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PCBB Banc Investment Daily February 01, 2013
Banc Investment Daily
February 01, 2013

THE GROUND HOG'S LONG SHADOW ON HOUSING

The ground hog, also known as a wood chuck, is a mammal found throughout most of North America. They are a bit bigger than a cat, are primarily vegetarians, eat wild grasses and nuts, agricultural crops and the occasional bug or snail. Ground hogs are wonderful diggers and live in underground burrows. It is well known that the most important day in a ground hog's life cycle is each year on Feb. 2, when it emerges from its burrow to determine the medium-term weather outlook for the country.
This special day was immortalized in the 1993 film Groundhog Day staring Bill Murray. In the film, Murray's character Phil, a television reporter, despises one particular assignment over all others - the coverage of Ground Hog Day in Punxsutawney, PA. Due to his bad conduct while reporting the event, Phil becomes magically involved in a time loop in which he repeats the day he hates, until he makes personal and professional progress.
Because of the film, "Ground Hog Day" has become a metaphor for any unpleasant situation that seems to continually repeat itself. It has been used by groups as divergent as the military for the passing of each day on tours of duty, or ex-British Prime Minister Tony Blair quipping after a number of inquiries by political opponents.
Many bankers too, have felt they are living in a Ground Hog Day cycle of their own for a number of years now. We know the macro and micro economic aspects of this all too well, and no one will deny that the landscape of banking has changed forever.
Many banks began with the implosion of their loan portfolios, as even high-quality borrowers could no longer keep up with their obligations. Some would argue that the biggest part of the economic contraction has been in the housing sector.
Earlier this week, it was decreed by the economic intelligencia that the housing market had decisively turned. The evidence cited was 10 consecutive months of improvement in the Case Shiller Home Price Index, plus 6 year-over-year price increases. Indeed, with prices up in almost every metropolitan area, improvement is widespread and hopefully sustainable.
However, the depth of the housing contraction cannot be understated. Nationwide, home prices are still about 30% below their Apr. 2006 peak and prices are similar to where they were in Sep. 2003. This crucial part of the economy that drives so many others has taken so long to turn, that we celebrate prices that have only recovered to the level of 10Ys ago.
The consequences of what has happened to the housing market are multifaceted. Regulations have driven many small mortgage firms out of business and banks must comply with a far more complex set of rules. Most home loans are also consolidated with only a handful of big banks.
We've seen Fannie and Freddie go from implicit backing by the Federal government, to near bankruptcy, to pretty much full backing. We have seen mortgage rates driven lower and lower by the Fed, in an effort to spur the economy through refinancing. We have seen MBS and CMO's - the pillars of bank investment portfolios - hit by low yields and high prepayment speeds, damaging returns. It has all added up to a significant challenge for community banks.
In the end, the film Groundhog Day is seen by many as a tale of self-improvement. No one will deny that the mortgage business had been frothy, with little consideration to either credit risk or fallout down the road. We have all learned some lessons. Let us hope that we really are moving toward the end of the housing market's Ground Hog Day.