Games Banks Play - Number Two

Over the next couple of years, many banks will fail and be taken over by the government or larger institutions. This will be an agonizing process that some banks will try to avoid at any cost. I will explain in a multi part series what to watch out for:

Other Real Estate Owned (OREO) - Banks will take title to many properties during this downturn and put them into a category called Other Real Estate Owned (OREO). This real estate must be recorded upon foreclosure at fair value, with the difference between the recorded amount of the loan and the fair value of the property charged to the allowance for loan losses. I suppose that some Banks will fudge on this "fair value" deduction and try to keep the loss as small as possible. Future writedowns of the OREO must be charged against operating income. Therefore, there will be two hits against banks regarding real estate. First, the difference between the loan outstanding and the fair value at the time title is taken, and second, the difference between this fair value at foreclosure and what the property is finally sold at.

I attended a banking conference in February and was told that current offers for OREO by buyers are in the range of 40-50 cents on the dollar, and that at this time, most banks aren't accepting such offers.

Part One

A Picture is Worth a Thousand Words

I was on vacation in Florida last week and saw the following sign in front of a half finished development.



I almost pulled off the road causing an accident when I saw the 2 for 1 special sign. It's hard to believe that new houses are being discounted 50% off list from a year ago.

Robert Toll on the Sub Prime Bailout

A few excerpts from the Toll Brothers fourth quarter conference call held last week courtesy of Seeking Alpha

Robert Toll had some interesting comments on the new plan announced by the Federal Government.

Comments on Sub Prime Loan Plan

"With respect to what do I think about the most recent announcements, to be a wise guy, not much. There is no such thing as a sub-prime loan. There’s a sub-prime borrower; that is a borrower who hasn’t got the credit, the respect for his credit in the marketplace that’s equal to what you would consider to be necessary, which we call now prime. A little misnomer in the use of the words."

"What I understand has been offered to the congress to consider and pass is a break for sub-prime. So if you’ve got -- sub-prime borrowers, so that if you are not credit worthy, we’ll give you five years at your present rate but the next door neighbor, who decided he liked the teaser mortgage and went for four for the first six months and six for the next six months and then according to an index with a differential, he would be pushed to eight and then to 10, he’s stuck because he had prime rating."

"I think what would have made more sense, if I were running the zoo, is I would have said we are going to stop teasers, not just sub-prime but for everyone at a rate and pick a number. If we think a -- we’ve done it in the past. The rates used to be regulated in this country up to the elimination of Regulation Q. I think that was in the ‘70s when disintermediation took place."

"I think it wouldn’t be a great feat for us to say that for the next two years, we are going to cap the rates for teaser mortgages at 8%, or 8.5%, which has been approximately the 40-year average rate that we’ve lived with."

Toll Brothers Conference Call

A few excerpts from the Toll Brothers fourth quarter conference call held yesterday courtesy of Seeking Alpha

Interesting that he said that 1974 was a rougher downturn than the current one.

Comments on Current Conditions

"By many measures, fiscal 2007 was the most challenging of the 40 years that Toll Brothers has been in business. 1974 was perhaps rougher, but the difficult times only lasted one year."

"Since going public in 1986, we’ve just reported our first quarterly loss this fourth quarter after 85 consecutive profitable quarters. The loss was driven by $315 million of non-cash pretax inventory related impairments and related write-downs."

"The creation of projections is difficult at any time. In the current climate, it’s particularly difficult to provide guidance for fiscal 2008, given the numerous uncertainties related to items such as sales paces, sales prices, mortgage markets, cancellations, market direction, and the potential for and size of future impairments. As a result, we will not provide earning guidance at this time."

Highly Recommended

I just found a blog that is probably one of the best I have seen on Homebuilders and the related mess that is going on in that area. It is written by Reggie Middleton and is located here:

Reggie Middleton's Boom, Bust & Bling Blog

He brings a lot of insight into an area that is usually full of hyperbole. I would recommend subscribing to his feed.

Hunting Bargains

Some of the best bargains during the trough of the real estate cycle may come in the condo market in Miami, where the word overbuilding acquired a new meaning. It's too early so don't get lured in by these auctions yet, but here's a web site to keep track of the foreclosure sales going on in that city:


Miami Dade County Clerk

Homeownership Rate

One of the symbols of the recent Housing Boom was the increase in the Homeownership rate to above trend levels. Some debated the cause of this increase. A recent study by Matthew Chambers, Carlos Garriga, and Don E. Schlagenhauf entitled "Accounting for Changes in the Homeownership Rate," published as a working paper in September 2007 by the Federal Reserve Bank of Atlanta, concluded that the main reason for this increase was the growth of exotic mortgage products, and not demographic reasons.

A copy of the study is here.

"We find that the long-run importance of the introduction of new mortgage products for the aggregate homeownership rate ranges from 56 percent to 70 percent. Demographic factors account for between 16 percent and 31 percent of the change."


What does all this mean? If this study holds up under peer review, it would argue for a more prolonged housing downturn for two reasons - this demand will not be coming back anytime soon, and houses purchased by this group will swell inventories.

The Final Straw

Is it possible that the previously untouchable Manhattan Real Estate market is about to be breached? Hovanian cut its prices on condos in West New York by 20%. Now those of you who don't know New York well may think that West New York is way out in the boonies near the Erie Canal and Niagara Falls, but it is not.

It is right across the Hudson River from the Big Apple, and if you look out the window of the condo you bought that just went down in price by twenty percent, you can see the glittering skyline of the unbreachable New York City market where you better damn well pay what they are asking and be glad to pay it.

New York City is the castle "keep" of Real Estate in the United States, so to speak, and this may be the residual effect of the Hedge Fund melt down the last two months as those bonuses become a trickle.

Struggling Hovnanian Offers Deep Discounts in Weekend Sales Blitz


NEWARK, N.J. (AP) -- Hovnanian Enterprises Inc., struggling like other home builders, is offering six-figure discounts on some of its properties this weekend as it attempts to draw interest in a slumping market. The sales blitz involves dropping prices by more 20 percent on some of its prime real estate. The largest discounts are on the most expensive homes, including a 3-bedroom condominium by the Hudson River in West New York, which has been reduced $240,000, or 22 percent, to $862,000 this weekend.


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