Subprime Disaster Continues To Unfold

It seems that nary a week can pass without a subprime disaster of some type. This week is no exception although there was at least a bit of variety due to bad news coming from other parts of the housing industry.

Here is the rundown.

On Tuesday Moody's Investors Service announced it was downgrading its ratings on 399 bonds backed by subprime mortgages because of higher than expected delinquencies in the loans. These residential mortgage-backed securities (RMBS) were largely underwritten by loans issued in 2006 and over 60 percent of the underlying loans were sold by GE, Washington Mutual (now known as WaMu), Fremont General Corporation, and New Century Mortgage which filed for bankruptcy several months ago. Moody's said it may add another 32 bonds to the list.

At about the same time Standard & Poors (S&P) said it would probably follow suit before the end of the week, downgrading about $12 billion of subprime RMBS. Most of the S&P targets are also tied to the four lenders downgraded by Moody's although S&P is also looking at other players such as Merrill Lynch & Company.

Several analysts said that they expected the big rating services would soon start looking at those lenders that deal in so-called Alt-A mortgages which are tailored to borrowers who lack the documentation to obtain conventional or prime mortgages or may have slightly damaged credit. As we reported earlier, American Home Mortgage (AHM) one of the larger Alt-A lenders announced it was withdrawing earlier estimates of second quarter performance because of a contractual necessity to redeem many of the mortgages it had sold to investors because of elevated delinquencies. The price of stocks of Alt-A lenders such as AHM and IMPAC Mortgage Holdings fell on Wednesday and Thursday with AHM reaching the mid-$14 range from recent highs in the mid-$30s.

Rex Nutting, in a strongly worded commentary for MarketWatch accused S&P of having been among the enablers of the wildly active subprime market but said that "S&P isn't going along with the charade anymore."

Nutting predicted that a lot of subprime debt will be downgraded to junk status. "A lot of that debt will have to be sold at fire-sale prices. A lot of pension funds and hedge funds that once thrived on the high returns they could get from investing in subprime junk will now lose a lot of money." He predicted that the S&P notice that they were re-evaluating the bonds "is a death warrant for the subprime industry. No longer will mortgage brokers be able to help buyers lie their way into a home" and fewer homeowners will be able to refinance themselves out of trouble, thus extending and exacerbating housing problems.

Wow!

In related news, two major builders announced that they expected to post quarterly losses. Ryland Group and D.H. Horton both announced that heavy cancellations of home-building contracts and the necessity of opting out of agreements to buy land would cause their most recent quarterly figures to slip into the red zone. Ryland expects to book charges of $145 to $155 million and Horton said quarterly orders for new homes fell 40% from a year earlier

A smaller Ohio based builder, M/I Homes, also backed off of earlier earnings projections saying its orders for new homes and deliveries both fell in the second quarter; new contracts by 10 percent year-over-year and deliveries 24 percent to a total of 755 homes.

Another sector beginning to feel the pinch from the declining housing market is home improvement stores. Home Depot said that it is lowering its year-long profit forecast because the weakening housing market is dampening earnings more than anticipated.

HD executives said they expect adjusted earnings per share to drop 15 to 18 percent to a range of $2.30 to 2.36. Two months ago the corporation said it anticipated a drop in income of 15% but that things would pick up in the second half of the year.

The monthly forecast by the National Association of Realtors� issued on Wednesday was among the more pessimistic we have seen. It projected that new home sales will total 865,000 this year and 878,000 next year compared to 1.05 million in 2006. In more bad news for builders, the forecast projected housing starts at 1.43 million units this year and 1.44 million next. This is a substantial drop from the 1.80 million starts last year.

Lawrence Yun, NAR senior economist projected that existing home sales will pick up late this year and will total 6.11 million in 2007 and 6.37 million in 2008. If the projections hold this would bring the 2008 figures back close to the 6.48 million sales recorded in 2006.

Existing home prices are also expected to recover, rising 1.8 percent to a median price of $222,700 next year, offsetting the 1.4 percent decline expected this year. The median new-home price should rise 2.2 percent to $245,400 in 2008 following a 2.6 percent drop this year.

Finally, Thursday the NAACP filed a class action suit against 14 of the nation's largest subprime lenders to stop these lenders from engaging in systematic, institutionalized racism in making home mortgage loans. We will have more information on this suit in the next few days.