The Next Leg up in Financials 41 comments
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Asking the right question at the right time is not an easy thing to do, but when investors can do it, big profits will follow. Currently, the most important question not being asked is this: ‘What happens to bank financial statements when a toxic mortgage gets refinanced?’
The implications of this question may very well pave the way for the next leg up in financials. At a time when most analysts are expressing concern that record amounts of refinances at such low rates will negatively affect bank earnings in the long run, I have a different take. I believe that these record number of refinances are more important than any government program to lead the way out of this crisis.
When a toxic mortgage has been written down to .40 on the dollar, why would a bank sell it through the government's program of TALF or PPIP for .60 on the dollar? Sure they make up some of their loss, but there is a better way. When that loan simply gets refinanced, the original loan comes off the books and is replaced by the new loan which is now fully priced at 100 cents on the dollar. The implications of refinancing are massive for the banking sector. In a crisis that was caused by toxic mortgage securities, the solution can be 100% accomplished by refinancing the toxic. You wonder why nobody is jumping out of their seats to participate in Geithner’s rescue plan? It’s because the banks can fix this thing by themselves and they can do it better.
The #1 item on the agenda for bank CEOs is to refinance every bad mortgage on their books. Not only do they collect the fees, but the effect of these writeups on their financial statements will restore them to full health. This is why Bank of America will rise from its low of $2.50 back to $20 and beyond. This is why companies like Citigroup and Etrade will return to prior norms as well. The banking stocks have been on quite a run lately and that run is going to continue. It’s important to remember that we began at distressed levels and it will take time to climb back up. This isn’t going to be a two week rally.
Analysts on the street were confused as to why Etrade decided to restart mortgage lending last month. The consensus feeling was why would they ever want to get back into the business that took them down? Some thought it was an effort to increase their chances to receive TARP funds, but they’re missing the key issue. It’s because they want to refinance every single loan that they have on their books. Etrade isn’t even doing it themselves. They hooked up with a third party mortgage outsourcer PHH Corp to do it for them. Etrade announced that the program will be targeted to current customers! Ding ding. This allows them to transfer the toxic stuff to PHH for 100 cents on the dollar. The best thing our government has done is to manipulate rates lower. By so doing, the banks control their own destiny towards recovery.
From now on, when you hear the reports of record numbers of refinances you will view it from a new perspective. When you see Bank of America CEO Ken Lewis smiling as he says Countrywide is totaling $5 billion per day in refinances you know what he’s really thinking. His loan portfolio contains $700 billion in loans that have been aggressively written down. Refi, refi, refi...
Disclosure: Long C, BAC, ETFC
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This article has 41 comments:
Let me see if I understand your point. These banks are going to refinance the loans of people that are either behind in payments, unemployed, underwater, initially lied about their income, or are already in foreclosure, and that's going to improve the banks balance sheet? Bet these people have excellent FICO scores. I don't follow your logic. I think I'll buy some FAZ.
Man you have some misleading information in your post that you need to correct.
You are inferring that E-Trade will be transferring there mortgages at 100 cents on the dollar to a 3rd party and wont have any write-downs. This is categorically false. The 3rd party who is targeting there current customers is simply targeting them for new mortgage or re-finance business.
This will have no effect whatsoever on there distressed or de-valued assets.
I like E-Trade - but you are throwing out some categorical mistatements in a widely read forum and should know better than to do that.
But there will always be some who cannot refinance (due to house valuation or personal financial trainwreck reasons). Those are what the TALF was designed for, and will be used for, even at 40-60 cents on the dollar.
I do think the bad ass stuff will still be there as a nightmare to someone, the financials or the tax payer, either way its a trillion out of the upside of the economy.
Ain't gonna happen cause Obama said so
On Apr 15 08:22 PM mcl_mixer wrote:
> ‘What happens to bank financial statements when a toxic mortgage
> gets refinanced?’
>
> Let me see if I understand your point. These banks are going to refinance
> the loans of people that are either behind in payments, unemployed,
> underwater, initially lied about their income, or are already in
> foreclosure, and that's going to improve the banks balance sheet?
> Bet these people have excellent FICO scores. I don't follow your
> logic. I think I'll buy some FAZ.
I suggest you consult with proper bank analysts who are more familiar with the dynamics on bank balance sheets. Your article is very misleading. After 27 years of working for a leading bank, I know your statements are false.
This has huge potential for them in that aspect as well as new customers and fees too. Buit most importantly if they can get those loans onto another institutions books they can begin again to downstream their brokerage profits into EPS and paying off Citadel. In fact if they can start showing EPS it is likely they could replace the Citadel 12.5% financing too.
Long on ETFC and BAC.
Regardless of what gymnastics you do, even if you refi the loan at say $140K (no more 100% mortgages, eh?) AND assuming the borrower/homeowner can afford that level of debt, there is still a balance of $60K that is lost. Depending on how much the earlier writedown was, there may or may not be an impact to the earnings statement or balance sheet.
If you have a loan loss provision and use it, you've still lost $60K.
True, the new mortgage may be carried at par, but it's still worth only $140K.
In one sense, since you are trading a loan loss provision for closing out a loss, you might look better on a balance sheet basis and perhaps provide more confidence going forward, but the bank has still eroded its capital base.
At any rate, the logic behind this whole article is non-sensical. Loans are written down for a reason....the reason being that there is a high probability that the borrower will default on interest and principal payments on the loan. Refinancing will do nothing to change this probability. Restructuring can potentially change the probability, but in most cases, will result in a writedown anyway (albiet, maybe smaller).
Frankly, I'm surprised this article made it to the mainstream public, due to the flawed logic. I thought these things were vetted first by the admins before publishing?
a) A bank has lent money to an individual, the house of that individual being held as collateral ("A mortgage").
b) If that loan is now held on the bank's book for 40 cents on the dollar, that would mean, from my perspective (As a _layperson_), that the bank (Or the market) thinks that there is only a 40% chance of getting that money back.
c) That bank now offers to that same individual who would only repay the original loan with a 40% probability a new loan to replace the original loan, with other terms.
d) That new loan will then be held on the balance sheet of the bank at 100 cents on the dollar, which would mean an estimated 100% chance of getting paid back by that same individual?
I do not think that that makes sense at all. Even if the bank was legally allowed to hold that loan at 100%, which it might (I do not know), the resulting balance sheet would not reflect the true financial situation of that financial institute, in my opinion.
Note that I am certainly _not_ a financial expert.
My own experience with attempting a re-finance at these historically low rates has been thwarted by a decided lack of equity in my house after the RE market plunged where I am in one of "those markets."
My only hope to refinance would be to throw in more equity myself...not bloody likely.
Jason, if you can mobilize 41% of everyone you feed this rubbish to, you can be on your way to being another Bernie Madoff!
That's why the government is stepping in and offering to subsidize the underwater portion of the loans to banks that are willing to refinance the original loan.
On Apr 17 01:58 AM ifuwish2 wrote:
> mcl_mixer i dont understand why you cant see why if someones house
> payments are $1200.00 a month and they refinance it and their payment
> is $800.00 now that they can pay their mortgage payments now. the
> banks then make 100% on the bad loans now so i guess some people
> still have no concept of the idea. it may be quite complicated for
> some,,,,so you buy your faz and ill buy the stocks and see who makes
> more..this is a win ,win situation for the banks
This author is assuming that underwater loans are able to be refinanced which is far from the truth. Toxic loans are, by definition, underwater loans, quite possibly either in foreclosure or in the beginning stages at the least. Unless someone subsidizes the underwater portion, it's gonna be a loss for someone, somehow.
The only other option, and in my opinion, more of a fair one, is for the government to step in and somehow either subsidize or guarantee the loan, giving the bank that's willing to finance the loan a percentage of loan guarantee, if they allow the debtor to refinance at a lower interest while somehow adding the underwater portion to the back end of the loan by an emergency extention of some sort(perhaps from 30 years to 40 years). Of course this would change the ammortization a bit.
The bank would be on the hook for a portion, the debtor would be on the hook for the loan itself, which they got themselves into in the first place, and the government would be on the hook as well(while they would need to guarantee something to give the bank a reason to refinance).
The reason I favor that plan is that the average Joe shouldn't be forced to subsidize people's loans that they shouldn't have been getting a loan for and that they weren't sure they couldn't afford after the teaser rate expired(normally a four year duration that finally adjusted in 2007 or so), and the banks should never have given a loan to them in the first place. They would both be on the hook.
This plan would slow the process of foreclosures which is the root cause of this financial crisis.
Just a quick recap, in my opinion, as to what has happened since late 2007.... a bunch of houses have been foreclosed on, so many, in fact, that supply has far outstripped demand due to the fact that not many buyers can either afford one or their credit is shot. This has even further accelerated the decline in housing prices which has spread as more and more have been foreclosed.
The way it was working up until this point is banks were making loans to people that couldn't afford them, and over the course of a few thousand or so took them and sold them as a big lot of "securities" to investors, who hired loan servicers to collect on the loans. The people that bought these loans always had a clause on the contract that said that if the securities values fell below a certain point, the bank had to buy them back. This is where AIG and friends came in. They insured the loans for the banks and got paid by the banks which is why they were making such obscene profits because the prices kept going up and they didn't have to worry about foreclosures until around 2007 when a lot of the 2002/2003 loans 4 or 5-year teaser rates started adjusting.
As it started spiraling out of control, and this is something I think I just started to figure out, AIG got bailed out by the government due to the fact that they were so far wrapped up in the CDS's with the banks and friends. That's why the government felt they had to bail them out. Of course there are lots of things that AIG has their hands on, but I think it's all peanuts compared to the securties and CDS's.
Furthermore, the additional money that AIG has continuously been given has, as we have now heard, been funnelled over to GS, JPM, and friends, which would not have happend had AIG gone under as GS, and JPM and friends wound up getting paid for the securties losing a ridiculous amount of value.
The real question in my mind is, where did all the money go, because it had to go somewhere. Think of all the buying of houses and securities as a big ponzie scheme. The people that got out before it crashed are filthy rich. But everyone is acting like they're broke, which most are. But someone has a lot of money.
Their problem before was HELOCs not 1st mortgages that they originated that weren't on their books.
What really needs to be known is how these mortgages have already been written down. If it's to $.40 on the dollar because of mark to market, they may very well get a huge bounce from refinancing. If the mortgages are written down to what they're really worth, then there would be no real bounce on a restructuring, and there won't be a "refinance" because you wouldn't refi at the same $$$$ level for a borrower who has no job or bad credit or whatever.
Banks have shown themselves to be incredibly stupid. I bought a foreclosure, but waited 45 days for responses on several homes, and the lenders clearly had no idea what the assets were worth...hire some realtors as asset managers, and be quick to respond, that's how to make money.
It really goes down to the fundamental difference between mark to market and mark to [insert fun name here: model, magic, whatever]. Specifically, there is a reason why securities trade at the prices they do. It's because there is a real risk that losses will materialize. Repricing them, or changing how you price them, does not alter this truth.
Imagine, for instance, that you are
I'm really curious to see how we'll deal with any problems that next arise in the credit card and student loan assets (if they do, as many expect). There will be no associated assets to bank their longer term valuation hopes on. They are unsecured general obligations - will they "mark-to-i'm sure that individual really doesn't want to hurt their credit score so they're just bound to pay it off at some point?"
Most of these banks really deserved to go out of business. Systemic risk or not, this is one of (if not the biggest) examples of moral hazard in US corporate history. I used to work in a group that sat next to the home equity ABS syndication and trading desks of a large bank, and what most folks don't realize is that they purposefully *wanted* to keep many of the riskiest, junkiest tranches of mortgages. Sure, they sold a lot, but in many of these deals the banks kept a very large percentage. They drank their own kool-aid about the mathematically low probabilities of losses and relied on the great equity-like yields of these securities. Why then do they get bailed out of these mistakes, when the investors who bought and own the same security got crushed? (and by the way YOU'RE the investor that go crushed).
Imagine GS (nothing against them, just an example) led the IPO of a stock at $50, and kept 25% of the issue for itself. You, joe the investor (either directly or though a mutual fund) bought the shares. Prospects were great, which is why they kept so much for themselves. Then, the stock tanks to $5. GS pleads to the government that that's not the "real value" and please let them mark it at... uhhh... how about $25? You, however, have lost 90% of your money. If that stock recovers and starts trading at $30 again, what do you think the chances are that GS will still be marking it to the model that priced it at $25? And the whole reason why the liquidity declined in that market to begin with? It's because the funds that bought those securities went under. So let me get this right: I create a security, I sell it to people, I trade it with them, it becomes worthless and they lose all their money so I lose my counterparties, I get a pass because I can't trade it to anybody because what I sold them made them go bust... hmmm. It's like robbing all the convenience stores in the country and then asking the government to bail you out when you've put all the convenience stores out of business. Not only that, the convenience store owners pay for it in taxes. Awesome. But I digress...
While the financial stocks have and might continue to enjoy some good performance in the near term, many of them I struggle to view as sound investments. I'd rather buy somebody who makes widgets, who I at least know that their entire existence doesn't hinge on FASB accounting freebies and government handounts.
On Apr 16 04:41 PM Mr. Big wrote:
> Are we talking about refinancing mortgages or restructuring mortgages?
> ...because they are not the same.
>
> At any rate, the logic behind this whole article is non-sensical.
> Loans are written down for a reason....the reason being that there
> is a high probability that the borrower will default on interest
> and principal payments on the loan. Refinancing will do nothing to
> change this probability. Restructuring can potentially change the
> probability, but in most cases, will result in a writedown anyway
> (albiet, maybe smaller).
>
> Frankly, I'm surprised this article made it to the mainstream public,
> due to the flawed logic. I thought these things were vetted first
> by the admins before publishing?
On Apr 17 01:58 AM ifuwish2 wrote:
> mcl_mixer i dont understand why you cant see why if someones house
> payments are $1200.00 a month and they refinance it and their payment
> is $800.00 now that they can pay their mortgage payments now. the
> banks then make 100% on the bad loans now so i guess some people
> still have no concept of the idea. it may be quite complicated for
> some,,,,so you buy your faz and ill buy the stocks and see who makes
> more..this is a win ,win situation for the banks
1. What about the trillion + dollars of option ARM resets that are due in the next two years that havent even as of yet hit the banks' books as "toxic assets"? Oh, I know, we can just get E-Trade to refi those too... Borrowers that are currently barely able to make INTEREST payments at teaser rates let alone interest and principal at adjusted rates. Borrowers that are so far under-water it would take them 30 years to dig themselves out of the holes they now find themselves in just to break even. And those are the borrowers with "best of" circumstances... what about everyone that now finds themselves without jobs and now lives off of unemployment? Not a very pretty scenario...
2. Who exactly are the "bag holders" in your proposed scenario? Not one mention of that... Guess it doesnt matter right, as long as you get your run in banks and balance sheets are shored up for the next few quarters, huh? Seems to me you would have done quite nicley in Madoffs firm, or better yet a high ranking US policy maker, pushing your problems as far down the line as possible until you simply can't push any further. Uncle Sam would be proud.
3. You seem to imply under your rosy scenario that all banks have already discounted mortgages 40 cents on the dollar, and somehow have these tidy rainy day accounts all set to go that the other 60 cents are sitting in if somehow they need to take the actual losses on these clusters of bad loans. Nothing could be further from the truth! Don't you get that one of the major problems with bank balance sheets now is that they HAVE NOT discounted bad loans to proper levels!? In most cases, they have only written them down to between 90-98% of bubble levels. Of course, who is going to argue with that? They have been enabled by the Fantasy Accounting Standards Board (FASB) and limitless injections of taxpayer TARP funds, so there is really no telling how long many of these banks will be able to keep these shenanigans up. With Obama nominating Herb Allison to head the Treasury Tarp office, I imagine they have now set longer term goals of pulling the wool over the publics and investors' eyes..
You may end up getting the run up on banks you want in the short term Jason, but it wont be because of the refinancing scheme proposed in your artice. Furthermore, it wont last. Take those profits you plan on making and do something good with them. Maybe donate something to charity. Of course I'm sure that won't happen, because your shortsighted profit seeking that is so prevelent today in American society is what got us all into this mess in the first place
The stocks Jason talks about as well as 35 plus other low priced stocks that are preparing for a major run-up are part of my Slumdog Millionaire portfolio which has had a return of 10.4% since I published it on April 8, 2009.
Now long when the stock is at 11 $ .
Verry intelligent, with this strategy we make a lot of money.
Or maybe the pros???
This is a great time to build long term positions...the financial crisis is over and Obama's going to bring some new optimism
Is the crisis now over?
On Apr 17 12:33 PM optionsgirl wrote:
> I have a question and would appreciate responses. How can these banks
> borrow money short term at low or almost zero interest, and turn
> around and lend Long term at artificially low rates? Won't they dig
> themselves into another grave that way? Please, explain.
Unfortunately what this article does not point out is that a lot of people are already underwater. As such they cannot refinance, even at lower rates, at least not without a government program. The government is actually providing such a program, but I believe it will still require people to have jobs. Since the unemployment picture is worsening (and is likely to continue to throughout this year), those many, many people who most need to refinance are likely still to be unable to.This means more foreclosures.
The huge amount of refinancing is a good step for the banks. It should help everyone longer term. However, it by no means solves all of the banking woes. There is a lot more pain to come. Plus the credit card business is supposed to be a huge drag this year as unemployment worsens. Ditto the commercial real estate loans. This area is predicted to implode this year. Common sense tells you that with 5% fewer workers actually working (i.e. 10% or more unemployment), you should get a cut in demand for commercial real estate of 5% or more. Many businesses are seeing cuts in demand for their products by 30% or more. S&P500 earnings are predicted to be down 37% in Q1. This will have a much bigger than 5% negative impact on commercial real estate prices. Currently the impact is being felt most by mall owners. If too many of a mall's businesses close, the mall is soon in financial trouble. It is unlikely that the mall is going to be able to sign up new businesses easily in this environment. You can see the problem.
The bottom line is that banks are still in trouble. Still a good step in the right direction is still a good step.