Consumer Slow Down?

Consumers Clench Their Wallets
Worries over mortgages and higher gas prices are starting to show up in their spending. And from Tiffany's to Wal-Mart, retailers are feeling the pinch
by Pallavi Gogoi
BW Exclusives
At first blush, it's easy to overlook the lackluster results posted by luxury jeweler Tiffany & Co. (TIF)—flat income and 15% sales growth, the stuff of a tepid quarter at a retailer known for its affluent and loyal clientele. Yet a closer examination of Tiffany's performance offers an interesting peek into how the folks who shop there—a broader demographic than many people realize—are starting to behave amid new economic uncertainties.
In fact, recent earnings and sales numbers released by Tiffany and other stores, such as J.C. Penney (JCP) and Macy's parent Federated Department Stores (FD), offer signs that the middle class is starting to show spending restraint. Climbing gasoline prices are already hurting lower-income consumers, who have responded by curtailing their shopping at retailers like Wal-Mart Stores (WMT). Even such inexpensive stores as Dollar General (DG) are feeling the pinch.
But the current slump in the housing market seems to be sapping some wind from the credit-card sails of middle-income shoppers. "People are worried about housing and the mortgage situation," says David Wyss, chief economist of Standard & Poor's, which, like BusinessWeek, is a unit of the McGraw-Hill Cos. (MHP). "And home mortgages are more of a middle-class issue—the rich usually don't have mortgages, and the poor rent."
No Slowdown for the Rich
And if the middle class is looking for some comfort, it hasn't come yet. The U.S. Commerce Dept. reported on Mar. 26 that sales of new single-family homes fell by 3.9% in February, to a seasonally adjusted annual rate of 848,000, the slowest sales pace in nearly seven years (see BusinessWeek.com, 3/26/07, "A Nasty Surprise on New Home Sales").
All regions of the country except the West experienced weakness last month. The February decline followed an even larger 15.8% sales drop the previous month. "When people have jumbo mortgage loans to pay off and also higher costs of health care, child care, and other services, you just can't afford any overheads," says Richard Hastings, vice-president and senior retail analyst at Bernard Sands. "I call it the trickle-up effect."
At Tiffany, the super-rich continued to spend at a prodigious pace—the average price per item sold in the U.S. rose to $91,000 from $81,000 in 2005, a 12% increase. However, those slightly lower on the income scale appear to be holding off on new Tiffany treats in the face of uncertainty.
General Restraint
It showed in the sales data: At the lower end, the average price per unit sold of Tiffany's silver jewelry in the U.S. rose just 2%, to $191 last year, vs. $187 in 2005. "We've noted a greater than expected shift in sales mix towards higher-end jewelry," Mike Kowalski, chairman and CEO of Tiffany, said in a Mar. 26 conference call discussing the results. The New York company's net income for its fiscal fourth quarter ended Jan. 31 barely budged, to $140.5 million, from $140.3 million last year on sales of $986.4 million, a 15% increase over last year's $858.4 million in the same period. Tiffany executives say higher cost of precious metals and diamonds ate into margins in the quarter.
Besides Tiffany, sales at other stores also seem to point to emerging signs of consumer restraint. J.C. Penney, the Plano (Tex.) department store chain favored by middle-income shoppers, reported a 0.2% decline in February sales at stores open at least one year, a key retail metric known as same-store sales. And Macy's parent Federated's sales rose a mere 1.2% in the same month, below the company's own guidance for a same-store sales increase of 2% to 3%.
Overall, shoppers generally shied from spending. The Commerce Dept. reported that in February, sales fell 0.3% at electronic stores, 1.2% at restaurants, 1.8% at clothing stores, and 1.7% at furniture retailers (see BusinessWeek.com, 3/15/07, "Consumers Feel a Chill").
Crunched Credit Scores
Analyst Michelle Tan of UBS (UBS) Investment Research believed that the mess in subprime loans would have a negative effect on housing-related retailers and reiterated her "reduce" ratings on home-improvement stores Home Depot (HD) and Lowe's (LOW). "We expect broader implications of the subprime fallout to remain limited to housing-related categories," Tan wrote in a Mar. 26 report.
On the lower end, the pressure is already showing. Wal-Mart, the world's biggest retailer, saw same-store sales rise an anemic 0.9%, missing its prediction for a 1% to 2% increase in February. And on Mar. 26, discount retailer Dollar General said its fourth-quarter profit fell 66%, to $50 million, on the costs of store closings and reduced prices.
Dollar General earlier this month agreed to be purchased by private equity firm Kohlberg Kravis Roberts. Clearly, people are hunting for deals at the lower end too. And even though short-term interest rates are falling, low-income consumers may not be benefiting. "Even if stores give 0% financing, many lower-income folks might not have credit scores that are good enough for them," says Hastings. "People are stretched."
Gogoi is a contributing writer for BusinessWeek.com.

Foreclosures Continue to Climb

The number of national foreclosure filings was up 4% in February as Nevada reported the highest state foreclosure rate for the second month in a row with a 24% monthly increase from January, according to RealtyTrac.A total of 130,786 foreclosure filings were reported during the month, down 4% from January’s revised total but still up 12% from February 2006. The national foreclosure rate stood at one foreclosure filing for every 884 U.S. households in February, according to the foreclosure tracking company.RealtyTrac considers default notices, auction sale notices and bank repossessions as foreclosure filings."Based on our numbers for the first two months of 2007, foreclosure activity is running at a rate that would project to a 33 percent increase over 2006," said RealtyTrac CEO James J. Saccacio."It appears that as subprime and FHA loans default at higher than anticipated rates, and lenders tighten their underwriting standards, we're going to continue to see a spike in the number of homeowners facing foreclosure."A 24% increase in monthly foreclosure activity kept Nevada in place as the nation's highest state foreclosure rate with for the second month in a row with foreclosure rate of one foreclosure filing for every 278 households In February, Nevada reported 3,124 foreclosure filings, up 77% from February 2006..Colorado followed with one foreclosure filing for every 345 households in February, a 9% month-to-month increase with 5,310 total foreclosure filings.Florida foreclosures skyrocketed more than 63% with 19,144 foreclosure filings – the most of any state - reporting one foreclosure filing for every 382 households.
The Top Ten Foreclosure Rates:

1. Nevada
2. Colorado
3. Florida
4. Georgia
5. Michigan
6. Tennessee
7. Ohio
8. Texas
9. Arizona
10. Indiana.

Pay my closing costs.

With the real estate slowdown coming into full effect and unsold homes amassing into glutted inventories across the nation, a new survey asked homebuyers what sort of incentives would make the sale. A free vacation? Free appliances? The answer came back loud and clear: pay my closing costs.Given a number of choices between various incentives commonly being offered these days, 77% of respondents chose “closing costs paid.”At a very distant second was “free upgrades,” with 9% of the vote, followed by “free property inspection” with 6% of responses. The results of the national survey, conducted by HouseHunt, Inc., may not be entirely surprising. Other surveys found that the closing process is a predominant source of anxiety for many consumers, who are often afraid of new fees springing up suddenly.Michael Bearden, president and CEO of HouseHunt, Inc., sees a more practical reason why the responses were so one-sided.“Not surprising, this would represent a bottom-line savings of several thousand dollars in normal closing cost fees and services,” noted Bearden. “As a result, today’s consumer buyer can afford to be more patient and more selective in the home buying process,” Bearden said. “Successful buyer incentives are more bottom line, like free closing costs and free upgrades…The frantic seller market activity we saw in the past few years is gone and is not expected to return anytime soon.” Survey Question: What Is Your Number One Incentive In Buying a Home Closing costs paid 77% Free upgrades 9% Free property inspection 6% Free appliances 3% Flooring credits 2% Paid trip/vacation 2% Landscaping credits 1%

New Home Inventory Up Despite Low Rates

Total New Home Inventory: 546,000 availableOne Month Change: Up 11.0% One Year Change: Up 26.6% Supply at Current Sales Pace: 8.1 months

Source: U.S. Commerce Department

What's that sucking sound?

I read an interesting report this morning written by an analyst who has actually put some thought into the aftermath of the subprime implosion. By his calculations, the subprime firms who have gone out of business generated approximately $280 billion of loans last year, a little more than 9% of all loans funded. The combination of these firms going out of business and tightened lending standards are creating a void in the amount of mortgage backed securities that were issued using these loans as collateral. Investors who purchased these securities will now have to look elsewhere for investments and borrowers will need to search for alternative financing. Many of these borrowers could end up in FHA or VA loans, except of course in high cost areas, and still others may choose the FNMA or FHLMC programs targeted to low income or credit impaired borrowers. So, while the no down payment, stated income, poor credit loans are gone, there are still alternatives available for the average home purchase.

The greatest concern is for the borrower with average credit looking to qualify in high cost areas such as CA, FL, NY. Even with six figure incomes we are finding that 100% programs are disappearing rapidly. The most aggressive programs are requiring clients to put at least 5-10% down. Many potential home buyers that have come out of hibernation are finding that they don't meet the new lending requirements. The smart ones are working on plans to save for down payments. The median priced home in Los Angeles last quarter was 586K. With 5% down and six months of reserves, the average borrower has to squirrel away over 50k and have an income of 150k to buy the average home on a standard 30Y fixed. As you can see, millions of potential buyers are unable to qualify under the current lending guidelines with the enormous run up in home prices. What does this do to the price of housing on the market? That sound that you heard earlier is the air rapidly escaping from the housing bubble.

Homes aren't like stocks, they don't fall that much. Do they?

This chart was compiled from an FDIC report. It's easy enough to dismiss the evidence from the oil patch, if you want to. Prices there were forced down by an unusual, and very local, economic shock. The economies of L.A. and Boston are better diversified. Then again, if the oil boom-and-bust of the 1980s was an anomaly, what should we call the easy-credit-driven housing inflation of the early 2000s? Liar loans, interest-onlys, option ARMs, and aggressive subprime lending have changed the rules. We don't know how some people will handle these mortgage loans in a falling real estate market with many loans resetting to higher rates. Do they walk away?Do they buckle down and take a second job to make ends meet? History wouldn't seem to be a very reliable guide right now.

Foreclosures:Just the beginning.

National figures point to a rise in foreclosures. Of course this chart represents the entire 8 trillion dollar mortgage industry. The foreclosure rate among sub prime mortgages which represent approximately 20% of the mortgage market is about 5%.

We are increasingly seeing lenders realize that as loans begin to adjust the homeowners are experiencing payment shock, rapidly forcing people into late payments and exacerbating the tight financial situation in middle class households. This is forcing people to desperatly try to refinance their mortgage or put their home up for sale. The amount of homes for sale will dramatically increase as $1.5 trillion dollars of adjustable rate mortgages reset this year and force people to downgrade or leave the dream of home ownership behind altogether. I think the old maxim holds true that things usually get worse before they get better.

Greenspan states subprime risk to spread.

Ex-Fed chair says woes could spill over into other sectors; sees problem of high housing prices rather than mortgage quality.
March 15 2007: 2:16 PM EDT
BOCA RATON (Reuters) -- Former Federal Reserve Chairman Alan Greenspan said on Thursday there was a risk that rising defaults in subprime mortgage markets could spill over into other economic sectors.
Speaking to the Futures Industry Association, Greenspan conceded that it was "hard to find any such evidence" about spillover from housing yet. But he added: "You can't take 10 percent out of mortgage originations without some impact."
Greenspan said the downturn in U.S. housing markets appeared to stem more from high housing prices than from a decline in mortgage quality but said he was not downplaying problems in so-called subprime loans.
He said that subprime woes were "not a small issue" and seemed to result primarily from buyers coming into lofty housing markets late after big price runups that had left them vulnerable to hikes in adjustable mortgage rates.
In his remarks, the ex-Fed chairman declined to comment on interest rates or current Fed policy.

How did this all happen?

The lending community had become complacent with a Wall St investment community that had an enourmous appetite for subprime and ALT-A mortgage paper. The lenders only acting as repackagers would bend guidelines to keep the volume growing. The number of mortgage lenders increased dramatically during 2004-2006 this resulted in no pricing power to compensate the lenders and the Wall St banks that purchased the loans for the added risk. The lenders and banks were scrapping the bottom of the barrel of borrowers during late 2005 and throughout 2006 to keep loan volume growing or stable because every company along the way was selling off the risk to other parties but would reap billions in fee revenue on the deals.

Then the party ended when the defaults finally appeared. Folks who took these loans were told that they could refinance into lower rates when their credit or property values increased. With falling real estate prices and loan programs disappearing by the day this won't happen for millions of families. The punch bowl is being removed and homeowners are waking up to the sober reality of losing their piece of the American Dream.