Home Builders Buy–and Bide–Time via Debt Moves
Tell us, have we tired of the phrase “the new normal” yet?
Also, do those who favor Adam Smith policy eat more of one kind of breakfast cereal at some point in their formative years, whereas the ones who adopt John Maynard Keynes’ principles to manage through economic hard times eat, say, Lucky Charms?
The question of the moment for businesses that make a living — or try to — in new residential construction is what to do in a mixed-signals economy other than dodge the carcasses of America’s regional banks and try to convince another buyer that a new home for 25% more is still better than a used home coming out of foreclosure.
To look at how public home builders are behaving–especially in managing their near-term debt maturities–a long runway to recovery is what they’ve got in mind. They’ll comp better year-on-year when we arrive in 2010, but regaining profitability may be more likely to occur on a run-rate basis during the back half of the year rather than on a 2010 fiscal year measuring stick.
Everybody with debt due in 2010, ‘11, and ‘12, has been working hard to get terms extended, with varying success. In this environment, what collateralizes that debt as it gets extended is slippery. Everybody’s got to have more cash capital backing loans, so borrowers are performing financial acrobatics to collateralize debt that’s pushed down the road to where it’s less menacing.
Home builders are averse to have cash sitting in a bank account as collateral for their debt, so they’ll alternatively look to supply lenders with a letter of credit that would allow the lender to come after the whole amount if there’s a default.
This is all to say that 2010 looks as if it’s another year of living dangerously for home builders. With jobs ranks still shrinking and household formations in a slow-down mode, expectations around cash from home sales have more to do with keeping the lights on and the wheels turning than generating a whole lot of equity growth.
Which is fine if you’re a public company, … one that can get the runway … toward the new normal. Ok that’s the last use of that term except to take pot shots at others who’ll go on to use it to death.
JP Morgan Research Marks a Housing Market Turn
This morning, Michael Rehaut, home building and materials analyst at JP Morgan, writes:
While fundamentals will likely not demonstrate an uninterrupted solid rate of improvement over the next 6-12 months, we believe that not only is housing solidly past its trough, but over the next 24 months will continue to recover and drive further upside to the current rally in the homebuilder stocks. Importantly, we believe a key distinction between today and the last three and a half years, during which time we have largely maintained our negative stance, is that during the downturn not only did supply rise, but demand also consistently fell as different buyers exited the market. Today, despite being elevated, supply appears more manageable, while demand has begun to stabilize and even slowly reemerge. In such an environment, we believe the builders will once again demonstrate positive order growth – historically a powerful positive catalyst – and home price declines will near their end, resulting in the abatement of impairment charges.
The moving target on supply is the foreclosure wave and how and when it gets absorbed during the 24-month period Rehaut eyes for stabilizing of home building’s landscape. As for demand, despite an uptick in the past quarter, some $12.2 trillion in lost household wealth will probably weigh heavily for some time on home buyer motivations. That figure knocks psychology as well as financial means for a loop in predicting buyer behavior.
“The desire is still there for the American Dream of homeownership,” says Senator Johnny Isakson (R-Ga.), who’s backing a hotly contested measure to extend and expand an $8,000 tax credit due to expire Dec. 1. Isakson is convinced that the domino-effect of a sudden, forceful, brief shove in demand for all price points in housing with taxpayer money would pay off in jobs, stabilized household equity, consumer spending, corporate earnings, and resumed economic expansion. “It wasn’t the focus on homeownership that was the problem, it was lending money to people who could not afford homeownership.”
Builderonline.com’s Boyce Thompson has doubts an extension to the credit is in the cards thanks to the incipient broader economic recovery.
But the sustainability of the current recovery is what’s in question. Minus a home buyer tax credit, particularly in the seasonal low-ebb of housing from December through February, we’d be looking at another brutal stretch for an industry that could put people back on payrolls.
Is Rehaut right to look at year on year comps ahead and conclude we’ve reached the bright line moment? He’s not going too far out on a limb with a prediction for improvement over the next 24 months.
Still, we think too many signals are in conflict to say we’ve turned the corner just yet. That might be because our viewpoint is the many home building enterprises still living on the vapor of their cash reserves and a few sales here and there.
A Look in the Rearview: Bottom Uncertain, Fannie in Limbo
The housing oriented government sponsored entities–Freddie Mac and Fannie Mae–have been in the eye of the residential real estate, financial, and economic maelstroms.
Within the far-reaching financial system regulation make-over President Barack Obama outlined today were designs for the near-term future and oversight of the GSEs that do not include their imminent re-privatization.
Here’s a report from Inman News.
Fannie Mae and Freddie Mac are likely to remain in government conservatorship until at least next year, the Obama administration indicated today in unveiling a sweeping plan to overhaul the financial regulatory system.
The mortgage giants’ “continued stability and strength” is needed during “these difficult financial times,” the administration said in a report outlining proposed changes to the regulatory system.
The proposed changes, which will require congressional approval, would include a new financial services oversight council to identify emerging systemic risks and a new national bank supervisor to oversee all federally chartered banks.
In addition, the plan would eliminate the federal thrift charter and other loopholes that the administration says allowed some depository institutions to avoid bank holding-company regulation by the Federal Reserve.
General Growth Collateral Damage
General Growth Properties succumbed this morning, with a Chapter 11 filing in U.S. Bankruptcy Court in New York, taking with it The Rouse Company and residential real estate entities including The Howard Hughes Corporation.
The Wall Street Journal reports extensively on what it terms “one of the largest real-estate failures in U.S. history, capping a precarious, months-long effort to juggle the crushing $27 billion debt load it shouldered in past acquisition sprees.”
The Las Vegas Sun runs this story this morning.
Earlier Wednesday, debt rating agency Standard & Poors said it had learned that a loan backed by the Grand Canal Shoppes at the Venetian resort was transferred to special servicing after General Growth, the mall owner, couldn’t come to terms with servicer LNR Partners Inc. on an extension. This means General Growth is in danger of defaulting on the loan.
The balance on the loan, which matures May 1, is $393.7 million, S&P said.
The New York Times notes the list of the key creditors:
Among the companies listed as General Growth’s 100 largest unsecured creditors are Eurohypo, a unit of Germany’s Commerzbank that holds $2.6 billion worth of loans; Wilmington Trust and the Bank of New York Mellon, representing several classes of bonds; casinos including Mandalay Bay and the Venetian; and an assortment of retailers such as Sephora, Guess?, Borders and Macys.
In its bankruptcy filing, General Growth said that it sought permission to retain a bevy of advisers, including the investment bank Miller Buckfire, the turnaround consulting firm AlixPartners and the law firms Weil, Gotshal & Manges and Kirkland & Ellis. The document was signed by Marcia L. Goldstein, the chair of Weil’s well-known bankruptcy practice.
An industry observer draws our attention to dismaying specifics with respect to the residential development implications in GGP’s filing. Here’s our note this morning from “Jennifer.”
Click on image for access to Summerlin, Nev., info
Key to the discussion of which entities are in bankruptcy is the definition of “GGP Group”. Page 62 of the document says “GGP, along with its approximately 750 wholy owned Debtor and Non-Debtor subsidiaries and affiliates, collectively “GGP Group”. On that same page there is a footnote to the document which says that its Exhibit “A” lists all of the entities for which Chapter 11 bankruptcy was filed on April 16th.
At the bottom of page 64 of that document, I was startled to see the following comment blithely made by the Debtor: “In addition to its core shopping center business, the GGP Group also owns and develops large-scale, long term master planned communities. GGP Group has five master planned communities in and around Columbia, Maryland; Summerlin, Nevada; and Houston, Texas. These communities contain approximately 18,500 saleable acres of land.”
I then went to Exhibit “A”, listing the 200+ new Chapter 11 debtors and scrolled down. I saw Chapter 11 Debtor names which included entities with Town Center Drive in them, and five entities with “Howard Hughes” in them, including The Howard Hughes Corporation and Howard Hughes Properties, Inc., as well as reference to a Canal Shops entity.
The standard “First Day” motions for the bankruptcy cases have been filed, including the all important motion to obtain authorization to keey paying the Debtors’ employees, and to pay them any unpaid prepetition wages. There is no indication yet as to when the first day motions will be heard.
In the Debtor’s Motion for Joint Administration of Cases (Court Document #2) which I read, it says that the GGP Group has a large unsecured line of credit, but it doesn’t say anything about how much money is available to be drawn. That document also says that most of GGP Group’s financing is through mortgages on specific properties.
That does not bode particularly well for the Summerlin operation, because it means that any land sales which are occurring have their cash proceeds tied up, as “lender’s cash collateral”, which an angry mortgage lender is not necessarily likely to let them use.
I am afraid that this is not a good day in the history of Columbia, Maryland, Summerlin, Nevada and ??? in Houston, Texas.
The “Next Wave” of pain in real estate–based on trillions of dollars of commercial mortgage backed securities debt due over the next several years and not enough capital access to offset it–has now begun.
Residential gets another blow as a result.
Reality Bites as Ratings Agencies Downgrade REIT Debt
From MULTIFAMILY EXECUTIVE, by Les Shaver: Single-family sneezes and the world economy, including apartment real estate investment trusts that are assumed to run contracyclical to single-family for-sale trends, get pneumonia. The reason this venue is called Housing Crisis is that the convulsion hits equally both the supply and the demand side of housing, whether you’re talking for-sale or for rent. And it’s hitting not only the balance sheet but also the daily and weekly access to normal working capital, assuming steady cash flow.
There’s an analysis on how tumbling fundamentals and squeezed access to credit have put a pall on REITs’ business and risk outlooks for the next stretch from Multifamily Executive senior editor Les Shaver.
S&P said the ratings were prompted by constrained access to debt and equity capital and concern that the struggling economy will put even greater pressure on cash flow. The agency said “heavy credit revolver usage (in excess of 50 percent), weak debt service coverage, and an over-reliance on earnings from fee-driven and/or asset sales activity are key areas of focus.” It also views the common dividend coverage as a “drawback,” given the need for REITs to preserve liquidity.
“Fundamentals in the multifamily sector are coming under pressure,” says George Skoufis, a director for Standard & Poor’s. “Their debt protection measures are kind of weak. In the previous cycle, they came in with a little bit more of a cushion. Their numbers are a little weaker, and their leverage is a little higher.”
Multifamily and commercial construction lagged the residential for-sale downturn, and many have another leg or two down as employment deteriorates and corporate earnings erode by virture of more conservative money habits among consumers and challenged consumer sentiment. Too, anecdotally anyway, demand for one- and three-bedroom apartments has decline while demand has stayed strong for two-bedroom apartments–an indicator of increased “doubling-up” among people who might choose to live with roommates to weather the downturn.
Dimon in the Rough
Straight talk from one worth listening to.
Very telling speech on the failures and the “pro-cyclical” nature of many banking mechanisms. Given on March 11, 2009. Jamie Dimon, CEO of JP Morgan.
This is more about how and why we’re looking at a tax bill of trillions to deal with over the next stretch of years.
Hat tip: Wine Rex
The Redemption: Geithner Plan a Wall Street Hit
Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
This above all: to thine own self be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.
– William Shakespeare, English dramatist & poet (1564 – 1616)
–”Hamlet”, Act 1 scene 3
Click image for access to Geithner's Wall Street Journal Op-Ed piece today.
The pipeline of trillion-dollar federal policy programs today offers the latest one that has made U.S. Treasury Secretary Timothy Geithner the sudden darling of Wall Street. Odd that several weeks ago–two weeks into his new job description–many of those same Wall Street denizens declared Geithner worse than useless, and as recently as last week, there were over-unders on when he would be headed out Treasury’s revolving door in ignominy.
Back those few weeks, the appetite for a groundwork of principles that would support a plan was not there, but now that the plan has been filled-out and articulated, critics are shutting up long enough for Geithner to appear to know what he’s talking about when he refers to the global financial complex and the trouble that it’s in.
Now that Wall Street investors appear to have bought-in to the details, the credibility capital Geithner seems to have lost when he opened his mouth in amid the crawl of stock tickers in mid-February now is back within his grasp.
The question remains though. What does the program fix? Borrower? Lender? Anyone?
Economics Nobelist, Princeton professor and New York Times columnist, Paul Krugman spells out the administration’s and Geithner’s theory underlying the current plan to wrest toxic assets from the banking system, a theory he disagrees with.
But banks can also fail even if they haven’t been bad investors: if, for some reason, many of those they’ve borrowed from (e.g., but not only, depositors) demand their money back at once, the bank can be forced to sell assets at fire sale prices, so that assets that would have been worth more than liabilities in normal conditions end up not being enough to cover the bank’s debts. And this opens up the possibility of a self-fulfilling panic: people may demand their money back, not because they think the bank has made bad investments, but simply because they think other people will demand their money back.
Bank runs can be contagious; partly that’s for psychological reasons, partly because banks tend to invest in similar assets, so one bank’s fire sale depresses another bank’s net worth.
So now we have a bank crisis. Is it the result of fundamentally bad investment, or is it because of a self-fulfilling panic?
Clearly, the assumptions underneath the administration’s plan embrace the latter of the two causes. So the program and the process, and the articulation, and the defiance that accompanies the roll-out of the Public-Private Investment Program rely extensively on a conviction that restoring calm and confidence–even a measure of greed–will get a flow of funds going.
But the base of the problem remains. Bad loans occurred. Lenders and investors took bad risks around those loans. People bought homes they should not have bought–20%-plus of them were investor purchases for flipping purposes during the final two or three years of the run-up–and now the reset on the value or lack thereof of those loans and the investments on top of the loans, will be deferred as a complex delay-the-pain mechanism kicks into action, aggregating what was bad into a toxic pool for a later day, and setting refurbished bank balance sheets back into business like an afternoon at the dog-groomers.
The wager here is twofold. One is that investors, lured by the virtual elimination of risk, will find that this is the place for all that pent-up liquidity that had been awaiting “the floor” for asset pricing before it moved in for the strike. Two is that borrowers will exhibit a more steadfast commitment to the obligations of their loans.
In our need for instant gratification and immediate solutions, we may have a blast of “good news,” that can bouy spirits and keep stocks on an upward trajectory for the month.
But we can see in our closer look beneath the headlines on existing home sales, starts, permits, etc., that there’s a lot of work to do, and much of that work is going to be a good, old-fashioned work-out between buyer and seller based on what a property is worth today, and tomorrow, and the day after, to someone who wants to live in that property.
Borrowing and lending are part of real estate in North America. So Shakespeare’s admonition could never be taken literally. But a great dramatist and poet of today would probably figure out a way to add to the phrase somehow. “Neither a borrower nor a lender be (unless there’s sufficient skin-in-the-game for the borrower and unleveraged capital on the part of the lender).”
Low Ebb Haiku–Bank Failures Mount, FDIC Reachers Deeper
Where economics and housing analytics rise to an artform, on Calculated Risk, he offered this fillip on Friday after learning of the failure of bank #17, Freedom Bank of Georgia, Commerce, Georgia.
Ah, seventeen! The CR Commentariat gets a hold of that number, and naturally, the conversation elevates to this contribution from a reader called “Soylent Green Is People.”
Friday: Freedom failed.
Cost Today: Thirty Six Mil.
Upward Soars Our Tab.
Meanwhile, the Wall Street Journal reports:
Click on image for access to WSJ article.
Legislation, introduced late Thursday by Senate Banking Committee Chairman Christopher Dodd, would temporarily allow the FDIC to borrow $500 billion to replenish the fund it uses to guarantee bank deposits, if the Federal Reserve and Treasury Department concur. Those funds would be distinct from the contentious $700 billion financial-sector bailout, which lawmakers are loathe to expand….The bill was championed by FDIC Chairman Sheila Bair, Fed Chairman Ben Bernanke and Treasury Secretary Timothy Geithner. In a Feb. 2 letter to Mr. Dodd, Mr. Geithner said he supported a move as it would allow the government to respond to “exigent circumstances.” Mr. Bernanke sent Mr. Dodd a similar letter the same day, suggesting a coordinated effort was at work.One difference between the FDIC’s insurance fund and the TARP is that any money the FDIC borrows from the Treasury would likely have to be repaid through assessments levied on banks rather than on taxpayers. The FDIC finances its fund through bank fees. Many struggling banks argue that the government should ease up on fees until the credit crisis abates.
Now, haiku that.
HASP Details with the Devil in Them
Here’s the link to the U.S. Treasury Department “Home Affordable Modification Program Guidelines” that anchors President Barack Obama’s $75 billion Home Affordability and Stabilization Plan. Here’s a fact sheet that outlines the ambitions and broad workings of the Treasury plan.
The Wall Street Journal reports:
“Two weeks ago, the president laid out a clear path forward to helping up to 9 million families restructure or refinance their mortgages to a payment that is affordable now and into the future,” Treasury Secretary Timothy Geithner said Wednesday in a statement. “Today, we are providing servicers with the details they need to begin helping eligible borrowers.”
The administration’s new housing rescue effort includes a program aimed at reducing the amount homeowners owe per month. Under the program, the lender will have to first reduce monthly payments on mortgages so that the borrowers’ monthly mortgage payment is no greater than 38% of his or her income. The program will then match further reductions in monthly payments dollar-for dollar from 38% down to 31% debt-to-income ratio for the borrower.
The modified payments will be kept in place for five years and the loan rate will be capped for the life of the loan, Treasury said in technical documents provided Wednesday morning. After five years, “the interest rate can be gradually stepped-up by 1% per year to the conforming loan survey rate in place at the time of the modification.”
Treasury said that in order to reach that 31% debt-to-income ratio level, interest payments will first be reduced down to as low as 2%.
The equities markets, lenders, and capital sources have shown a high degree of intolerance for “plans to have a plan,” lack of details, lack of action. This release of information and operational steps can kick the program into gear effective now. The WSJ highlights the following in a post seeking audience comments on its Real Time Economics page.
Eligibility and Verification
Loans originated on or before January 1, 2009. First-lien loans on owner-occupied properties with unpaid principal balance up to $729,750. Higher limits allowed for owner-occupied properties with 2-4 units. All borrowers must fully document income, including signed IRS 4506-T, two most recent pay stubs, and most recent tax return, and must sign an affidavit of financial hardship. Property owner occupancy status will be verified through borrower credit report and other documentation; no investor-owned, vacant, or condemned properties. Incentives to lenders and servicers to modify at risk borrowers who have not yet missed payments when the servicer determines that the borrower is at imminent risk of default. Modifications can start from now until December 31, 2012; loans can be modified only once under the program.Loan Modification Terms and Procedures Participating servicers are required to service all eligible loans under the rules of the program unless explicitly prohibited by contract; servicers are required to use reasonable efforts to obtain waivers of limits on participation. Participating loan servicers will be required to use a net present value (NPV) test on each loan that is at risk of imminent default or at least 60 days delinquent. The NPV test will compare the net present value of cash flows with modification and without modification. If the test is positive – meaning that the net present value of expected cash flow is greater in the modification scenario – the servicer must modify absent fraud or a contract prohibition. Parameters of the NPV test are spelled out in the guidelines, including acceptable discount rates, property valuation methodologies, home price appreciation assumptions, foreclosure costs and timelines, and borrower cure and redefault rate assumptions. Servicers will follow a specified sequence of steps in order to reduce the monthly payment to no more than 31% of gross monthly income (DTI). The modification sequence requires first reducing the interest rate (subject to a rate floor of 2%), then if necessary extending the term or amortization of the loan up to a maximum of 40 years, and then if necessary forbearing principal. Principal forgiveness or a Hope for Homeowners refinancing are acceptable alternatives. The monthly payment includes principal, interest, taxes, insurance, flood insurance, homeowner’s association and/or condominium fees. Monthly income includes wages, salary, overtime, fees, commissions, tips, social security, pensions, and all other income. Servicers must enter into the program agreements with Treasury’s financial agent on or before December 31, 2009.Payments to Servicers, Lenders, and Responsible Borrowers The program will share with the lender/investor the cost of reductions in monthly payments from 38% DTI to 31% DTI. Servicers that modify loans according to the guidelines will receive an up-front fee of $1,000 for each modification, plus “pay for success” fees on still-performing loans of $1,000 per year. Homeowners who make their payments on time are eligible for up to $1,000 of principal reduction payments each year for up to five years. The program will provide one-time bonus incentive payments of $1,500 to lender/investors and $500 to servicers for modifications made while a borrower is still current on mortgage payments. The program will include incentives for extinguishing second liens on loans modified under this program. No payments will be made under the program to the lender/investor, servicer, or borrower unless and until the servicer has first entered into the program agreements with Treasury’s financial agent. Similar incentives will be paid for Hope for Homeowner refinances.Transparency and Accountability Measures to prevent and detect fraud, such as documentation and audit requirements, will be central to the program. Servicers will be required to collect, maintain and transmit records for verification and compliance review, including borrower eligibility, underwriting, incentive payments, property verification, and other documentation. Freddie Mac will audit compliance.
The worriers on Calculated Risk’s self-described “Commentariat” are fretting that the program is a multigenerational debt-shift. One comment re-coined the program “United States Program to Underwrite Real Estate Speculators… UPURS.”
Here’s a link to a statement from James Lockhart, director of the Federal Housing Finance Agency, about revelation of the plan’s details.
Warren Buffett’s Take on the Housing Crisis
The Oracle of Omaha–sins of commission, omission, warts and all–has spoken, and he’s got his devout host of acolytes and admirers poring over every word of the Berkshire Hathaway annual letter to shareholders.
Housing, particularly the financial storm and economic crisis around housing, is getting some attention in the wake of the B-H annual report release.
In this report, MarketWatch’s John Spence dissects Warren Buffett’s extrapolation of the performance and business environment challenges for Berkshire’s Tennessee-based manufactured home builder Clayton Homes, as he offers observations about the broader housing economy’s dislocation. Connecting the dots from the modular home marketer’s customer base to the bubble-crazed housing boom of the first part of the decade, Buffett coins this year’s letter’s most quoteworthy quotes.
“Home purchases should involve an honest-to-God down payment of at least 10% and monthly payments that can be comfortably handled by the borrower’s income.”
In most cases, homes go into foreclosure simply because the borrowers can’t keep up with the monthly payment, not because they owe more than the house is worth due to falling prices, he said.“Home ownership is a wonderful thing. My family and I have enjoyed my present home for 50 years, with more to come,” he commented. “But enjoyment and utility should be the primary motives for purchase, not profit or refi possibilities. And the home purchased ought to fit the income of the purchaser.”Buffett still lives in the house in Omaha he paid $31,500 for in the late 1950s.“Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective,” he wrote. “Keeping them in their homes should be the ambition.”