Mark Alexander

Private Label RMBS: Opportunity of a Lifetime?

iffy,

Thanks for the response and the update.

I see losses at least through 2010 similar to you, and the examples you provide do not bode well for last-to-pay tranches like A-2D after 2010.

If the trustees for this and similar deals are smart, they will accelerate forecllosures and/or short sales over the next six months to take advantage of the home purchase tax credit.

Good luck with the battles. Keep me posted if anything interesting happens and you find time.

On Nov 07 03:41 AM iflyjetzzz wrote:

> Mark,
> Thank you very much for the reference information; I have been reviewing
> the data.
> On my particular house, I doubt that the trust will recover much
> more $50,000 after all fees are paid, representing an ~38% recovery.
> That is a best case scenario. And please keep in mind that my particular
> house is very much a best case scenario for the trust. The home is
> in excellent shape and I have no intentions of trashing it before
> I leave. However, I can tell you that there have been several foreclosed
> houses in my subdivision that have had substantial repairs made after
> foreclosure. You can pretty much write those off to 0% (or more likely,
> negative) recovery.
> We have no idea of the shape of the remaining REOs that are sitting
> on the trust's books. I'm sure that they sell the best houses very
> quickly and are stuck with the bad ones. Although the bulk of REOs
> on the trust's books are 2009 foreclosures, there are still quite
> a few 2008s and even a 2007 on the books. I think that you can write
> those down to zero; they are probably in such bad shape that the
> trust is unable to sell them.
>
> I see no abatement in delinquencies; the October data showed a 56.5%
> delinquency rate.
> The lower tranches are rapidly becoming worthless and based on trend
> data, I would expect class M-5 to be a 100% loss before the end of
> 2009. By this time next year, I expect to see class M-2 taking losses,
> as I expect M-3 and M-4 to be 100% losses within the next year.<br/>Good
> call on your part for taking any gain and walking away.
>
> Again, thanks much for the link. That's some great data that will
> likely serve me well in future court appearances.
> ... and to fill you in on the latest in my saga, I went to court
> last week to fight the eviction notice. The trust's lawyer rambled
> for ~30 minutes trying to evict me. The judge dismissed the case.
>
> To date, there has been no request for rent.

Accounting for Losses at BofA and Fannie

After looking at the companies’ financials in more detail, the situation looks more complicated than John Hempton’s analysis or my off-the-cuff response (above).

Table 12 in FNM’s financials do the work of adjusting charge-offs to a basis closer to what a bank would report. Even if lost interest on nonperforming loans are added to the charge-off numbers, they are still very small when compared with the combined loss reserve (less than $5B per quarter compared with over $60B).

Current charge-offs are a poor relative measure of future loan losses, because Fannie is trying to accommodate. Fannie’s new loans and modifications are much more likely to default than B of A’s new loans, because the company is tightening lending standards.

A reasonable overall guess would be that actual losses on the existing portfolio will be about twice as high as the current provision for Fannie, and maybe two and one-half times for B of A. In other words, Fannie’s provisions are more adequate, but not by much.

This only tells part of the story. A potentially bigger issue is each company’s ability to earn its way through the losses, and B of A has a huge advantage on this front. B of A is earning healthy spread income on loans carried on its balance sheet. By comparison, Fannie earns this on only a small proportion of the portfolio. On the remainder, it earns a much thinner guaranty fee (around 30 bps fees vs. hundreds of basis points that B of A earns in spread income). In the third quarter, B of A earned $11.4B of net interest income. Fannie, earned $5.7B of net interest income plus guaranty fee income. Fannie is earning less and has a much bigger pool of nonperforming assets.

Accounting for Losses at BofA and Fannie

James,

First of all, I would like to say that I have read a number of your articles and think they are excellent -- well-thought and provocative. I also like what John Hempton has to say, because he usually offers some type of quantitative support for his position.

That being said, I think his math is off in the article you are discussing.

A comparison is made between charge-offs and loan loss reserves. For Fannie, charge-offs include the difference between fair value and the purchase price (the outstanding principal balance) for impaired loans acquired from MBS trusts. There is no equivalent to this for a typical bank, so these charge-offs are excluded from Fannie's charge-offs.

To make the comparison between charge-offs and reserves valid, one would also need to impute charge-offs on properties that Fannie disposes of. Fannie has already taken a hit to fair value loans that acquires, and therefore does not need to charge-off as much (and may not need to charge-off anything) when a foreclosed property is disposed of, whereas a bank like B of A would.

In contrast to John Hempton's argument, B of A's loan loss reserves look quite a bit more adequate than Fannie's from my perspective. B of A's allowance for loan losses at 3Q09 was 117% of non-performing loans. Fannie's was 33%. Just like the charge-off comparison is not apples to apples, the ratio of reserves to non-performing assets is also not apples to apples. This is because some of Fannie's non-performing assets have already been charged-off to bring them to fair value at the time they are purchased from MBS trusts.

As far as I can tell, it is not possible to determine the current discount on loans carried at fair value from Fannie's financials, so it is not possible to make an apples to apples comparison of loan loss reserves to non-performing loans. However, the volume of loans purchased at fair value (~$20B acquired during 2009 at an average price of around 45 cents on the dollar) leads me to believe that Fannie's loan loss reserve is less than half as adequate than B of A's allowance.

The Homebuyer Credit as Economic Success Story

The tax credit is clearly a success story for realtors and those who want to sell their houses and downsize over the next six months. It is basically a transfer payment from the rest of society to these groups. Otherwise, it will probably do more harm than good.

It will inflate home prices temporarily, but will deflate prices after the credits are removed partly as a result of pure economic costs, and partly because of a demand vacuum.

The credit also increases the risk of increased costs to bail out the FHA, which wil finance a large percentage of the new purchases at artificially inflated prices.

10.2%

"You just can’t raise rates when unemployment is in double digits."

Our current situation is unprecedented, and it is entirely possible (perhaps likely) that inflation will cause interest rates to increase even with double digit unemployment. The monetary base is sky high. If GDP keeps growing, rates may increase despite the Fed's best laid plans.

The Fed’s comment about keeping interest rates low for an extended period of time should probably be viewed as a statement about what the Fed would like to happen, because it would make their life easier

The comment about keeping rates low is reminiscent of the Fed's decision not to lower rates in late 2007 based on concerns about inflation. This may have been true in early 2007, just like the Fed’s current comments make sense for six months ago.

Research in Motion Negativity Looks Overdone

This has turned into an excellent debate, particularly for someone like myself who does not really understand the detailed technical issues all that well. I appreciate this (and there are probably other silent readers who do as well).

Bear Market Rallies and Lessons of History

Everything you say is entirely plausible except for the possibility of keeping rates down in the face of inflation. This is impossible given the explosion of the Fed's balance sheet. An inflationary spark could easily turn hyperinflationary. Bernanke knows this (and has even made comments to this effect). The Fed will either need to raise rates or sell securities, probably both. The net effect is the same. If we see meaningful inflation, nterest rates will need to go up.

On Nov 02 10:19 PM Ricard wrote:

> I believe a mild to tepid recovery will take hold, with higher than
> average inflationary pressure (mild to moderate stagflation). <br/>
>
> The Fed and the rest of our political apparatus will have the political
> capital to stoke inflation, because they are not dependent upon China
> or Japan for votes. Politicians have every reason to see inflation
> infect housing prices with the 'fever' and get our D/E ratios back
> under control. That will probably win them votes if nothing else.
>
>
> Higher inflation does not necessarily have to lead to high rates
> unless the Fed is determined to end it. Given the unprecedented amounts
> of 'accommodation' that has come out of Bernanke, I'd say that at
> most he will 'tap the breaks' even in the face of high single digit
> inflation.
>
> I wish I knew more about the inflationary pressures during Volcker's
> term (was there a credit bubble accompanying sky-high oil prices?),
> but I think the situation this time around is slightly different.
> We have every reason to let inflation run amok until we are good
> and ready to end it. What's great about this time is that we don't
> need to pay for it, so more than likely it will continue for longer
> than it otherwise would, just like how the long end of the yield
> curve stayed artificially low under Greenspan's 'conundrum'. Both
> would be contingent upon externalities (China and Japan), except
> this time around they will work for us, and not against us.
>
> The only drawback would be that general price levels would increase,
> and we would be materially poorer relative to other countries. That
> is a small price to pay to recover from insolvency, IMHO.
>
> On Nov 02 04:30 PM Mark Alexander wrote:

Research in Motion Negativity Looks Overdone

I hope you are right, but I think the onslaught from competition will be relentless and continuous. RIMM has the advantage of being in the poll position when it comes to businesses. In some ways, too much competition could help Blackberry, because too many products can make it harder to differentiate, so buyers may just go to the default, which is Blackberry for now ... or we could see competition destroy the bottom lines of all, something the telecom industry seems to experience periodically.


On Nov 02 09:53 PM Ricard wrote:

> LOL, touche.
>
> Well, I suppose what I meant to say was that RIMM survived the initial
> onslaught, and has come out largely intact. I cannot say the same
> for the legion of much larger competitors in the iPod space. It has
> been two years, so RIMM has proven to be a survivor.

Research in Motion Negativity Looks Overdone

I trust you know what you are talking about, but none of this means very much to me. I am not enough of a techie and a bit ignorant, I guess.

To be honest, too much flexibility can be a pain because it takes more to learn. This is not true for younger users or people who are really into technological gadgetry. The challenge for all the new technology is that by the time the young bucks are making the decisions, a newer better technology will probably come along.

It would be great to understand why RIMM is a bad investment so I can wisely dump and avoid further losses,so if anyone else can offer additional color, I will greatly appreciate it. Specifically, why will my company want to dump Blackberry when our deal expires? It seems like Blackberry will continue to appeal to relics like me, at least for a while, unless there is something that is clearly cheaper and better.

The company added almost 4 million subscribers last quarter (something like 40% growth on an annualized basis) and the PE (based on the most recent quarter, excluding litigation charges) is in the 13-14 range.

On Nov 02 09:20 PM JamesApple wrote:

> Thank you Mark. I will be brief.
>
> Enterprises today suffer from lack of innovation because it is very
> expensive to differentiate products and services using fixed rigid
> infrastructures most enterprises have adopted. Blackberry OS is a
> fixed rigid infrastructure limiting the hardware and software aspects
> of Rim's products and services. Rim customers inherit this rigidity
> and are thus unable to deploy Rim for functions outside of email
> and messaging. Android is designed with layers of customizations
> allowing Android customers to modify or add functions and capabilities
> from hardware to software and application services which differentiate
> specialized advantages to the Android customer. For example, if a
> warehousing company deploys RFID and wants to hook up the RFID system
> to its truckers' handsets, the warehousing campany can modify the
> Android OS on their handsets adding RFID enabled code without disrupting
> the other functionalities already there. Blackberrys cannot because
> its OS does not allow OS kernel hashing (customization). This is
> only one example but you can see one distinct advantages Android
> has over blackberry OS. Enterprises buy devices hoping they are versatile
> and flexible. Android is definitely much more versatile and flexible
> than blackberry. Rim has no way to open up blackberry OS the way
> Android already is. For Rim to develop an Android phone would mean
> major disruption to existing enterprises forcing them to abandon
> the Rim platform altogether en masse.

Research in Motion Negativity Looks Overdone

JamesApple,

Thanks for the response, but it would be nice to hear some examples of RIMM's myriad problems. The only specific point you mentioned was the lawsuit, which is over, is it not?

Specifics about how Android will reach critical mass and render RIMM obsolete would also be greatly appreciated. Your comments sound like a glorified theory about what customers need. Most professionals just want something with a phone, e-mail, scheduling, and GPS would be a plus. If the company I work for is going to switch from Blackberry to another service provider, there will need to be a concrete reason (or reasons). Most of the options seem like more of the same from my perspective, except for Apple, which seems fancier (probably the reason we will not go this route). My failure to see the light could very well be because of my ignorance, but as ignorant as I am when it comes to technology, I can assure you our CEO is a couple of years behind.

On Nov 02 06:36 PM JamesApple wrote:

> 28% of Rim's revenue booked came from Verizon mostly because of the
> BOGO campaign. Now that Verizon brings its focus on Android with
> the Moto Droid coupled with other carriers rallying around the new
> Android 2.0 Rim will receive less vital revenue from Verizon and
> other carriers, Rim will also have to promote and advertise more
> on its own meaning more Rim costs and expenses against an already
> dwindling Rim margin on top of the $237 million IP lawsuit loss,
> and myriads of Rim problems internal and externally. Enterprises
> evolve in tandem, when critical mass of Android acceptance is reached
> amongst the enterprises, Rim will lose its reason-to-be and ceases
> to be an ongoing business entity.
>
> As to Android superiority over blackberry OS, Corporate buyers want
> something that does what it needs to do, is reliable and does not
> cost too much. New technology that improves business efficiency is
> a bonus is a valid statement, but you forgot that the number 1 concern
> for enterprise is long term survival. An enterprise that cannot effectively
> differentiate its product and service offerings from the competition
> can simply not survive in the highly competitive, fast moving disruptive
> world. Android is an open system offering customizable layer allowing
> each enterprise to exploit this layer and differentiate their offerings
> with their specialized advantages. Rim blackberry OS is a closed
> and very restricted and limited system which can simply not allow
> enterprise specialization which is the key factor for long term enterprise
> survivals. Rim itself is a prime example of an enterprise that fail
> to differentiate or specialize as so many competitions are surpassing
> Rim in very threatening ways. I foresee Android reaching critical
> mass in enterprises which strive to differentiate and specialize
> to survive and emerge from this Recession, once Android reaches critical
> mass the enterprises will replace their Rim products with Android
> products literally overnight. This is Wall Street's view of the enterpises
> in the near future, and it is an accurate and correct view .

Research in Motion Negativity Looks Overdone

Winning the battle for retail consumers is probably necessary to justify a $100 valuation, but for $55, it does not seem necessary.

Are there real indications that RIMM will start losing corporate clients in a big way? If so, it would be greatly appreciated if someone could share some specifics.

Is the momentum really all that negative at this point? Blackberry added 3.8 million subscribers last quarter. Has new business stopped on a dime since August?

On Nov 02 04:51 PM Kevin A wrote:

> For the most part, JamesApple is correct, although I think his 'out-of-business'
> prediction is WAY too extreme (odd to tag a strong argument with
> such an outlandish conclusion). You need to respect the simple concept
> of momentum, which RIM has - but in the wrong direction. With respect
> to consumers, momentum is always difficult thing to stop and reverse.
> There's a reason that AAPL is trading at 30x P/E, and RIMM only @
> 15x. If RIM does not innovate and recapture its lost brand equity
> soon, then I suspect that there will also be a revolt at the enterprise
> level. Given their current path, they won't meet their FY 2011 estimate
> of 4.86, so I wouldn't put too much faith into that number. [This
> is coming from a longtime Blackberry user.].

Research in Motion Negativity Looks Overdone

Ricard, what makes you think RIMM has "survived" Apple. Isn't the battle still on?

MM2, competition is brutal. Innovation can render companies with good products and smart managers obsolete. This happens all the time.

Having bought shares on the way down from $68 to $55, I hope Chad is right and JamesApple is wrong, but it would be nice to hear him flesh out the argument, to see if there is anything to it.

On Nov 02 03:29 PM Ricard wrote:

> Good article.
>
> RIMM survived Apple. Anything else is child's play.

Bear Market Rallies and Lessons of History

The Fed does appear intent on stoking inflation to a degree – a goal it can achieve so long as it has the political capital – but this weakens the case for a forward P-E for the market of 18-20.. If you believe a strong recovery will take hold, then corporate profits could grow rapidly, but this seems unlikely because inflation will bring higher interest rates which will hurt real estate (which will hurt the economy).

By a recovery of sorts, I assume you mean that we bounce along in a not very fun but not terrible path of low growth. If so, I agree with you, but this means that we might not hit the forward earnings estimates, and investors may want better than an 18-20 forward P-E.

On Nov 02 03:20 PM Ricard wrote:

> The way I read the Fed, this is exactly what they want (inflation
> in the short-medium term). Every time you hear them say 'must fight
> the deflationary death spiral' I translate it to 'must stoke inflation
> to get rid of toxicity in the system'. China and Japan will pay for
> it.
>
> I agree with your final sentence, and will add that there's no need
> for the recovery to be legitimate. In that sense, we may see both
> ultra low rates and a recovery of some sort.

Research in Motion Negativity Looks Overdone

James, it is good to have critical viewpoints rather than just cheerleaders.

Is there any chance that you can provide one or two concrete examples of why corporate clients will abandon Blackberrys in favor of the competition? For example, if smartphone XYZ offers everything a Blackberry offers at half the price, this would not be good RIMM. I do not think that offering 15,000 applications will be the deciding factor in a typical corporate purchaser’s decision. Corporate buyers want something that does what it needs to do, is reliable and does not cost too much. New technology that improves business efficiency is a bonus.

On Nov 02 02:43 PM JamesApple wrote:

> Rim's shares may seem undervalued because Rim is going to be out
> of business in a few years succumbing to being technological obsolete,
> and managerial incompetence. iPhone has already irreversibly surpassed
> the blackberrys in consumer smartphone space, capturing the top spot
> for user satisfaction in both consumer and business categories. Android
> addresses a whole lot more enterprise mobile needs and issues than
> Rim can ever address, and there are a whole army of smartphones using
> Android to create new smartphones which surpass Rim blackberrys in
> quality, enterprise and social/community mobile services, price to
> performance value, hardware such as camera, faster CPU, choice of
> makes, openness, flexibilty, modern technologies, Android has 15000
> apps against Rim's 2000 apps, Rim's hardware and software are a lot
> more restricted than Android's, costs of BES are exorbitantly high,
> Rim servers have a history of crashing, and a whole lot more Rim
> problems and issues that Rim customers used to bear when Rim was
> the only choice but now there are a whole lot more choices coming
> up, and that's not counting Apple's many inroads into the enterprise
> markets that Rim relies upon, Microsoft's dominant business position
> with its impending Win Mo 7, Palm Pre's superior multitasking Pre
> better suited to enterprise productivity than Rim blackberries, the
> fact that almost every other smartphones are better made and received
> than Rim pumping out old Unwanted outdated blackberrys wrapped in
> new skin. Rim is barely surviving in the longer term hanging by the
> smallest threads of remaining enterprise clients who are not expired
> in their Rim contracts but are increasingly using more American contents
> for the American companies. Rim's Storm 2 and Bold 2 are far 2 little
> 2 late. Rim has clearly demonstrated again that Rim cannot innovate
> and compete in the smartphone business. There are no reasons for
> Rim not being bankrupt no later than year 2012.

Bear Market Rallies and Lessons of History

With the S&P up 55% from its low 8 months ago, it does not seem like the pessimism is all that severe.

Are you not at all concerned about continued problems with overleveraged consumers? Those who did not overextend themselves in 2006-2007 are enjoying very cheap credit, but a significant percentage of the population continues to drown in debt. This is why mortgage delinquencies have continued to increase in August and September rather than improving with the overall recovery,

Hopefully, you are right and I am being pessimistic to worry about this, but I have a hard time seeing an easy and comfortable solution.

On Nov 01 02:05 PM E Nuff Sed wrote:

> I respectfully disagree with the pessimistic view point.
>
> First, the intermediate term technicals are still solid. None of
> the longer term moving averages have crossed path towards the downside
> (as was in late 07-early 08) which is an indica of an impending bear
> market.
> www.freestockcharts.co...
>
> Second, I don't think the US economy has as much to do with S&amp;P
> 500 companies as in the past. Most of the multinationals are more
> and more relying on global growth. The emerging economies of the
> BRIC's and other mini-BRIC's will more than make up for the weakness
> in the US.
>
> Third, the decline of the US dollar is a huge tail wind for the S&amp;P
> 500 (increasing export, repatriation of foreign profits) which I
> believe will keep earnings healthy.
>
> Fourth, I don't think the S&amp;P 500 is over-valued (I think it
> is fairly valued) at a forward P/E of ~18 - 20. While this may seem
> high you have to consider this in terms of the low interest rate
> environment we are in.
>
> Fifth, the Fed will keep interest rates low until unemployment falls
> below ~8%. This is unlikely to happen in 2010. By being bearish you
> are fighting the Fed which I don't think is a wise strategy unless
> it is for tactical / short term reasons.
>
> I feel that many of you have fallen into the trap of pessimism which
> invariably follows a traumatic event. A year ago we were in the middle
> of a full blown financial panic and no doubt the recovery since then
> seems like a mirage. But I think it is real. Just my personal opinion
> for whatever it is worth.