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Five Things You Need to Know: Fitch: "It's Not Getting Better, It's Getting Worse"


Subprime and Alt-A loan performance is not getting better; it's getting worse.


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Fitch: "It's Not Getting Better, It's Getting Worse"

No one is really paying much attention to it yet, but in a conference call update this morning Fitch Ratings said it expects subprime mortgage losses to increase and that things are not, in fact, getting better. They are accelerating.

The following slide from the call was particularly interesting since it's both counterintuitive and indicative of deterioration, not improvement in the subprime mortgage situation. The slide shows the roll rate from current loans to delinquent loans, where loans that have been performing roll into delinquency.

What is interesting is that one would intuitively expect that a borrower who has been current for 12 to 18 months or so would be less likely to become delinquent than a newer borrower as the highest-risk borrowers get "flushed out" after about six months, leaving some positive selection and a pool of better-quality borrowers.

But in reality, there has been no decrease and, in fact, it has actually gotten worse. This is a clear sign of deteriorating conditions and acceleration in market weakness.

Meanwhile, the Alt-A performance is also deteriorating, and the bad news is that Fixed-Rate loan performance, while significantly better than Adjustable Rated Mortgage, is deteriorating.

Below are all-market Alt-A default rates, not Fitch-rated only.

Fine, but what about the full-court press by government officials to modify loans to prevent foreclosures? Sorry. Glenn Costello, co-head of Fitch Ratings, said on the conference call update that "loan modification programs have been slow to gain traction and have not mitigated foreclosure rates." He added that while the Federal Reserve's aggressive easing policy has eliminated near-term Adjustable Rate Mortgage shock risk, the weakening economy will likely offset this benefit.

2. This Thing is Going Worldwide!

Still think this is just a U.S. problem as the rest of the world hums along buying commodities and building a brand new consumer class across a wide spectrum of emerging markets economies? Then perhaps take a look at the Baltic Dry Index.

At one point back in October this index was up 169% for the year. Since then it's down 29%. Ok, you say, great. But what is it?

The Baltic Dry Index is a number issued daily by the Baltic Exchange, a London-based organization whose members arrange for ocean transport of industrial bulk commodities from producers to end users. Every day they survey brokers around the world to find out how much it costs to book cargoes of raw materials on a variety of shipping routes. The answers are then reformulated as the Baltic Dry Index.

Now, why is the Baltic Dry Index considered important? Well, first off, it's not a speculative index. In other words, no one is out there bidding up the Baltic Dry Index because they believe shipping costs will change in the future. Instead, it tracks the actual cost of shipping raw materials by sea based on real cargo bookings and is therefore considered a pretty good indicator of global trade volumes.

For those without access to Bloomberg, the Web site has updated Baltic Dry Index data available.

Baltic Dry Index

Click to enlarge

3. FedEx Feeling the "Tradedown Effect"

FedEx (FDX) reported third-quarter profit fell 6.4% due to a cocktail of higher fuel prices and slowing U.S. economy. We all knew the record-high fuel prices were going to deliver a tough-to-swallow drink, but the company was a bit more adamant than expected in their pessimism about the slowing economy.

Frederick W. Smith, Chairman, President and Chief Executive Officer, said up front on the earnings conference call that the company is seeing declining domestic express volumes and increased signs of consumers trading down. "We believe persistently higher fuel prices and the related effects of our fuel surcharges are reducing demand on a macro economic basis and leading some customers to shift to less expensive services," he said.

The company also revised guidance for the fourth quarter downward based on deteriorating macroeconomic conditions. For the fourth quarter, FedEx forecast earnings in the range of $1.60 to $1.80 a share, below the consensus of $1.97 a share.

4. Oh No, Not the Affluents!

OK, now this is getting serious. Not only are investment bankers and Wall Streeters losing their jobs, but affluent Americans in general are beginning to find themselves victimized by the collapsing housing market. Clearly, somebody better do something, and fast.

More affluent consumers with annual incomes of $100,000 or more are increasingly being ensnared in the home mortgage crisis, the New York Times reported today ("The Affluent, Too, Couldn't Resist Adjustable Rates").

According to Loan Performance, a real estate information company, about 870,000 borrowers took out jumbo Adjustable Rate Mortgages (mortgages of $417,000 or more) from 2005 to 2007, the Times reported.

In the fourth quarter of 2007, 8.10% were two or more payments behind, Loan Performance found, while 2.62% were in the foreclosure process and 1.35% had been foreclosed upon.

The Times story noted the hard luck case of an attorney being forced to sell:

"One of those homeowners, a lawyer who spoke only on condition of anonymity for professional reasons, said he refinanced his mortgage with an ARM in January 2006 to take $510,000 out to invest in a hotel. "I planned to run the hotel with my lovely wife," he said.

Their strategy was to sell the house after a couple of years, but when they put it on the market in April 2007, there were no buyers. The lawyer, now divorced, calculated that the mortgage payments, now $6,200 a month, plus taxes consume 96 percent of his net income, which includes occasional rent from vacationers who use the house. He lives with relatives and sleeps on the floor.

"I don't regret what I did," he said. But a foreclosure would hurt his career and finances, he said. "And I was raised to pay back what I borrow."

His strategy now is to sell when prices revive. But that could take time, because a bank just sold a neighbor's foreclosed home for $850,000

What is interesting about the story are the sharp moral contrasts and subtle codes percolating beneath the surface. The attorney was "raised to pay back what I borrow," the article notes. The implication being... what?... that his plight is somehow more noble than that of the factory worker who is simply playing by the rules of the system and allowing foreclosure to proceed?

5. Not the Affluents! Part Two: Even Bernanke Victimized by Housing Bubble

An article on Bloomberg this morning caught our attention. Apparently housing deflation has even ensnared Federal Reserve Chairman Ben Bernanke.

"Bernanke lives in Washington's Capitol Hill area in a four-bedroom, 2,600-square-foot house he bought new in May 2004 for $839,000. Almost four years later, it may not be worth any more, according to real estate records and local agents," Bloomberg reports.

Real estate records show Bernanke's next-door neighbor's house sold in July 2007 for $880,000, a mere 4.9% increase over Bernanke's purchase three years earlier, Bloomberg said.

Well, on the bright side, at least he has his job.

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