I have repeatedly warned you about major, major problems brewing in the housing and lending industries. I said a credit disaster was unfolding … I explained that the “soft landing” scenario was a bunch of baloney … and I red-flagged many stocks vulnerable to a serious plunge.
Now, fasten your seatbelts: Things are getting very ugly, very quickly.
The latest news from WCI Communities (WCI) will blow your mind. WCI builds condo towers and single-family homes all over Florida and a few other places. I want to direct your attention to a line from the company’s earnings release this week:
“Tower homebuilding orders for the second quarter 2006 decreased 82.6% in value to $57.0 million and 88.8% in units to 36.”
Orders for condo towers declined 88.8 freaking percent? That’s insane!
If that’s not a total market collapse, I don’t know what is. The market is coming unglued even faster than even I could have imagined.
And this is not an isolated event …
Toll Brothers (TOL) constructs “McMansions” — those cookie-cutter, oversized, status symbol homes piling up like unwanted flotsam from one end of the country to the other.
The company’s new unit orders plunged a whopping 48% in the fiscal third quarter. That’s almost half of their business up in smoke!
Toll also cut its 2006 home delivery target … again.
And it said it would have to write down the value of options to buy land that it previously purchased.
Ugly, ugly, ugly.
The stock is a total piece of junk. Toll’s shares have already fallen off a cliff, but I think they’ve got further to go.
Want more wreckage? Look at Countrywide Financial (CFC). Just last week, I wrote the following:
“Commentators on CNBC are pounding the table on Countrywide Financial (CFC) for instance. Who are they kidding? This subprime lender has huge exposure to slumping California real estate and option adjustable-rate mortgages that might never be paid back.”
Well, guess what? This week, Countrywide’s shares plunged!
The catalyst: A July activity report. It showed declining loan origination volume and a spike in mortgage delinquencies. The late payment rate climbed to 4.11% in July, a multi-month high. I’m expecting that rate will top 5% in the not-too-distant future.
Then, there’s Fremont General (FMT). This California company is a big player in the subprime mortgage and real estate lending arenas. It gives mortgages to people with bad credit, and funds the construction of condominiums and other commercial property all over the country.
Its shares just plunged this week to their lowest level since January 2004. Why?
Fremont released a dreadful earnings report rife with evidence of credit problems among its subprime borrowers. Two excerpts (with the important lines in bold):
“The Company recorded these increased provision levels primarily as a result of increased loan repurchase and re-pricing trends from its previous whole loan sale transactions, as well as lower secondary market pricing for second mortgages. These increased loan repurchase and re-pricing levels, which have been noted industry-wide, are primarily due to increased levels of early payment delinquencies and a greater incidence of repurchase requests from whole loan purchasers.“
“Given these loan repurchase and re-pricing trends, with an objective of reducing its early payment delinquencies, the Company made modifications in its loan origination parameters during the second quarter of 2006, including eliminating or reducing certain higher loan-to-value products and lower FICO bands.“
Translation: Fremont is saying that borrowers are in such bad shape, they’re barely able to make their first couple of payments, much less hold onto their homes and pay their loans off longer term.
The company is also admitting that the secondary market — where primary lenders sell their mortgages to wholesale lenders and investors — is deteriorating rapidly.
That’s because end investors are starting to realize there’s a credit quality train wreck coming right at them. So they’re paying less for new mortgage loans. And they’re demanding that lenders buy back some of the old loans they’ve already bought because they’re going bad so fast.
Last but not least, note that Fremont said it’s now tightening lending standards. The government has been trying to get mortgage companies to do this for a long time. But rather than crack down with hard and fast rules, they chose to use namby-pamby “guidance.” Lenders roundly ignored them, and kept on making junk loans. Maybe they’re finally starting to catch on!
End Result: Wall Street’s
“Buy Financials” Trade
Is Backfiring …
The suspense is over — we got the “pause heard ‘round the world” at this week’s Federal Reserve Board meeting.
The funny thing is, Wall Street had been spewing a bunch of claptrap before the meeting about how you should load up on financial stocks. The conventional wisdom: A Fed pause is extremely bullish for financials.
There’s just one problem: Too many near-sighted analysts have been ignoring credit quality.
Now, the jig is up. Losses are piling up fast. The market is getting tighter and tighter. This is truly a disaster in the making. Look at some more of the carnage:
Accredited Home Lenders (LEND) just blew up this week, plunging almost $8 a share in a single day after a massive earnings warning …
Subprime lender AmeriCredit (ACF) took an Acapulco cliff dive …
MGIC Investment (MTG), a mortgage insurer, plunged to new lows …
And I think more pain is on the way for stocks like New Century Financial (NEW), too.
The fact is, we’ve seen an absolute explosion in junk lending in the past few years. Firms have completely thrown underwriting standards out the window — for everything from car loans to mortgage loans. Now, it’s starting to come back to bite them.
That will only be made worse if the economy slows and inflation news keeps the pressure on interest rates. And there are certainly new signs that it will:
- On the very morning the Fed met, we got a report showing the biggest year-over-year surge in non-farm unit labor costs since December 2000.
- Productivity plunged in the second quarter.
- And with crude oil prices surging as high as $77.45 a barrel this week, consumers and businesses are getting squeezed.
As I see it, you can do one of two things here:
You can succumb to the simple: “No more Fed hikes; Buy financials!” mantra they’re spewing on CNBC.
Or …
You can start focusing on the real news behind the headlines … for example, the fact that the housing market continues to unravel, credit quality continues to deteriorate, and the list of victims keeps getting longer and longer.
I think that first choice is a sure fire way to lose your hard-earned money. And that’s why I suggest sticking with door number two.
Until next time,
Mike
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