios to more effectively identify undervalued securities and improve the accuracy of loan-level delinquency, default, and prepayment predictions. Loan-level updated borrower information used in combination with powerful analytics gives investors the information needed to differentiate the “good deals” from the “bad deals” and better correlate risk with default rates.

Servicers tend to focus on debt-to-income ratios in performing loan modifications, but loan modifications have changed the debt-to-income requirements. How can servicers calculate debt-to-income ratio without an accurate view of the income portion? Servicers that rely on the stated income from a borrower’s loan application to calculate debt-to-income, in an economy where salary reductions and unemployment numbers are continuing to rise are simply exposing themselves to greater risk.

There are several viable solutions available today. Outsourcing employment and income verification to a trusted third-party allows servicers to focus on their core competencies of evaluating and modifying loans. Streamlining this step enables servicers to process more loan modifications in a timelier manner, which puts us on the path to a housing recovery.