BluefoxToday blog : May 2008

 The home loan industry has been dealing with all sorts of problems lately, from a soaring heap of foreclosures to a stagnant real estate market that makes meeting monthly revenue projections difficult. Many companies have been forced to close their doors and a host of others still operating are barely hanging in there. Those record-breaking earnings years of the recent past are long gone. Amid all that distress, now it's forced to battle another challenge.

 And this one comes from the investment community. Investors who bought mortgage securities on the secondary market during the boom years are increasingly seeking to force mortgage lenders and banks to take back loans that have failed. A good many are subprime paper, but there are others, too. When these complicated sales contracts are drafted they normally include all sorts of conditions and if they are not met, then the holder can, for instance, return the loan to the originator. A lot, of course, depends on the wording of the agreement.

 The terms could stipulate that if a loan goes bad within a short time period, like two years, it can be sent back. Or obvious mistakes discovered later on could violate the contract. And fraud is now coming up frequently as a reason the investor wants to jettison the paper. Under the fraud label one of the leading contenders has been the doctored appraisal, this one likely a no-brainer to avid industry observers.  

 Countrywide disclosed in a recent securities filing that it expects these types of claims to reach $935 million as of the end of March, while the number was $365 million at the same time last year. That's a heap of money just for this purpose. Other mortgage lenders are now pushed to shore up their reserves, too, putting more pressure on their bottom lines.  

 A large number of these take-back requests are settled in negotiations, some get done by arbitration and then a decent share winds up in litigation. All the same, these claims use up lenders' resources at a time when they can ill afford it. Hopefully they are taking notes so this kind of meltdown won't happen again.

 Nowadays, there's very little to write home about the overall U.S. housing market. True, some areas, including the metropolitan Las Vegas, are showing cautious signs of the slump being at or near the bottom, which is very encouraging. Yet, the recovery to a healthy environment will likely be slow and long and probably infested with a few more bumps. 

 While the mood here can understandably be fluid, those in Europe and Asia and other far-flung places looking in are seeing a great opportunity. The reasons to that are pretty obvious. Domestic real estate prices have taken a beating in many popular destinations like Florida, California and Las Vegas, so simply put there is great value to be had. To many foreign buyers it's like a one grand sale event and they want to take advantage of it while it lasts.

 The U.S. dollar has also seen better days, much better in fact, giving the international investor another incentive to come over and acquire property that a few years ago was clearly out of his reach. Many of them understand how markets work and now two, not just one, key elements here, real estate and currency, are down and this kind of opportunity may not happen again in a long while. As an added bonus, mortgage money continues to be very affordable and widely available with a decent down payment. To the savvy investor from abroad, all the lights should be showing green.

 Moreover, in the global family, the U.S. as a marketplace is still viewed as the venue to go to for opportunity and long-term economic health. Nevertheless, it admittedly does get spanked hard every so often for indiscretions, like right now, but time and again it has proven strong bounce-back ability. What comes with that is the confidence factor and it plays a large role in all of this.

 Condominiums that can be doubling as hotel rooms was introduced a few years ago as a new concept to Southern Nevada, likely migrating here from Florida where it had already seen quite a bit of success. Vegas being such a hot-spot tourist magnet world over proved to be a fertile ground for the idea. Developers quickly realized the opportunity and were soon elbowing their way to authorities to get building permits. A frenzied housing expansion was already gathering steam in town when this phenomenon was discovered and what it did was add a smaller side boom to merge with the larger general boom.

 All good booms come to an end one day, though, as the single-family house and townhome segments in Las Vegas have already proved with their soft performance of late. Now it's the condo-hotel's turn.

 Overbuilding is a significant reason to the current decline in the bazaar. Boom years as a rule keep attracting adventuresome builders to the scene well beyond the actual need who will eventually saturate the market with too much product and it'll tank. The weak national economy hasn't helped any either in this case.

 But there is another intriguing reason to the sector's present dilemma and that is the condo owner. When he purchased one of these units he thought he had made one of the better investment decisions of his life. When he wasn't using it he could have the hotel rent it out for extra income, predictably cover the mortgage payment and perhaps leave some extra for a gourmet meal, too.

 However, the owner in many instances failed to understand, or wasn't informed about, how much he would have to pay for the marketing and management fees and the condominium's maintenance. Those numbers often eat up all of the rental income and can actually get worse than that. Much worse, to the tune of putting him several hundred dollars in the red each month. That's one thing. To add insult to injury, the current real estate slump here has also phased in declining property values to the picture and now he is really feeling the pain. Negative cash flow and upside down on the mortgage isn't much fun.

 As a result, some owners are walking away from their investments, letting them go into foreclosure. Some are frantically trying to sell, even at a loss. Some are hanging in there and are seeking to rent them out on their own, bypassing the expensive hotel setup. And of course lenders are aware of the dire situation and now are very cautious about providing financing for these once-popular units, whether resale or new.  

 Yet, as always, in time a full recovery will sweep into town and once again spawn a stable condominium marketplace to work with.

 MGM Mirage's CityCenter is currently regarded as the biggest privately-financed real estate project in the U.S. It consists of many components large and small, okay mostly large, and they each have been given names long ago. Except one. And it happens to be the main attraction of the entire development sitting on Las Vegas Boulevard.

 The showpiece hotel with over 4,000 rooms housed in two glass towers and a 150,000 square foot casino to keep the patrons busy has jealously managed to guard its future name from the curious, but now the cat is out of the bag. Its official name is Aria. There it is for everyone to spell out and touch.

 The Vdara condo hotel recently celebrated top-off, the first so far to do that of the five high-rise hotel and residential towers. The others coming along later are Mandarin Oriental, Harmon Hotel and Veer Towers, the latter being by the way the only building that is purely residential. Vdara is scheduled to complete in August 2009 and the rest will follow later in stages, leaving Aria the last one to open doors in December 2009. The Crystals is the city-within-a-city's dining, entertainment and retail complex, spread out over 500,000 square feet.

 CityCenter price tag is now estimated at $9.2 billion and the project is a joint venture of MGM Mirage and Dubai World. One noteworthy aspect here is the LEED certification from U.S. Green Building Council that the resort is to striving to achieve. It can be accomplished with a sustainable design. To get there the project is incorporating creative processes on site development, energy efficiency, materials usage, indoor air quality and water savings.

 The subprime home loan debacle sure has exposed the huge and complicated marketplace to careful scrutiny as to how it handles risk management. Sterling banking firms and mammoth investment organizations have lately lost untold amounts of money on U. S. mortgage-backed securities. When some of the better finance minds the world over get dragged into a mess like this there must be something fundamentally questionable about it all.

 Let's take a closer look. For residential mortgages, the current risk management function rests on two legs.

 The well-known element is the one where a weak borrower is charged a higher interest rate than the borrower with solid credit credentials. No one argues with that. This is so far pretty basic and widely supported. But what happens to the premium that is collected from the weak borrower is where the system's drawback becomes glaring. If there are no immediate losses to cover, the proceeds from the premium are generally counted as income by the mortgage security holders, the investors.

 So, under normal market conditions, many years will go by with mortgage defaults bouncing within a predictable loss range and the premiums will easily take care of any deficits. All the excess is entered into the books as income, year after year. Business is good and everybody is happy. But all of a sudden a major market upheaval, like the one we are seeing today, generates huge losses and since there are no reserves put aside, the investors are hit hard. The current premiums are far too little to bail them out and they are taking a serious bath.

  Mortgage insurance is the other leg. When a borrower has less than 20% down payment, he is required to buy mortgage insurance to cover the extra risk. The big difference here is that about .50 cents of each premium dollar collected goes to a reserve fund and it is there as a backup when the market hits the skids. During low default years the accounts grow substantially and are much better prepared to tackle any future tough years.

 The investor community could be planning some changes to the existing interest rate premium system, the obvious weak link here. It could introduce a still higher premium and then a fraction of that is put into a reserve account and the rest is kept as income, essentially preserving their current income stream. Mortgages, though, would now become more expensive to the borrower. Leaving the current risk premium intact but giving up some of it as a reserve would cut into their own profits. Probably a non-starter.

 Maybe they won't do anything. These market blow-outs happen every 20 years or so and they figure they can live with that.

 Fannie Mae is one of the two gigantic GSEs, or Government Sponsored Enterprises, that helps the nation's housing business by buying mortgages on the secondary market. By doing so it adds liquidity to the banking system and enables lenders to make more home loans. The guidelines for the loans it purchases are crucial to the process.

 As the real estate market sailed arms swinging into rough seas, Fannie Mae started tightening the criteria for the conforming loans it would acquire for its huge portfolio. Just like private banks were doing, simply to deal responsibly with the increased risk.

 One of the guidelines was the declining market "penalty" it instituted in December. What it means is that let's say a loan product requires a 5% down payment, then in a declining market an additional 5% is tagged on that for the extra risk, making it a 10% down payment mortgage. Las Vegas in Clark County for instance is currently considered a declining market, as are most counties in Nevada. 

 But Fannie Mae is about to reverse that policy. It is ready to announce in the coming days that it'll be discontinued altogether and that decision will go into effect in early June. While details are being worked out, this change will evidently apply only to single-family houses occupied by the owner. The reversal then leaves condominiums and townhomes still to be judged by the existing guidelines, as are second homes and investment properties. Those segments continue to be deemed more risky.

 The about-face was largely the result of serious pressure from groups such as national and regional housing advocacy organizations, the National Association of Realtors and the National Association of Home Builders and of course Washington.  The guideline, according to them, was far too restrictive and was putting extra strain on the already reeling real estate market, which is true.  

 The amendment might be also partly backed by the faint signs that the mortgage and housing markets are about as beat up as they will be. There have been no major banking crashes, or near crashes, recently and the real estate markets in some areas are stirring a bit, like here in Las Vegas. The decision makers may be counting on an about-to-happen road to recovery that would justify this move.

 The Southern Nevada real estate market is doing all it can to shake off the jitters that have bothered it for a long time. Since it took a while to get buried this deep into the housing and mortgage mess, it'll likely take at least as long to completely wiggle out of it. That's just the way it is. Nothing is going to happen overnight.

 Another positive foreclosure statistic was released this week. The California online research shop Foreclosures.com reports that Clark County, more or less Southern Nevada, logged 4,426 pre-foreclosure filings in April. This figure is a sizable decrease from the record March filings of 6,152, a very welcome development.

 However, caution is still the word. In January the number was almost 6,000, then dropped to about 4,000 in February, jumped high in March as noted earlier and now fell again. In essence, it resembles a roller-coaster ride. Often as market corrections take place it happens in this manner when the upward curve is about to break and after a few months of up-and-down movement the steady, perhaps still slow, trend down begins to gather steam. That's what everyone is now looking forward to.

 Foreclosures.com also informs its readers that Nevada remains at the top of the heap in pre-foreclosures of all households statewide, with 3.15%. The percentage really isn't a high number in itself, although it is up from its historic levels. Arizona came in second with 2.87% and third place went to Florida at 2.56%.

 Nationally, pre-foreclosure filings are also heading down, at least for April. Maybe the steady climb is about to come to an end here, too.

 The giant purchaser of mortgages on the secondary market is back in the headlines, this time delivering news that it'll further tighten up on acceptable guidelines for its portfolio. Just a few weeks ago its image took a step up when it agreed to buy jumbo paper from several large banks, thus helping improve refinance and purchase activity in high-value areas, like much of California is.

 Most of the new changes touch on investors, second-home buyers and refinances.

 Freddie Mac will no longer buy loans on investment condos and houses if the borrower owns either individually or jointly four properties with mortgages on them. Before this the limit was 10, so that is a rather serious contraction. Second-home buyers face the same restriction, four is the ceiling in combination of that home and possible rental units, come August 8 when these new rules go into effect.

 As far as refinances go, Freddie Mac considers ineligible a cash-out refinance application if the same property has absorbed a refi in the previous six months. Its description of a refinance in this case is one where the new loan balance tops the old balance by 5% or more.

 These are limits, yes, but how large a section of the total mortgage borrowing platform do they affect? Frankly, it isn't that much. How many second-home buyers own four units? There aren't too many homeowners, either, who are doing refinances every five months. The impact to the market as a whole looks to be rather minimal, probably more psychological than anything else.

 Freddie Mac is understandably adjusting to the current risky market conditions and prefers now to drive along with both hands on the wheel and observe speed limits. That's only prudent.

 Development in metropolitan Las Vegas is pushing in all directions, along the cactus-dotted desert floor and up and over craggy foothills and mountains surrounding it. When about 5,000 to 6,000 people move here every month there has to be housing and services for them, but as developable and reasonably-priced land is becoming increasingly scarce, the city is understandably forced to spread further out.

 A few years ago another master-planned community was announced straight up north about 60 miles from town, way out in the high desert, named Coyote Springs. It's a 40,000 acre spread that'll hold 159,000 homes one day and will have thousands of acres reserved for parks, trails and nature sanctuaries. According to the primary builder, the project is outlined to be "sustainable and environmentally responsible".

 One of the main concerns in Las Vegas today is its slowly dwindling water resources, and where to get more of it and how to effectively conserve it. Coyote Springs, fortunately, won't be part of that debate because it has its own groundwater supply.     

 The residential building there, however, is put on hold for the time being and the reasons are evident. The local real estate market is still struggling royally and the mortgage sector isn't doing much better, either. That's plenty of reason to postpone a major development and wait for the weather to clear. In the meantime, some of the basic infrastructure over there is either completed and ready to go or is currently under construction.

 Yet, the way Southern Nevada is growing, Coyote Springs will be built sooner rather than later. As things stand right now, the first models there will open in September of 2009. Another sign that it'll be done is that the Jack Nicklaus-designed golf course is already operational for public play. If anyone is looking for a peaceful round in a pristine high desert, Coyote Springs is the answer.

As the spring advances toward summer, the Southern Nevada real estate scene continues to show signs of slow improvement. The long-expected recovery is still fragile and is in its early stages, so it'll be a while before things return to a more balanced market environment. The mortgage industry, despite its own problems, is one key sector that has been helping all along with low interest rates and its cooperation will be sorely needed in the future, too.

In the month of April there were 1,794 single-family home sales in Las Vegas, up about 20% from March, reports GLVAR, or Greater Las Vegas Association of Realtors. This turns out to be the fourth consecutive month when the numbers have grown, and done so decisively, a very encouraging trend. In addition, the sales figure is almost 30% higher than the one from April of 2007, another piece of good news. So, the sales side is doing very well right now.

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