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Rakesh Saxena's  Instablog

Rakesh Saxena is a risk pricing specialist for Quote Platform Syndicate Inc. (http://www.quoteplatform.com/), part of a network of international risk buying and arbitrage pools. He has been active in the execution of derivatives and insurance contracts, and asset securitizations, particularly in... More
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  • Get Ready To Short Banks 6 comments
    Oct 12, 2009 07:13 PM | about stocks: BAC, C, GS, JPM, WFC, XLF
    There is, of course, no consensus on the potential impact of the $10-$11 trillion worth of outstanding residential mortgages on the banking system in the event of a delayed recovery. The Obama administration, preferring not to indulge in any negativity, has a simple theme: just keep the mortgage sector alive long enough for an economic turnaround to remedy all the inherent problems. But eating away at the dubious merits of the wait-and-hope approach are the mathematical realities which have not been factored into the government’s foreclosure-prevention exercise which, according to Treasury officials, is getting an enthusiastic response.
     
    Treasury Secretary Timothy Geithner announced last week that 500,000 financially-troubled homeowners were now participating in the government’s foreclosure-prevention plan. Under the plan, those behind on their mortgage payments and those facing imminent default can apply to reduce their monthly payments in line with monthly incomes. Bank of America (BAC) and Well Fargo (WFC) have begun “trial” modifications for 11% and 20% respectively of their eligible borrowers who are at least 60 days past due; Citigroup (C) has started modifications for 33% of its eligible borrowers, and JP Morgan (JPM) for 27%.
     
    But is the Obama administration’s focus on capping debt service by income creating unrealistic “implied” valuations? Are traditional LTV (loan-to-value) measurements no longer workable propositions? And is the loan modification scheme simply deferring the substantial systemic risk which continues to threaten bank balance sheets?
     
    Firstly, on all present indicators, income-linked monthly installments are likely to cause a forced extension of loan maturities, dramatic changes in the medium-term yield curve and unwieldy maturity mismatches on bank books. Secondly, the foreclosure-prevention plan does not aim to answer the most politically-sensitive of questions: how many eligible borrowers are living in homes they just cannot afford and what are the affordability benchmarks banks are currently using? Thirdly, how and when will banks make further provisions for loan delinquencies if a sizable proportion of trial modifications fail to result in final loan restructurings?
     
    A BofA executive working on the plan helpfully suggested that “only 50% of the trial modifications should result in full modifications.” He acknowledged that even the 50% estimate was predicated on ongoing government assistance; for reasons which are obvious, he did not want to predict how home prices will react to the highly unlikely event of a large-scale unwinding of government intervention.
     
    In fact, in a scenario so heavily dominated by government intervention, it is difficult to see why analysts are making calls on the housing market. One proposal in Washington is for the lowering of monthly payments by borrowers to below the 31%-of-income standard for the foreclosure-prevention plan. Another proposal gaining favour amongst lawmakers is the extension of an $8,000 tax credit to first-time home buyers; Rep. Eric Cantor (R., Va.) wants that amount raised to $15,000!
     
    Without doubt, the Obama administration is preparing for further unprecedented measures if the situation so demands. “The government answer to the challenges in the housing market remains a work-in-progress, at best,” said the manager of a Geneva-based hedge fund. “There is no evidence to show that anyone has a complete grip on the problem.”
     
    This writer was aggressively shorting banks during the first half of this year, expecting that a broad nationalization would reduce private equity in some of the banks to zero. But governments all over the world managed to devise rescue programmes which kept banks afloat on taxpayer dollars and which, at the same time, left room for shareholder gains. As a result significant profits on shorts were wiped out in the March rally.
     
    Today, major banks are nearing price levels which cannot, by any measure, be justified by the earnings-potential matrix created by “partial nationalizations” and which will be seriously threatened by the failure to bring a measure of realism to valuations in the housing and consumer sectors. As this week’s earning reports (JP Morgan on Wednesday, followed by Goldman Sachs, Citigroup and BofA) will show, Wall Street’s risk-friendly investment banking model has been decisively shelved for now; so don’t look for any above-average gains from the derivatives complex.
     
    Disclosure: No position in tagged counters; looking to build shorts in the event of 5-10% gains from Friday’s close.
     
    Themes: anti-foreclosure plan, bank earnings Stocks: BAC, C, GS, JPM, WFC, XLF
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This post has 6 comments:

  •  
    Rakesh---- Your market calls have been spot on from early last Fall through early March of this year, when you discontinued posting until recently. If anyone questions this, all they need to do is read your earlier posts available here on Seeking Alpha. You were generally short right up until early March this year when you started urging caution and getting out of your shorts. With that terrific track record it would be nice if you would post a heads up when you pull the trigger on the short side again. Thank-you.
    2009 Oct 12 07:50 PM Reply
  •  
    Would you prefer shorting outright or buying FAZ?
    2009 Oct 12 07:55 PM Reply
  •  
    YH---Those leveraged ETF's are too sophisticated for me. Although the author may hedge with them, I don't know.
    2009 Oct 12 08:07 PM Reply
  •  
    Sorry, Boyz, the beat goes on. With the "window" lending on the cheap, and the markets leaping upward, the big banks will report huge gains...leading more to the frustration of the careful hedgies who've not yet gotten in...leading to more to support for this "recovery"...leading to further upside-ness in the markets...leading to more hedgies and mutual funds getting in, providing even more support...leading to..."The Great Plan"...that is, when all the money is back in the market, when everyone is participating...that's when Goldman Sachs puts the hammer down.

    Conclusion: Don't short the banks right now.
    2009 Oct 12 11:15 PM Reply
  •  
    Thanks Swashbuckler---advice taken. - Rakesh


    On Oct 12 07:50 PM Swashbuckler wrote:

    > Rakesh---- Your market calls have been spot on from early last Fall
    > through early March of this year, when you discontinued posting until
    > recently. If anyone questions this, all they need to do is read your
    > earlier posts available here on Seeking Alpha. You were generally
    > short right up until early March this year when you started urging
    > caution and getting out of your shorts. With that terrific track
    > record it would be nice if you would post a heads up when you pull
    > the trigger on the short side again. Thank-you.
    2009 Oct 13 09:51 PM Reply
  •  
    On Oct 12 07:55 PM yellowhoard wrote:

    > Would you prefer shorting outright or buying FAZ?

    On Oct 12 07:55 PM yellowhoard wrote:

    > Would you prefer shorting outright or buying FAZ?

    YH, since you're even considering FAZ, you might be interested in a little tidbit I worked out. When the shenanigans do finally stop and the market get's back to reality, I calculated that DRV (real estate triple bear) would move even more than FAZ. It's underlying is $RMZ.

    Reading Mayascribe's words of warning, I can't help but think that since everybody seems aware that the numbers that are going to be released by the banks on Wed., Thur., and Fri. are going to be pretty impressive although as phony as a $3 bill, that maybe these facts are already baked into the cake. The chart pattern suggest that if the market hears the news out of the banks, doesn't rally particularly well on it, and drops... it would take very little downside to initiate an avalanche.

    I wish I knew, but I'm not very impressed with this rally. But like they say, "don't fight the FED" and as long as those co#$%^&*ers want to drive it higher, it'll go higher until they decide otherwise. But in my view, it's pretty much GS and BAC who are doin' most of the buying, so I say let 'em party until they start pukin', because sooner or later, they will.
    2009 Oct 13 10:12 PM Reply
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