The SEC is looking to expand investigations into the spread of false rumors that may affect the financial system. Articles at Reuters and Bloomberg mention the recent slide in Freddie Mac (FRE) and Fannie Mae (FNM), as well as Lehman Brothers (LEH), for the increased SEC attention. No word in either article whether a member of Congress will be investigated after the recent collapse of IndyMac, although an LA Times article does mentioned that some federal regulators are looking into the issue.

This all comes just as the International Herald Tribune is reporting how banking analysts are predicting that as many as 150 of the 7,500 banks nationwide (mainly small and mid-size) could fail over the next 12 to 18 months. Others disagree and state that while there will be liquidity issues, many lenders are likely to first either shut branches or seek mergers with stronger banks. The article also notes that the nation's banks are in less danger now than in the late 1980s and early 1990s when over 1,000 institutions failed during the savings-and-loan crisis. Unfortunately, even with fewer bank failures, the $125 billion government bailout that resulted at the time may seem like a good deal if things were to get as messy this time around. Hopefully we can avoid reaching the same levels, but some analysts are not optimistic.

Subprime Fallout

Countrywide's Pressures Mount. “Three states [have] filed separate legal actions against Countrywide Financial Corp. (CFC). The actions, by the attorneys general of California and Illinois, and the Washington State Department of Financial Institutions, came on the same day that Countrywide shareholders voted to approve the sale of the company to Bank of America Corp. (BAC). The all-stock transaction was valued at $4 billion when BofA agreed to buy Countrywide in January. But BofA shares have since slipped, and the value has fallen to about $2.8 billion. The transaction is scheduled to close on July 1.”  (Wall St. Journal, June 26^th)

Here are some more facts about the Commonwealth of Puerto Rico:

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Among the key questions is the progress on shareholder lawsuits and restructuring of the balance sheet including possible refinancing of the $625 million Floating Rate Notes [FRN]. Analysts are looking for a $1.32 loss per share on average including one-off items, but more interesting might be any insight into 2007 and beyond.

Doral provides consumer financial services through its mortgage banking and thrift operating units. It is primarily engaged in a wide range of mortgage banking activities in Puerto Rico. Doral Financial has the leading share of the Puerto Rican mortgage market. In the past weeks, the press has mistakenly lumped it together with ailing subprime players. In fact, it seems to have a relatively healthy portfolio, at least when taking into account current weakness in the Puerto Rican economy.

Doral has been rocked by accounting scandals under the previous management. It still faces various shareholder lawsuits, regulatory issues and importantly refinancing of $625 million of floating rate senior notes in July. Analysts have largely abandoned Doral. Those remaining rate it a sell or weak hold. Morningstar switched from a 5 star rating to a 1 star rating overnight in the last months calling Doral “toxic waste”. Its price target is $1.50 which is simply the average of $0 or $3 in a good case scenario.

The highlight would be the stock of Doral Financial (DRL), whose chart resembles the flight of Icarus. I don’t know the full story (I think few do) of what happened to Doral. A few years ago, this was regarded as one of the fastest growing banks in the U.S.

But they got into trouble by overestimating their income from interest only strips, which are the coupons from mortgages dealing only with interest and not principle. They sold them to other PR banks but had an off balance sheet agreement in which they guaranteed payment. Hence these were not true sales and so the accounting was improper.

What did the Commission find? According to their complaint, they charge that Doral “overstated income by approximately $921 million or 100 percent on a pre-tax, cumulative basis between 2000 and 2004,” which enabled the firm “to report an apparent 28-quarter streak of “record earnings” and facilitated the placement of over $1 billion of debt and equity.”

2006 Roundtable: Second-Half Outlook