|
Credit Market
The credit market has changed drastically in recent years, as banks grew far less important and credit rating agencies like Standard & Poor’s and Moody’s became the essential players in the new financial architecture. Many loans, whether mortgages or loans to corporations, were financed by selling securities. It was the credit agency ratings that determined if those securities could be sold, and deals were structured to meet the criteria set by the agencies.
Wall Street institutions and banks consistently pushed their envelopes in search of higher returns and new outlets for their capital. Deals were widely shopped and tightly bid with the result being, in our opinion, a departure from prudent lending and risk-return analysis.
Now, however, there is fear, almost panic, about those securities. The rating agencies are changing their criteria for the loans, and many investors no longer trust the ratings. The markets are “very panicked and illiquid,” according to Mike Perry, the chief executive of IndyMac Bank, the ninth largest mortgage lender. All this has happened with just an incremental increase in defaults. Mortgage delinquencies are up, particularly on loans made in 2006 when credit standards were very low, but the real problem is that lenders and investors fear things will get much worse. There is no catastrophic rise in the default rates commensurate with this credit crunch. The fear that is driving this market "correction" is based on speculation about what is to come.
This credit squeeze is coming at a time when the American economy seems to be growing, despite problems in the housing market. But if this one continues, pressure will grow on the Fed and other central banks around the world to lower the short-term interest rates they control and thus stimulate the mortgage industry. But this will stimulate the economy as a whole, causing some inflation, especially in real estate (and that's a good thing). Such an outcome will surely slow the default rate.
Mortgage Market
Nationally, mortgage distress has been adding to the rise in foreclosures and the toughening of underwriting conditions. Tightening underwriting standards have dampened demand for new and existing homes. Volume declines had moderated earlier, but in June 2007 existing home sales fell 3.8% to a new cyclical low, and new home sales plummeted 6.6%, close to the previous cyclical low in March 2006. While the new home supply overhang has left homebuilders no option but to cut prices, resale prices have remained sticky until recently. The price resistance in resales is already weakening now. The existing housing market is being squeezed by higher foreclosures increasing the resale supply with more motivated sellers and by cheaper new home product.
Housing Market
The California housing market also continued to weaken in 2007 Q2. Notices of default were rising to new record highs, and new home sales in the State continued to decline, albeit not at the same rapid rate of 2006. The supply of “finished lots” and unsold new home inventory came down somewhat but not enough to make a significant dent in the new home supply overhang. California resales also continued to limp, and resale listings rose again vigorously in the second quarter. Despite worsening supply and demand ratios, resale pricing has been holding up for most of the housing recession. This is changing. By early summer, there were signs of resale price erosion with differing degrees of weakness spreading to all price points except super luxury homes.
Other regional markets, Arizona, Nevada, Florida, the Washington DC/Virginia area, and the Midwest were going through a similar squeeze as California: Sales were sluggish or declining and supply adjustments were turning out to be difficult for cash flow driven builders, while resale listings were rising again, and downward pricing pressure was becoming more ubiquitous. Seattle and Denver were doing better, although Denver was beginning to get encumbered by high foreclosures becoming resale supply. Texas was skidding a little by early summer.
Investment climate
Opportunities for investors are arising from an over-correction by Wall Street and Banks on the availability (or scarcity) of financing - resulting in the recent credit crunch. As such, more and more borrowers who find it increasingly difficult to secure loans from conventional institutional banks are turning to private lenders. They are better qualified in terms of credit worthiness and security quality than what has traditionally been representative in the marketplace.
|
