Looks like lots of future foreclosures

Housing in U.S. Poised to Worsen, Derivatives Show (Update1)

By Darrell Hassler and Hamish Risk
Oct. 23 (Bloomberg) -- The slumping U.S. housing market is about to get a lot worse, according to traders of mortgage-backed securities and the so-called derivatives on which they are based.
The ABX index, which measures the risk of owning bonds backed by home-loans to people with poor credit, rose 30 percent since Aug. 9 to the highest since January. There are more than $500 billion of such notes outstanding.
The increase in the index shows traders expect mortgage delinquencies and foreclosures to increase at a time when the number of homes for sale as measured by the National Association of Realtors is at a 13-year high. The percentage of home-loan payments more than 60 days delinquent rose to 7.23 percent in July from 5.9 percent a year earlier, the fastest rate of increase since 1998, Moody's Investors Service said Oct. 17.
``Delinquency trends and home prices'' show a weakening real estate market, said Scott Eichel, head of credit trading for New York-based Bear Stearns & Co., the biggest underwriter of bonds backed by mortgages. ``A lot of investors that have concerns about the housing market'' are using the ABX index to speculate on a continued drop, he said.
Sales of new and existing homes probably will drop 9.4 percent to 6.76 million in 2006 from a record last year, McLean, Virginia-based mortgage buyer Freddie Mac said Oct. 10. Home sales have risen the past five years.
ABX Index
The ABX index, created by London-based Markit Group Ltd., measures prices of credit-default swaps based on the $565 billion of bonds secured by so-called subprime mortgages and home-equity loans. Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on the ability of borrowers to repay debt. An increase in price indicates deterioration in the perception of credit quality; a decline suggests improvement.
The index tracks 20 asset-backed securities that contain loans rated BBB-, the lowest level of investment grade debt. Based on the index, it costs an investor $267,000 to protect $10 million of bonds against default for five years, up from $205,000 in August. The investor would get face value for the bonds in exchange for the securities should a borrower fail to adhere to the debt agreements.
`Unequivocally Bad'
``The unequivocally bad housing data we've seen'' is prompting investors to seek to profit from potential declines in mortgage-backed securities, said Greg Lippmann, the head of asset-backed trading at Deutsche Bank AG in New York who helped create the ABX indexes in January.
Contracts covering $5 billion of home-loan debt change hands daily, he said. Derivatives are contracts whose value is derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates or the weather.
The housing boom spawned new types of mortgages that allowed consumers to buy homes they may not have been able to afford otherwise.
About 18 percent of all mortgages issued in the first half of the year were to borrowers considered most likely to default, such as those with high credit-card balances, up from 2.4 percent in 1998, based on data from the Mortgage Bankers Association. The Washington-based trade group's 2,700 members represent 70 percent of the home-loan business.
The amount of bonds backed by subprime loans more than doubled since 2001, according to the Bond Market Association, a New York-based trade group of more than 200 securities firms.
Worst Month
A Merrill Lynch & Co. index of debt securities derived from home-equity loans rated AA to BBB is having its worst month this year, falling 0.01 percent. They have returned 4.54 percent since the end of December. Banks and lenders such as Countrywide Financial Corp. in Calabasas, California, and Washington Mutual Inc. of Seattle typically take mortgages and package them into bonds for sale to investors. The bonds are then divided into pieces of varying risk.
More borrowers are finding it harder to meet interest payments following 17 interest-rate increases by the Federal Reserve since mid-2004.
The default rate for subprime loans rose to 7.35 percent in July from 5.51 percent a year earlier, according to investment bank Friedman Billings Ramsey Group Inc. in Arlington Virginia.
Nine percent of all subprime loans made in 2006 may default within five years, the worst performance since at least 1998, Glenn Schultz, head of asset-backed securities at Charlotte, North Carolina-based Wachovia Corp., said in an Oct. 17 report.
`More Visibility'
``People have a little more visibility on the slowdown than they did two or three months ago,'' said Andrew Chow, who manages $5.5 billion of asset-backed securities and credit-default swaps at Seneca Capital Management in San Francisco.
Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co. in Newport Beach, California, forecasts the housing slump will cause the economy to slow and force the Fed to lower interest rates to 4.5 percent next year. The central bank's target for overnight loans between banks is 5.25 percent. Pimco is a unit of Munich-based Allianz SE.
The National Association of Home Builders/Wells Fargo said on Oct. 17 that its index of builder confidence this month rose to 31 from 30 in September, the first increase in a year.
Housing starts in September rose to an annual rate of 1.772 million from a 1.674 million pace in August, the Commerce Department in Washington said Oct. 18. The median estimate of 61 economists surveyed by Bloomberg News was for a decline to an annual rate of 1.64 million.
Falling Prices
Even with the gains, the National Association of Realtors this month predicted prices of new homes may fall for the first time in 15 years. The trade group on Oct. 11 estimates that the median price of a new U.S. home probably will drop 0.2 percent to $240,500. The inventory of homes on the market rose to a record 3.92 million, the group said Sept. 25.
Most credit-default swap trading is in securities rated BBB or BBB- because they are the most volatile and have the greatest chance to be profitable, said Jack McCleary, head of asset-backed trading for UBS AG in New York.
Subprime mortgages with those credit ratings historically have had losses of about 5 percent of the loan value, McCleary said. Some investors are betting that losses may increase to 12 to 14 percent in the next three years, which could exponentially increase value of credit-default swaps, he said.
``In effect, it's a lottery ticket,'' he said.