Bank of America made some headlines today when it announced that losses on its book of home equity loans, or second mortgages, would be worse than expected. Specifically, according to Bloomberg:

"Bank of America Corp., the nation's biggest consumer bank, said losses on home-equity loans will be even worse than predicted three weeks earlier, adding to evidence that more consumers are falling behind on debts.

"More customers are under financial stress and using credit cards to pay for necessities, said Liam McGee, president of the consumer and small business division, at an investor conference today in New York. Losses on the bank's $118 billion in loans linked to home values may top 2.5 percent, higher than the 2 percent to 2.5 percent projected last month.

"Credit-card customers are cutting back on retail, travel and entertainment purchases, said McGee, whose company is the nation's largest credit-card issuer and ranks No. 1 by deposits. That backs up economists and bankers who say the U.S. may be teetering near a recession as consumers struggle with job losses and gasoline prices of more than $4 a gallon.

"McGee said Bank of America expects the economy, measured by real gross domestic product, will shrink in the second quarter. The bank had $184 billion of credit card debt outstanding at the end of the first quarter and about a 20 percent market share.

"Credit and debit-card purchases for "necessary'' items, including fuel, food and utilities, grew by 13 percent in the first quarter, while spending for retail, travel and entertainment increased 0.5 percent, the bank said today."

Meanwhile, Moody's Investors Service is out on the tape talking about how the bond insurers MBIA and Ambac Financial face "meaningfully" higher losses on HE loans and CDOs. Specifically, Moody's says seconds are performing much worse than expectations. Here's an excerpt from the firm's "U.S. Subprime Second Lien RMBS Rating Actions Update," which provides some more details on what the firm is seeing:

"Losses to date on loans backing 2005-2007 vintage subprime second lien-backed RMBS have greatly exceeded Moody's original expectations. Beginning early in their lives, second lien pools included in 2006 and 2007 transactions saw substantially higher delinquency and loss levels in comparison to earlier vintages at the same level of seasoning. Three months after issuance, serious delinquencies (those more than 60 days) on 2006 vintage loans were 2.7% of original issuance compared with 1.7% for 2005 vintage pools. 2007 vintage loans deteriorated even more rapidly; by month three, 5.3% of loans were seriously delinquent, nearly double the level for 2006. The extreme level of early payment default seems to be attributable to aggressive loan underwriting as well as to payment behavior by certain homeowners who may never have intended to make a payment on their loans.

"Pool losses came quickly with the rapidly rising delinquencies. Unlike first lien loans that go through a lengthy process of foreclosure, second lien loans are written off by servicers when they expect that no recovery is foreseeable. In light of the pressure on home prices and limited or negative borrower equity in their homes, many second lien loans were simply written off after being delinquent for six months. Because the limited borrower equity left little room for recovery, many of the loans have defaulted with severities around 100%.

"With only 15 months of seasoning, 2006 vintage loans have lost nearly 10% of their original balance, and 2007 vintage pools have lost just over 8% by month 9. Even with these early losses, the pace of delinquency has not yet significantly slowed with seasoning. Troubled borrowers concerned about losing their houses tend to default on their second lien loans before their first lien loans because, with no equity in the home, the second lien lender has little incentive to pursue foreclosure."

That's a lot of jargon and industry-speak to digest -- and it might leave you wondering what things look like on the ground. What's happening with second lien loans in the "real world" and why are they performing so poorly?

Well, I just stumbled across a nearby town house listing. It's advertised as a short sale at $108,000 (subject to bank approval, of course). So I did a bit more digging into the property's history. Turns out it sold for just under $80,000 in August of 1990, then next changed hands for a little less than $90,000 in May 2001. Total gain in almost 11 years: about 13%.

It next sold for $94,000 in November of 2002. But shortly thereafter, our bubble here in South Florida started inflating. Before long, people were outbidding each other left and right for both new and existing homes and lending restrictions were being slashed to the bone. The same property then changed hands for $170,500 in October 2004 -- up more than 81% in just under two years.

Here's the kicker -- it looks like the property was financed with a $153,450 first mortgage and a home equity line of credit for $17,050. Yes, that means the buyers put nothing down on a home that had almost doubled in value in just a couple of years. And yes, this same town house -- with $170,500 in loans (minus whatever principal has been paid down in the meantime) -- is now being marketed as a short sale for almost $63,000 less. I'm betting the second lien lender isn't feeling too warm and fuzzy about his loan.

Hopefully this example gives you an idea why second lien lenders are in a world of hurt, especially if they're loaded up with loans against properties in markets where values are deflating fast.

Good Monday morning to you all. Here's a quick roundup of the headlines that are capturing my attention at this time ...

* HSBC set aside $3.2 billion to cover bad U.S. loans. That sounds awful, but it's actually below the $4.2 billion to $4.8 billion that analysts polled by Bloomberg were expecting. HSBC got into subprime mortgage lending in a big way when it acquired Household International back in 2003.

* Bond insurance firm MBIA announced a Q1 net loss of $2.4 billion, which compares to a profit of $198.6 million in the year-earlier period. The biggest hit came from a $3.6 billion, unrealized pre-tax loss on credit derivatives.

* IndyMac Bancorp, a leading Alt-A mortgage lender during the boom times, said it lost $184 million in the first quarter. That compared with a profit of $52.4 million in the same quarter a year earlier. The company is deferring interest payments on some securities and suspending dividend payments on others. It has boosted its credit reserves to $2.7 billion (from $813 million a year prior), and shifted to a GSE/FHA/VA lending model (88% of its production in the latest quarter fell into that category)

* Late Friday, we learned that another bank failed. ANB Financial of Bentonville, Arkansas was closed by the Office of the Comptroller of the Currency. Pulaski Bank and Trust Company assumed its deposits. ANB had roughly $2.1 billion in assets at the time of the closure. Some details on why the bank failed, and how its failure compares size-wise to other failures, are included in this AP story excerpt:

"It was the third closure this year of an FDIC-insured bank. Douglass National Bank, a Missouri bank with $58.5 million in assets, was shut in January; another Missouri institution with assets of $18.7 million, Hume Bank, was shut down in March.

"Both were dwarfed in size of ANB Financial, where regulators found lax lending standards, mostly for construction and development loans for projects in Utah, Idaho and Wyoming, as well as Arkansas."

Late yesterday, we got some startling statistics. In the month of March, consumer credit outstanding (auto loans, credit cards, and other non-real estate loans) surged $15.3 billion. That was the biggest rise since November and much more than the $6 billion economists were expecting. In fact, consumers took out $34 billion in consumer loans during the first quarter, the most since 2001.

It’s generally considered healthy when consumer borrowing rises. It shows that consumers are ready and willing to borrow and spend, promoting growth. But that’s only if the economy is strong and consumer balance sheets are in good shape. And you probably don’t need me to tell you that is most definitely NOT the case right now.

Instead, I think consumer borrowing is surging for two UNHEALTHY reasons ...

* First, falling home values and tighter mortgage lending standards have all but shut down the “housing ATM.” Borrowers had grown accustomed to taking out home equity loans and lines of credit, then using that money to pay for vacations, boats, RVs, and more. They can’t do that any more – either because their equity has evaporated or because banks no longer want to lend against what remains out of fear home prices will fall further – leaving them holding the bag.

* Second, surging food and energy prices have left consumers with few options. Their incomes generally aren’t keeping pace with inflation, so they’re being forced to use credit cards to finance even everyday purchases.

In other words, this surge in consumer credit isn’t a sign of strength. It’s a sign of weakness. It also leads me to believe that delinquency rates on consumer loans will continue their upward trend.

It's pending home sales day again. This time, the National Association of Realtors is providing data on pending sales activity for March. What did the numbers show?

* Pendings dropped 1% in March, right in line with the forecast for a 1% decline. February's reading was revised lower, however -- to -2.8% from the previously reported 1.9% decline.

* Regionally, pending sales fell in 3 out of 4 regions -- the Midwest (-10.4%), the South (-0.1%), and the West (-1.4%). Sales rose 12.5% in the Northeast.

* The index level was 83 in March, down 20.1% from the year-earlier reading of 103.9. That's the worst on record for this index, which dates back to January 2001.

The string of unimpressive housing numbers continues, with pending home sales showing another decline in the month of March. Sales are down more than 20% from a year ago, and almost 35% from their April 2005 peak. There's a real risk that many of these pending sales won't turn into closed transactions, too, given the tightening we've seen in the mortgage lending market. The latest Federal Reserve figures show that a greater percentage of lenders than ever before are tightening standards on prime mortgages. And you don't need me to tell you the subprime market is all but gone.

If there's a bright spot out there, it's that the supply of homes for sale does appear to be declining in some markets. I attribute that to a combination of falling construction activity, fire sales of spec homes by home builders, and aggressive pricing by other motivated sellers, including banks holding foreclosed properties. The quicker prices decline, the sooner affordability will be restored, and the faster the overhang of inventory will be worked down.

In another sign of continuing fallout from the housing downturn, Home Depot is out this morning with some news. The home improvement retailer said it is:

* Shutting 15 U.S. locations, a move that affects 1,300 workers (some of whom will be offered work at other locations). The move will result in a $186 million charge. The locations are scattered in various states, including Wisconsin, New Jersey, and Indiana.

* Scrapping plans to open roughly 50 stores that had been in its expansion pipeline. It will take a $400 million charge related to store development costs and other obligations.

* Total capital spending on new stores will drop by $1 billion over the next three years. Total capex for the current fiscal year will approximate $2.3 billion, compared with $3.6 billion in the previous year.

There's a lot of economic data to digest today. So I'll try to just hit on the major points:

* Both initial and continuing jobless claims rose in the most recent week. Initial filings were up 35,000 to 380,000 while continuing claims topped the 3 million mark. At 3.019 million, they are the highest since April 2004.

* Challenger, Gray & Christmas said layoff announcements jumped 27.4% from a year ago in April. At 90,015, job cuts were also up more than 36,400 from March. Financial cuts topped the list at 18,443, followed by telecommunications (6,810), and computers (4,687).

* The April ISM index was unchanged at 48.6 in April. The prices paid subindex rose to 84.5 from 83.5 in March -- the highest going back to May 2004. The new orders subindex was unchanged at 46.5, while the employment subindex slumped to 45.4 from 49.2. That's the lowest this measure has been since May 2003.

* Construction spending fell 1.1% in March. That was worse than the -0.7% reading that was expected, but February's figure was revised to +0.4% from -0.3%. Private construction spending was down by 1.7%, led by a 4.6% plunge in residential spending. Nonresidential spending actually increased by 1.9%, led by lodging, office, and communication spending. I suspect this activity will start declining on a fairly consistent basis in 2008.

Net it all out and you get a mixed bag for the markets: Long Bond futures are holding gains from earlier, which were prompted by the lousy jobless claims figures. They were recently up 22/32. The Dow is modestly higher at +23. After initially selling off post-Fed, the dollar has continued to catch a bid that began around 3 a.m. EDT. The dollar index is now up about 70 bps to 73.21.

It's been a busy day on the data front.  Here's the scoop on today's batch of news ...

* Q1 GDP managed to come in positive -- +0.6% vs. expectations for +0.5% and a Q4 reading of 0.6%. Personal consumption was a bit stronger than expected, at 1% vs. a Bloomberg forecast of 0.7%. But that was still the smallest rise since Q2 2001 and down sharply from 2.3% a quarter earlier.

Also, inventory building added 0.8% to growth ... not necessarily an indicator of strength. If inventories rise, but spending cools, it leaves businesses with unwanted stockpiles, leading to future cutbacks in production and employment.

Residential construction activity plunged at an annual rate of 27%, the worst decline since 1981. Also noteworthy: Investment in nonresidential structures fell 6.2%, down sharply from 12.4% a quarter earlier and the worst reading since Q3 2005. This could be evidence the credit crunch and real estate downturn has spread to the commercial market, as I've been expecting for some time.

Lastly, a key price index embedded in the GDP report came in at 2.6%, up from 2.4% in Q4, but below forecasts. A separate reading on core inflation was up 2.2%, down from 2.5% a quarter earlier.

* The Chicago-area PMI index inched up to 48.3 in April from 48.2 in March. That topped expectations for a 47.5 reading. A subindex measuring production rose to 53 from 50.4, while an index measuring new orders dipped slightly to 53 from 53.9 and an index measuring employment fell sharply to 35.3 from 44.6.

Speaking of jobs, the ADP report (PDF link) says the private sector added 10,000 jobs in the month of April, up slightly from 3,000 in March.

* Mortgage application activity is slumping, a troubling trend I discussed recently. The refinance index tanked 16.7% after falling 20.2% a week earlier, while the purchase index fell 4.8% (after declining 6.4% in the prior week). The purchase index, at 340.1, is now the lowest it has been since all the way back in February 2003.

Every quarter, the Census Bureau releases a broad snapshot of the U.S. housing industry -- specifically, it tallies up the U.S. homeownership rate and the U.S. vacancy rate (what percentage of U.S. homes are sitting empty). The latest figures for Q1 2008 show:

Sorry for the lack of posts today -- been pretty busy. One thing that I couldn't help comment on, however: Have you noticed that mortgage rates have been ticking higher lately? And that this has had an impact on purchase applications?

The Mortgage Bankers Association's weekly purchase application index dropped 6.4% to 357.30 in the week of April 18. This index has only been lower once this year -- 356 in the week of March 28. The MBA also said its measure of 30-year fixed-rate loan rates popped back above 6% (6.04%) for the first time since the beginning of March.

Now I don't want to make too big a deal out of this. But if we were to break down out of the recent range in purchases (let's say, below 350) and/or break out to the upside in interest rates (let's call it above 4% in the 10-year Treasury note yield, or 6.4% on 30-year mortgages), it'll be something to pay attention to.

The culprit for this recent upside move appears to be inflation fears, spurred by record-high commodity prices, and the flight of money out of bonds and into stocks, spurred by greater risk-taking behavior on the part of investors.

Punch up a crude oil futures quote, ladies and gentlemen, and that's what you would have seen a few moments ago for the price of a barrel of black gold. Even the "see no inflation, hear no inflation" Federal Reserve crowd can't seem to ignore this market action any more. Bloomberg just ran with a story called "Fisher says inflation beginning to burden consumers." The money quote from Dallas Fed President Richard Fisher: "I'm concerned that we might be on a path of higher inflation that we would otherwise have had."

My general stance is simple: Even the best-intentioned moves can have unintended or unforeseen consequences. The Fed slashed rates to the bone to save the economy after the dot-com bust. That helped cause a housing bubble. Now, it has slashed rates to the bone again to save the economy after the housing bust. What's that doing? Helping fuel (pun definitely intended) a brand new boom/bubble in commodities. And yes, I realize other forces are also at work, such as the "turning-food-crops-into-ethanol" phenomenon and rising wealth and consumption in countries like China and India.

Are we ever going to get off this bubble-bust-new-bubble treadmill? Maybe only when the Fed takes a Volcker-esque approach to monetary policy. In other words, a "tough love" approach where rates are raised or held higher than they otherwise should be to crush commodity speculation/long-term inflation once and for all -- even if it means the economy suffers a deeper short-term recession.

Would that cause more banks to fail? Probably. Would it drive unemployment higher? Yes. But the alternative seems to be "rice riots," a further gutting of the U.S. dollar, $6-a-gallon milk, and $3.50-and-rising gasoline prices ... despite a weak economy. We're all getting hit in the wallet ... and the Fed's inflation-flighting credibility is going up in smoke ... as a result.

I found this story on Kimberly-Clark's earnings to be particularly illustrative of how corporations and consumers are being forced to adapt (emphasis mine):

"Chairman and Chief Executive Thomas J. Falk called the first-quarter results a good start to the year despite "unrelenting inflationary pressures," especially for fiber and energy. He said the company was reducing costs where it could but increasing the marketing of its brands.

Falk said the company underestimated its exposure to inflation by $100 million to $200 million.
He said the company will try to offset the increases with more revenue instead of more cost-cutting, and that if inflation continues at its current rate, Kimberly-Clark will raise prices.

Kimberly-Clark pushed through price increase of 4 percent to 7 percent in February on diapers, training pants, bathroom tissues and paper towels, yet saw no loss of market share to cheaper private-label brands, Falk said.

"That would say the consumer is holding up pretty well in this environment," he said, adding that female shoppers are looking to give their families "little luxuries that don't cost that much more," such as premium tissues.

Kimberly-Clark has been more aggressive in raising prices on commercial customers, such as office buildings -- sometimes twice a year. Executives said they would pave the way for even faster increases by changing contracts to allow price increases any time, not just when the contracts expire."

In other words, we're facing stagflation-lite. Is that really better or worse for the economy and Americans in the long term? Maybe someone should ask Ben Bernanke.

The latest National Association of Home Builders survey was just released. The data for April showed ...

* The overall index held steady at 20, the same as in March and February

* The sub-index measuring current home sales dropped 2 points to 18, the lowest since November. However, the sub-index measuring expectations about future sales rose 4 points to 30, the highest since August. The sub-index measuring prospective buyer traffic was unchanged at 19.

* Regionally, the index ticked up to 22 from 21 in the Northeast and to 17 from 15 in the West. It declined to 15 from 16 in the Midwest and to 24 from 26 in the South.

The latest figures from the NAHB show a housing market that's still groping for a bottom. Builders are more optimistic about the future than they've been recently. But readings on buyer traffic and current sales remain weak. In other words, while hope springs eternal, there is little concrete evidence of a rebound in activity. Tighter lending standards, a slumping economy, and worries over future price declines remain very real obstacles.

I never understood why Wachovia bought California-based Golden West Financial after the housing market was already showing signs of topping out. Golden West's star product is the option ARM, or "pick a payment" mortgage. A large percentage of those loans were made in California, one of the states with the most bubbleicious housing markets. But acquire GDW it did ... and now, it's paying a heavy, heavy price. Because of problems at the former GDW, and its own credit issues, Wachovia announced today that:

* It would lose $393 million, or 20 cents per share, in the first quarter. That's a gigantic swing from the year-ago period, when Wachovia earned $2.3 billion, or $1.20 per share. It's also well below the 40 cents in earnings per share that analysts were expecting. The firm increased its provision for credit losses to $2.8 billion from $408 million a year earlier.

* Net charge-offs jumped to 0.66% of average loans from 0.15% from a year ago. Nonperforming assets as a percentage of loans, foreclosed property and loans held for sale quadrupled to 1.7% from 0.42% in Q1 2007.

* Wachovia is also slashing its quarterly, per-share dividend to 37.5 cents from 64 cents. And it's hitting the market up for about $7 billion by selling common and convertible preferred shares.

Look, there's no way to sugarcoat the import price figures that were released today. They stunk to high heaven. Some details:

* Overall import prices surged 2.8% in March, well above the 2% rise that was expected. If you strip out petroleum, you still get a very large 1.1% rise. Strip out all fuels? Prices were up 0.9%, the biggest since this data category started being reported in 2001.

* The year-over-year rate of import inflation is up to a whopping 14.8%. That is up from 13.4% a month earlier and the highest rate in U.S. history (data goes back to 1982; shown above).

CIT Group is having a rough day, with the stock down roughly 39% at last check. What's going on? CIT is a company that does a lot of corporate finance -- big-ticket equipment leasing to aerospace and rail customers, trade finance, student lending, and vendor finance. It also has a book of home loans that it is in the process of running off (It hasn't originated any new mortgage loans since the second half of 2007).

CIT relies on a number of market-based funding programs to raise money for its loan and lease programs. They include (per its last 10-K): "commercial paper, unsecured debt, and both on-balance sheet and off-balance sheet securitizations" plus "conduit facilities and committed bank lines of credit."

The trouble is that CIT's ratings have recently been cut by Moody's and S&P. That has market players worried the company could lose access to short-term funding. The result: CIT is being forced to draw on its $7.3 billion in backup, unsecured bank credit lines. If you recall, we saw Countrywide Financial do something similar last August when it experienced funding pressures in the market.

The moral of the story? Every time you think you have the credit market turmoil and problems licked, another "mole" pops up.

We just got a look at home construction activity in February. The devil is really in the details here, so allow me to explain:

* Overall housing starts came in hotter than expected -- 1.065 million units at a seasonally adjusted annual rate. That was above the 995,000 units that the markets were looking for. Moreover, January's number was upwardly revised to 1.071 million. But starts are still down 28.4% from a year ago (and 53.5% from their January 2006 peak of 2.292 million). Also ...

* Building permit issuance dropped sharply -- from 1.061 million units in January to just 978,000 last month. That's the lowest level since September 1991 (974,000), down 36.5% from the year-earlier level, and off 56.8% from the peak (2.263 million units in September 2005). Since permit issuance is an indicator of future construction, we will likely see starts fall further.

* Now, let's dig even deeper into the starts figure. When we do, we see that the strength was in the more volatile multi-family market. Specifically, multiple-unit starts were up 14.4%. Single-family home starts, on the other hand, dropped sharply again -- 6.7% on the month to 707,000 from 758,000 a month earlier. That leaves SF starts at the lowest level since January 1991 (604,000).

* And what about permitting? There, the news was bad for both MF and SF -- down 10.8% on multi-family permits and 6.2% on single-family.

Bottom line: Yes, the report was "better than expected." But no, it doesn't show an end to the slump in the single-family home market.