Reality Check for Bank Investors, Mortgage Investors and Home Buyers

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 |  Includes: BAC, C, FMCC, FNMA, GS, IYR, JPM, KME, MS, PNC, WFC
by: Reggie Middleton

Last week I posted a Bloomberg news article supporting my suspicions that investors are putting bad loans back to the banks at an increasing rate. I used JP Morgan (NYSE:JPM) as a specific example - Banks Swallow Another $30 billion or So in More Losses as Their Share Prices Surge (Again).

A few commenters on syndicated sites appeared to have really underestimated the significance of this development. In the article, it is alleged that Freddie (FRE) and Fannie (FNM) are forcing banks to eat up to $30 billion in soured mortgages under the warranties and representations clauses of the sales contract. To highlight the significance of this development, let me remind all that Fannie and Freddie are benchmarks for mortgage lending in the US.

(Bloomberg) -- Taxpayer losses from supporting Fannie Mae and Freddie Mac will top $400 billion, according to Peter Wallison, a former general counsel at the Treasury who is now a fellow at the American Enterprise Institute.

“The situation is they are losing gobs of money, up to $400 billion in mortgages,” Wallison said in a Bloomberg Television interview. The Treasury Department recognized last week that losses will be more than $400 billion when it raised its limit on federal support for the two government-sponsored enterprises, he said.

The U.S. seized the two mortgage financiers in 2008 as the government struggled to prevent a meltdown of the financial system. The debt of Fannie Mae, Freddie Mac and the Federal Home Loan Banks grew an average of $184 billion annually from 1998 to 2008, helping fuel a bubble that drove home prices up by 107 percent between 2000 and mid-2006, according to the S&P/Case- Shiller home-price index.

With this in mind, I want to parse the logic behind my posting the Fannie/Freddie issue in the first place. This is not about Fannie and Freddie, this is about all investors they have sold MBS and mortgages to as well as all insurers they have bought insurance from. The monolines are putting bad loans back to originators too. The administrators of loan pools, CDOs etc. also wish to minimize their losses. If the banks had to eat a 50% loss of all of the bad loans they have sold (which is at least a third of all of the loans sold from '05 to '08) then we are talking significant numbers. The loss rate on subprime mortgages is nearly 50% now.

Bloomberg : Real estate loans at U.S. banks that are at least 90 days overdue or that are expected to default almost doubled in 12 months to 7.1 percent, according to December FDIC data. Non- performing loans for construction and development rose to 16 percent from 8.6 percent.

...The sale of loans from failed banks in 2009 brought on average 43 percent of their book value, according to an FDIC summary. Non-performing loans, those on which the borrower has defaulted or there is little prospect of repayment, were sold for 26 percent of their book value on average.

In the meantime, the collateral behind these loans are still trending downward in value after many hundreds of billions of US tax dollars thrown at the situation. For residential values, see It's Official: The US Housing Downturn Has Resumed in Earnest, - If Anybody Bothered to Take a Close Look at the Latest Housing Numbers... and "A Fundamantal Investor's Peek into the Alt-A and Subprime Market". For commercial property values, see CRE 2010 Overview 2009-12-16 07:52:36 2.85 Mb.

Of course, this data invalidates the findings of the government SCAP stress tests for US banks (see links towards the bottom of this post).

Now, on to the latest data available for Alt-A and subprime mortgage performance.

The Facts as reported by the FDIC and the NY Federal Reserve Bank (their numbers, not mine)

  • Foreclosures on First Lien Mortgages increased from 11.5% as of 31st October 2009 to 11.74% as of 31st January, 2010.
  • Mortgage charge-off rates on Prime loans and Alt-A loans increased by 25bps and 21bps to 7.66% and 12.23% respectively over the same period.
  • Delinquency rates for first lien mortgages on the other hand decreased by 7bps to 5.6%, for the quarter ended December 31, 2009.
  • While Net Charge-off rates for Alt-A loans increased by 2.12% points q-o-q to 30.49% as on 31st Dec 2009, delinquency rates dropped by 27bps over the same period to 12.1%.
  • In the case of Subprime loans, Net Charge off rates and Foreclosure rates, both rose to 44.6% and 15.6% respectively during 4Q09, compared to 42.9% and 15.4% during 3Q09.
  • Delinquency rates declined from 26.4% in 3Q09 to 25.3% in 4Q09.
  • Net charge off rates for HELOCs rose 13bps to 3.34% during 4Q09 while delinquency rates had a negligible decline.
  • Net charge-off rates and delinquency rates for Business Loans (C&I loans) marginally declined during 4Q09 remaining more or less constant at 2.5% and 4.5% respectively.

    Delinquency rates under CRE loans remained steady during 4Q09 at 8.8% when compared with 3Q09. While delinquency rates for multifamily loans did not show any drastic changes in 4Q09, net charge-off rates under construction loans increased considerably from 6.3% in 3Q09 to 8.4% in 4Q09

    Credit cards had a better quarter with net charge off rates and delinquency rates showing marginal improvements in 4Q09. Net charge off rates declined from 10.2% in 3Q09 to 9.5% in 4Q09, while delinquency rates declined from 6.6% to 6.4% over the same period.

  • Other consumer loans showed a healthier 2.7% net charge off rate in 4Q09 as against 3.2% in the previous quarter. Delinquency rate in this segment also improved marginally, declining by 19 bps to 3.5% in 4Q09.
  • Net charge-off rates and delinquency rates for Other loans marginally increased. While net charge off rates increased from 1.7% in 3Q09 to 1.8% in 4Q09, Delinquency rates remained constant at 1.1% over 4Q09.

This is all against a backdrop of what was increasing home prices in many (if not most) MSAs for the quarters in question, which is a definitively positive development for it was the drop in home prices that precipitated much of the financial malaise of the last few years.

Click any graph below to enlarge.

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The direction of home prices has a very high correlation with foreclosures and delinquency rates (as well as unemployment), not to mention the trillion dollars or so of direct and indirect fiscal and monetary stimulus. While the delinquency data definitely shows a positive uptrend, when taken in light of what it took to get it and its correlation to home prices and employment (must read Are the Effects of Unemployment About To Shoot Through the Roof?), I believe we are definitely in a wait and see scenario with a potentially negative outlook.

In analyzing the performance of Alt-A and subprime loans, it is best to look at things against the backdrop of housing prices for the comparable period. As you can see, the trend for pricing is down for both the last quarter and December of 2009, and from my anecdotal research and extrapolation from the data sets will be down Q1-2010 as well as for some time after that. Thus, it is fair to say that the collateral behind these loans will continue to be challenged. As a result of this in combination with stubbornly high unemployment, there will probably be a decent amount of pressure on delinquencies. Things have not gotten better from a fundamental or macroeconomic perspective, thus at this point I do not see a sustainable upward trend. As I stated earlier, we are in a wait and see mode.

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As you can see, the residential housing uptrend is now apparently over, and we are resuming the downward descent.

Let's look at the improvement in delinquencies and losses as compared to home prices in the grand scheme of things, a bird's-eye view so to speak...

janimage032.pngClick to enlarge

Now, hopefully all can see what I mean in terms of the recent downtick in 30 delinquencies.

Loss Severity and Potential Loss Severity According to the Most Recent Data Points

Alt-A Loans

  • Total loan value of Alt A loans declined from $615 bn in 3Q09 to $590 bn in 4Q09, maintaining an average FICO score of 705 in both quarters.
  • In 4Q09, nearly 43% of Alt A loans had least one late payment over the past year, while 3Q09 had nearly 40.7% of such loans. In Florida nearly 57.2% of Alt-A loans had at least one late payment over the past year in 4Q09 followed by Nevada with 53.9% and California with 48.7%. The percentages were comparatively lower in 3Q09 at 54.5%, 50.9% and 46.5% respectively.
  • Nearly 8.2% of Alt A loans were 30-89 days past due during 4Q09, marginally higher when compared to 8.1% in 3Q09. During 4Q09, Rhode Island and West Virginia witnessed the highest delinquencies with 11.1% and 10.6% of loans 30-89 days past due, respectively.

    Alt A loans 90+ days past due increased to 12.1% of total loans in 4Q09 compared to 10.1% in 3Q09. Nevada and California had the highest 90+ days loans past due at 18.4% and 16.9% of total loans, respectively in 4Q09.

  • Total Alt A loans past due stood at 16.3% of total loans as of December 31, 2009 (30-89 days past due loans and 90+ days past due loans) compared to 14.6% as of September 30, 2009. Additionally, in 4Q09, 11.5% of Alt-A loans were under foreclosure, marginally higher than 3Q09 share of 11.1%. Share of REO loans were 3.0% in 4Q09, compared to 3.2% in 3Q09. There was an increase in the share of “Alt-A loans in risk of default based on pro-rata share” (based on weighted average foreclosure / past due loans and REO loans for each state with weights based on average loan outstanding at each state) from 34.3% in 3Q09 to 36.6% in 4Q09.
  • As of December 31, 2009, approximately 43.3% (43.0% as of September 30, 2009) of Alt-A loan outstanding originated on or before 2005 while 35.0% (35.2% as of September 30, 2009) and 21.7% (21.8% as of September 30, 2009) of loans were originated during 2006 and 2007, respectively. With S&P Case Shiller declining by nearly 17% , 28% and 28% since 2005, 2006 and 2007, respectively, most of these loans are still underwater and there has not been much improvement in view of the fact that average LTV at origination for Alt-A loans has been constant at 81% in 4Q09 as well. To estimate current LTV for Alt-A loans we have used housing price decline for each of these states (based on S&P Case Shiller Index with weights based on percentage of loan origination for each year) and LTV at origination to determine current LTV. As seen from the table below current LTV for Alt A loans in U.S is at 111.5% with California and Florida (which together account for 53% of Alt-A loans) having one of the highest LTV ratio at 115% and 126%, respectively. LTV for Alt A loans remained more or less constant compared to 3Q09.

alt-a_ltv.png

Note: The "total" line is actually a simple average.

Subprime Loans

  • Compared to 3Q09 when almost 66% of subprime loans had least one late payment over the past one year, 4Q09 fared worse with an increase in the category to 67.1%.
  • This is a very interesting tidbit that many probably did not realize. The total value of subprime loans outstanding drifted from $421 bn in 3Q09 to $403 bn in 4Q09 with a constant average FICO score of 616 in both quarters. California and Florida together constituted nearly 24% and 11% of total subprime loans followed by New York and Illinois. Despite these demographics, in Florida and New Jersey nearly 75.9% and 74.5% of subprime loans had at least one late payment over the past year. It appears as if the California/Florida coastal state combo are no longer the loss leaders in the subprime malaise. It is getting worse, and it is spreading!
  • As of December 31, 2009, 15.9% of subprime loans were 30-89 days past due, an improvement from 16.4% recorded as of September 30, 2009 (I sense this mostly due to the acceptance of short sales by the lender, which will end up as losses through the income statement – eventually). Mississippi and North Carolina witnessed the highest delinquencies with 19.7% and 19.5% of loans 30-89 days past due, respectively. Loans 30-89 days past due for California and Florida stood comparatively better at 11.6% and 11.9%, respectively. Again, the malaise is spreading outward and beyond the highly damaged coastal states.
  • At the national level, Subprime loans 90+ days past due worsened materially and significantly in 4Q09 at 20.2% compared to 17.7% in 3Q09. Nevada and Massachusetts having the highest 90+ days past due at 27% and 26.5% of total loans, respectively California and Florida were stood at 24.6% and 18.7%, respectively as of December 31, 2009. Again, the malaise is spreading outward and beyond the highly damaged coastal states.
  • Total loans past due for subprime stood at 34.3% as of December 31, 2009 compared to 32.9% in September 30, 2009. Foreclosed and REO loans stood at 13.9% and 3.7% (the REO numbers are highly suspect due to many reports on the ground indicating that banks are refusing to take back delinquent properties), respectively in 4Q09 as compared to 13.5% and 2.3% in the previous quarter. Overall, in 4Q09, 54.3% of subprime loans are in risk of default based on pro rata share (based on weighted average foreclosure / past due loans and REO loans for each state with weights based on average loan outstanding at each state), a deterioration compared to 3Q09 share of 52.6%.
  • As of December 31, 2009, nearly 49.5% of current subprime loans outstanding were originated on / before 2005 while 35.2% and 15.3% of loans were originated during 2006 and 2007, respectively. These percentages stood 49.2%, 35.5% and 15.2% respectively as of September 30, 2009. With S&P Case Shiller declining by nearly 17%, 28% and 28% since 2005, 2006 and 2007, respectively most of these loans are still underwater and there has not been much improvement in view of the fact that average LTV at origination has been constant at 84% in 4Q09. As seen from the table below, the current LTV for subprime loans is at 111%, with Michigan and Arizona having the highest LTV at 147% and 141%, respectively (again, the malaise is spreading outward and beyond the highly damaged coastal states). LTV for Subprime loans remained more or less constant compared to 3Q09, due to the short-lived upward blip in home prices.

subprime_ltv.png

Note: The "total" line is actually a simple average.

As can be seen from the chart below (3Q-09), there are still plenty of losses to be taken in these loan categories.

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So banks are doing well, after all their stock prices have gone up over 100% from last year's lows, right? You see, I am a fundamental investor, and the fundamentals say many of the banks are nothing but big, black, sinkholes. The stock market has decided to "all of a sudden" disagree with this assessment. I wonder why? Of course, FASB has allowed them to absolutely ignore everything in all of the charts you see above.

fasb_mark_to_market_chart.pngClick to enlarge

Reality is, after all, reality - and it will hit, sooner or later. At that time we will have a dot.com style moment, except we will be talking trillions of dollars instead of billions. For more on this, see "How Regulatory Capture Turns Doo Doo Deadly."

I have written A LOT on the topic of banking, fraud and bogus stress testing. The numbers that you see above reveal the stress tests to be a fraud, as does Barney Frank's admission that second lien loans essentially have no economic value (more on that later, I have alleged this for over 2 years now)...

The Truth! The Truth? Banker's Can't Handle the Truth!!!

Residential Lending Credit Losses Worsen as Unstainable Government Support Proves... Unsustainable

Welcome to the Big Bank Bamboozle!

About the Politically Malleable FASB, Paid for Politicians, and Mark to Myth Accounting Rules

At What Point Does Accounting Gimmickery Become an Outright Lie? Let's Ask PNC

If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It? Pt 5 - PNC Bank

You've Been Bamboozled, Hoodwinked and Lied To! Here's the Proof. What Are You Going to Do About It?

The Real Stress Test Results

America, You have been outright lied to! Bamboozled! Swindled! Hoodwinked! The Worst Case Scenario

The Truth About the Banks Has Been Released: the open source spreadsheet edition

The Re-Release of the Open Source Mortgage Default Model

Green Shoots are Being Fertilized by Brown Turds in the Mortgage Markets

Beware of Bank Earnings Propaganda - They are still in BIG trouble!

Banker Busted?

If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It? Pt 4 - Wells Fargo

Fact, Fiction, Farce and Lies! What happened to the Bank Bears?

PNC plus CRE = Doo Doo hitting the Fan

Other banks to look at with suspect portfolios:

JP Morgan Chase (JPM)

(Free Preview) JPM Public Excerpt of Forensic Analysis Subscription JPM Public Excerpt of Forensic Analysis Subscription 2009-09-22 14:33:53 1.51 Mb

JPM Forensic Report (092209) Final- Retail JPM Forensic Report (092209) Final- Retail 2009-09-24 03:12:17 130.93 Kb

JPM Report (092209) Final - Professional JPM Report (092209) Final - Professional 2009-09-24 03:13:31 550.72 Kb

Bank of America (NYSE:BAC)

BAC Swap exposure_011009 BAC Swap exposure_011009 2009-10-15 01:02:21 279.76 Kb

PNC Bank (NYSE:PNC)

PNC Report 050508 revised PNC Report 050508 revised 2008-08-30 06:38:42 711.95 Kb

PNC Report_update final - Pro PNC Report_update final - Pro 2008-10-15 13:21:22 590.98 Kb

PNC Report_update final - Retail PNC Report_update final - Retail 2008-10-15 13:21:38 337.21 Kb

PNC SCAP Results recast using FDIC and NY Fed data - Pro PNC SCAP Results recast using FDIC and NY Fed data - Pro 2009-05-15 07:31:21 455.37 Kb

PNC SCAP Results recast using FDIC and NY Fed data - Retail PNC SCAP Results recast using FDIC and NY Fed data - Retail 2009-05-15 07:30:25 395.18 Kb

PNC Simulated Government Stress Test PNC Simulated Government Stress Test 2009-05-01 13:09:19 664.87 Kb

PNC Stress Test Pro PNC Stress Test Pro 2009-04-13 02:10:17 3.11 Mb

PNC Stress Test Retail PNC Stress Test Retail 2009-04-13 02:11:08 323.51 Kb

PNC Stress Test update - Professional PNC Stress Test update - Professional 2009-04-21 15:55:56 3.00 Mb

PNC Stress Test update - Retail PNC Stress Test update - Retail 2009-04-21 15:53:52 777.50 Kb

PNC stress test write up - public lite PNC stress test write up - public lite 2009-07-27 02:37:11 995.30 Kb

Sun Trust (NYSE:STI)

STI update STI update 2009-09-03 06:33:371.08 Mb

Sun Trust Bank Report Sun Trust Bank Report 2008-08-30 06:39:22 391.89 Kb

Sun Trust Bank Stress Test Scenario Analysis – Government Simulation Sun Trust Bank Stress Test Scenario Analysis – Government Simulation 2009-04-30 03:43:18 665.82 Kb

Sun Trust Banks Simulated Government Stress Test Sun Trust Banks Simulated Government Stress Test 2009-05-05 11:37:13 1016.17 Kb

The Government Stress Test

The Supervisory Capital Assessment Program: Design and Implementation The Supervisory Capital Assessment Program: Design and Implementation 2009-04-30 02:16:44 286.90 Kb

Wells Fargo (NYSE:WFC)

WFC Investment Note 22 May 09 - Pro WFC Investment Note 22 May 09 - Pro 2009-05-27 01:56:54 853.53 Kb

WFC Investment Note 22 May 09 - Retail WFC Investment Note 22 May 09 - Retail 2009-05-27 01:55:50 554.15 Kb

WFC Off Balance Sheet Exposure WFC Off Balance Sheet Exposure 2009-10-19 04:25:53 258.77 Kb

WFC Research Note Sep 2009 WFC Research Note Sep 2009 2009-09-30 13:01:30 281.29 Kb

All subscribers can download the data that generated the graphs above here:

Click here to subscribe. The dataset contains a LOT of data to slice and dice, and is broken down by state, so you can actually back into your favorite bank's propspective portfolio performance if they give a geographic break up, like Wells. See the following screen shots. Click to enlarge...

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Disclosure: Short the tickers mentioned above