Earnings season is upon us and there will be the usual scrutiny attending each release. At a time like this in the business cycle, investors will be poring over the financial results to try and get a sense of whether or not we are at an inflection point in the recovery, one way or the other. Are the cyclicals on the upswing? How is the tech sector faring? Consumer staples? Financials? The actual numbers can help to give some context for the latest economic data and the information in the Beige Book, and it is particularly critical now that the Federal Reserve is about one-third of the way through QE2.
If we are looking for evidence of trends and cycle markers, however, we have to also remember to listen to what they say, not just what they report. Case in point is the earnings release of JP Morgan Chase (JPM) Friday morning. As it relates to the housing market, CEO Jamie Dimon called it “terrible” although better than it had been, and that the bank reserved another $2.1 billion for its WaMu loans and another $1.5 billion for litigation expenses to fight against private-label mortgage put-backs. On a call with analysts, Dimon said this is a long-term issue. “We will be talking about this for every quarter over the next three years,” he said.
The informed mind makes many mental leaps when reflecting on this fact pattern. There are the obvious connections, such as the potential economic ramifications of a subdued housing market and the ongoing costs—including management distraction—of the put-back issue for large banks. And there are the not-so-obvious ones, such as the shape of regulation and implementation under the Dodd-Frank Act—for example, disclosure and reps & warranties requirements for asset-backed securities, or the definition of Qualified Residential Mortgages—and the future of housing finance reform in the United States.
But sometimes the connection is simply back to the root of what got us here in the first place: the deterioration of underwriting standards for residential mortgages during the boom and the resulting woeful credit performance. The graph below (click to enlarge) sets forth the serious delinquency performance of conforming mortgages—with a maximum LTV of 80%, good credit, under the loan size limit and fully documented—and non-conforming prime mortgages since the beginning of 2008. Before 2008, they used to be on top of each other, but since that time they have diverged widely, with Fannie Mae (OTCQB:FNMA) reporting serious delinquencies of 4.5% in its conforming pools, and CoreLogic data showing 90-day plus delinquency rates of over 15%. (Subprime mortgages, needless to say, have performed even worse: the Mortgage Bankers Association subprime index now has a 26.2% delinquency rate.) As policymakers consider the future of housing finance, it is worth recalling that the conforming mortgage—which is wrapped by the government guarantee—has performed far better than other sectors of the market.