A Positive Slant on Financials: Wells Fargo, BofA, Citi

I know that this sounds odd coming from me, a long term bear, but the mortgage crisis hitting the market today is not as bad as everyone seems to think. Yeah, consumer spending is going to wane, and yes, business activity will dry up somewhat for a short while until this works its way out of the system, but the mortgage crisis is not going to hurt the economy for years on end, and it is not the reason I am a long term bear. There's another reason for that.

Look at it this way: If banks indeed get foreclosures at the worst possible frequency, what is the worst thing that could happen? We're talking about asset backed securities. Yeah, there will be losses, but not 100%, or anything near that. Consider a $10 billion portfolio. Assume the entire portfolio gets foreclosed and returned to the bank (unlikely that the entire portfolio comes back). Assume that the lending institution reverses these properties back into the economy at steep discounts; call it 20%. That's a $2 billion hit, and it hurts, but it won't cripple the lender. In fact, a nimble lender may even find a way to front run the loan for the foreclosed property too, thus solidifying revenue streams, albeit at a lower rate.

Think about Wells Fargo (WFC), Bank of America (BAC), and Citigroup (C).

From a report recently published by the street, Wells Fargo currently holds $33 billion in mortgages for sale; Bank of America currently holds about $6 billion; And Citigroup currently holds about $7.5 billion worth of mortgages for sale. The balance of their mortgage portfolios have already been sold to distribute risk and to free up capital.

Using the 20% estimate, WFC would lose $6.6 billion in real assets; BAC could lose $1.2 billion; C could lose $1.5 billion. Losses will also stem from hedge fund trading errors, and derivative trading miss-steps, so don't think this is the sum of losses by any means, but this gives you an idea of the hard asset losses facing these firms, and this gives you an idea of their relative ability to stomach those losses. In each instance, their ability to handle these losses is significant.

In the near term these firms, and others like them, will have substantial balance sheet write-downs, but those won't last forever. In fact, in many cases, these write downs may be more paper than hard asset losses.

I don't want you to change your thinking long term, because the market is headed substantially lower over time, but not for the reasons facing the market in relation to the current mortgage mess. The Investment Rate explains why the market will fall over time, and it is the rationale for my long term bearish stance, not the current situation in the economy.

Comments

[User 119158]

20%, I been shopping for Florida Condo and I see short sales where th mortgage company is taking more like 35%. Add broker commission, legal cost, carrying cost of these condos and other; the mortgage companies are lucky to get 50 cents to the dollar.

[Thomas Kee]

Florida may be a little different. Moreso, so are you...a buyer? :-)