Wednesday, 21 October 2020 12:16

Correction, and further thoughts on the topic

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It has been called to my attention that among the many typos in my earlier post, an important one was the reference to the funding costs of DHI. The company in question was actually DHOM - Dominion Homes, not DR Horton - DHI. The general theme still stands, though, these guys as an industry who hold significantly depreciating real assets or options on said assets, financed by debt (all of them) or those who have significant mortgage banking operations without internal financing (ex. deposit accounts, etc.) (the vast majority of them), and who are running consistent operating losses for the last quarter and foreseeable next half (all of them) are in trouble, to say the least.

TOLL will exhibit a lag in some of the effects since they deal in a slightly upscale market, but are far from immune. They say that they do not warehouse mortgages without a buyer committed for the paper. If true, that is good management, but

the problem still remains... Who will be the buyer for the non-conforming stuff in this market. If Countrywide can't do it, you can bet your buttocks that a fancy homebuilder can't do it. If you think 30% losses quarterly looked bad, at earnings time, wait until you see next quarter's earnings after the effect of the mortgage crunch which slows sales, the land impairment charges, and impairment from whole loans (not necessarily MBSs) that are stuck in warehouse credit line show up!!!! In addition, some of these warehouse lines will be pulled by the banks during this fiscal quarter. As my little baby girl says, "Uh Oh!!!"

The mortgage insurers and investment banks like bear Stearns have similar issues, of reliance upon credit during bad times. There was a post on another blog by a fellow pundit that detailed two large mortgage insurers having leverage of up to 90:1. They cannot afford a run on the bank, which is exactly what is to be expected as ARMS reset.

Bear Stearns has about $22 billion dollars of equity capital, and about $423 billion dollars of assets. It is also the MBS king of the Street. With this leverage, a 5% move does a lot of damage to Bear Stearns equity. The same with the mortgage insurers.

Can this happen? Well, if I am not mistaken, Countrywide's sub-prime portfolio is currently experiencing a 5% default rate, and we have not even experience the first deluge of the 2 year ARM resets or significantly higher interest rates.

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