Using Veritas to Construct the "Per…

29-04-2017 Hits:88598 BoomBustBlog Reggie Middleton

Using Veritas to Construct the "Perfect" Digital Investment Portfolio" & How to Value "Hard to Value" tokens, Pt 1

The golden grail of investing is to find that investable asset that provides the greatest reward with the least risk. Alas, despite how commonsensical that precept seems to be, many...

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The Veritas 2017 Token Offering Summary …

15-04-2017 Hits:82279 BoomBustBlog Reggie Middleton

The Veritas 2017 Token Offering Summary Available For Download and Sharing

The Veritas Offering Summary is now available for download, which packs all the information about Veritas in a single page. A step by step guide to purchasing Veritas can be downloaded here.

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What Happens When the Fund Fee Fight Hit…

10-04-2017 Hits:82173 BoomBustBlog Reggie Middleton

What Happens When the Fund Fee Fight Hits the Blockchain

A hedge fund recently made news by securitizing its LP units as Ethereum-based tokens and selling them as tradeable (thereby liquid) assets. This brings technology to the VC industry that...

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Veritaseum: The ICO That's Ushering in t…

07-04-2017 Hits:86669 BoomBustBlog Reggie Middleton

Veritaseum: The ICO That's Ushering in the Era of P2P Capital Markets

Veritaseum is in the process of building peer-to-peer capital markets that enable financial and value market participants to deal directly with each other on a counterparty risk-free basis in lieu...

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This Is Ground Zero for the 2017 Veritas…

03-04-2017 Hits:83100 BoomBustBlog Reggie Middleton

This Is Ground Zero for the 2017 Veritas Offering. Are You Ready to Get Your Key to the P2P Capital Markets?

This is the link to the Veritas Crowdsale landing page. Here is where you will be able to buy the Veritas ICO when it is launched in mid-April. Below, please...

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What is the Value Proposition For Verita…

01-04-2017 Hits:85222 BoomBustBlog Reggie Middleton

What is the Value Proposition For Veritas, Veritaseum's Software Token?

 A YouTube commenter asked a very good question that we will like to take some time to answer. The question was, verbatim: I've watched your video and gone through the slides. The exchange...

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This Real Estate Bubble, Like Some Relat…

28-03-2017 Hits:56322 BoomBustBlog Reggie Middleton

This Real Estate Bubble, Like Some Relationships, Is Complicated...

CNBC reports US home prices rise 5.9 percent to 31-month high in January according to S&P CoreLogic Case-Shiller. This puts the 20 city index close to an all time high, including...

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Bloomberg Chimes In With My Warnings As …

28-03-2017 Hits:84564 BoomBustBlog Reggie Middleton

Bloomberg Chimes In With My Warnings As Landlords Offer First Time Ever Concessions to Retail Renters

Over the last quarter I've been warning about the significant weakness in retailers and the retail real estate that most occupy (links supplied below). Now, Bloomberg reports: Manhattan Landlords Are Offering...

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Our Apple Analysis This Week - This Comp…

27-03-2017 Hits:84255 BoomBustBlog Reggie Middleton

Our Apple Analysis This Week - This Company Is Not What Most Think It IS

We will releasing our Apple forensic analysis and valuation this week for subscribers (click here to subscribe - lowest tier is the same as a Netflix subscription). As can be...

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The Country's First Newly Elected Lame D…

27-03-2017 Hits:84116 BoomBustBlog Reggie Middleton

The Country's First Newly Elected Lame Duck President Will Cause Massive Reversal Of Speculative Gains

Note: Subscribers should reference  the paywall material here for stocks that should give a good risk/reward scenario for bearish trades. The Trump administration's legislative outlook is effectively a political desert, with...

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Sears Finally Throws In The Towel Exactl…

22-03-2017 Hits:90616 BoomBustBlog Reggie Middleton

Sears Finally Throws In The Towel Exactly When I Predicted "has ‘substantial doubt’ about its future"

My prediction of Sears collapsing once interest rates started ticking upwards was absolutely on point.

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The Transformation of Television in Amer…

21-03-2017 Hits:88184 BoomBustBlog Reggie Middleton

The Transformation of Television in America and Worldwide

TV has changed more in the past 10 years than it has since it's inception nearly 100 years ago This change is profound, and the primary benefactors look and act...

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I have some good news and some bad news. The good news is that that market neutral strategy illustrated through the blog research is working like a charm (I will be posting some results soon). The market has been on a massive bullish tear, to the dismay of market bears. Well, the new strategy works and it allows us to profit from both bullish and bearish moves. I have transformed my personal portfolio to the market neutral strategy. The bad news is that the problems that caused those of us who know how to count to be bearish are still abound and have apparently been conspired into the bin of ignorance.

 Accounting boards, banks, media and sell side analysts in general appear content to ignore the facts, change the way we count losses (after all, losses are,,, well,,, losses. Right???!!!), and generally sweep the banking problems under the rug in anticipation of bubbling our way out of the problem or at least concealing it long enough through accounting shenanigans to allow accounting profits to somehow paper over economic losses. Good luck with that. Underlying fundamentals are still deteriorating, albeit potentially at a slower pace, as share prices are literally flying through the roof. Those who are in the market and are bullish or not market neutral are, in my opinion, playing with fire. It is gambling to buy stock just because the stocks prices are going up. I know it feels good when the prices go higher after you buy the stock, but the underlying fundamentals are atrocious and if one were to get caught in a nasty correction, one could not have said it was "impossible to see coming".  This is exactly the same scenario that played out in the dot.com bubble. Bulls were justified because share prices went higher, not because underlying values increased. When reality hit (and it always does hit, that's whey they call it reality) folks were literally wiped out.

I will anecdotally illustrate some of that fire investors are playing with in the banking sector. While I was browsing through the extremely interesting, if not controversial Zerohedge.com blog, I came across this video of Elizabeth Warren, who heads the Congressional Oversight Committee's investigation of the banks. I will like my readers to listen to it then continue reading this post.

 

Visit msnbc.com for Breaking News, World News, and News about the Economy

 

Wells Fargo and over $100 billion of economic losses????

 In the case of Wells Fargo, we have applied high LTV ARM loss rates to calculate the losses on HELOCs (which comprises of total 1-4 family junior lien mortgages and line of credit) since the direct HELOC data was not available for WFC. The total losses in these loans are expected to skyrocket as can be seen from the raw, and unbiased NY Fed and FDIC call sheet data (see The Re-Release of the Open Source Mortgage Default Model and Green Shoots are Being Fertilized by Brown Turds in the Mortgage Markets). It is a small wonder why the Treasury failed to use this government data to run the bank stress tests, for if they did the outcome would have been far different, and decidedly much more negative. We have taken a conservative approach in valuing the loan losses due to which the total loan losses in the HELOCs alone would be 56.4% or US$62.1 billion.

We have segregated the total HELOC loans as owner occupied and non-owner occupied based on the proportion mentioned in the FDIC data derived spreadsheet for each respective states. Than, applying the default rate assumption made in this sheet for High Risk ARM (owner occupied - 65% & non-owner occupied - 95%) we calculated the total default rate for each state.

Further, we applied the recovery rate based on the current LTV to arrive at the total charge-off in the next two years.

The total losses are expected to jump to US$187.4 billion in the adverse case in the coming two years. Wells Fargo's current Tangible Common Equity (TCE) stands at 3.28%, which is significantly lower than the prescribed limit of 4%. According to our estimate, the bank's TCE would fall to 1.56% at the end of 2010 after adjusting for accounting and economic losses. Considering the massive anticipated losses in the next two years, Wells Fargo's capital would fall short by US$34.3 billion and not US$13.7 billion as shown by the SCAP result (see America, You have been outright lied to! Bamboozled! Swindled! Hoodwinked! The Worst Case Scenario, Welcome to the Big Bank Bamboozle!, and The Real Stress Test Results) to maintain a TCE ratio of 4% in the pessimistic case. As Wells Fargo has raised US$8.6 billion capital it would still be required to raise additional US$25.65 billion as a safeguard against a deeper economic downturn or a recovery marred by another negative dip, OR a recovery hampered by lingering unemployment OR a recovery contrained by floundering property sector OR a recovery pulled down by mediocre growth. 

Here is the Wells Fargo Eyles test, Texas Ratio and Tangible Equity trends using FDIC and NY Fed data as fed though our forensic model, incorporating off balance sheet entity risk.

  Click graphic to enlarge

wfc_eyles.png 

Wells share price is up nearly 400% since March while nearly every compreshensive credit metric (if calculated using real, unbiased data in a real, unbiased fashion) forecasts a very, very different outcome.

image031.png

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Federal Reserve Vs Our Computation - Loan Loss Estimates

Our Analysis

Methodology to compute loan loss rate: Real estate 1-4 family mortgage loans

Real estate 1-4 family mortgage loans comprise prime loans and Alt-A loans. Since the complete breakdown of loans into prime and Alt-A is not known for Wells Fargo, we have assumed the default rate of Alt-A loans in the US. Thereafter, we adjusted this default rate to factor in the prime real estate 1-4 family mortgage loans. We computed the net loss rate for two years (2009 and 2010) based on the Alt-A default rate to arrive at the overall default rate. We then applied the recovery rates, based on the decline in the housing prices and LTV, to calculate the total loss rate. We assumed the loss rate to be 20% lower than the loss rate of the Alt-A loan in each state as some proportion of the loans could be prime loans. The S&P Case-Shiller Index has declined around 18.9%, 29.3% and 29.2% since 2005, 2006 and 2007, respectively, as majority of these loan value have been wiped out completely due to the severe correction in prices while the LTV still remains very high. Based on the current LTV, we have assumed the recovery rate to derive the loss rate for 2009 and 2010.

The total impaired loans would thus have a loss rate of 31.2% in the coming two years while loss rate in the real estate 1-4 family first mortgage would be 20.1%. The Federal Reserve loss rate of 7-8.5% is far too optimistic to give a true picture.  

 

Real estate 1-4 family first mortgage

Impaired Loans

Current LTV

Overall Defaults rates

Recovery rate: Case-Shiller - LTV

Loss rate for 2009 and 2010

California

128%

34.8%

12.0%

30.6%

Florida

124%

38.6%

12.0%

34.0%

New Jersey

108%

36.6%

21.4%

28.8%

Arizona

146%

36.5%

12.0%

32.1%

Other

112%

40.2%

19.4%

32.4%

Total Impaired Loans

 

 

 

31.2%

All other loans

 

 

 

 

California

125%

22.4%

12.0%

15.8%

Florida

122%

29.2%

12.0%

20.6%

New Jersey

105%

23.3%

21.4%

14.7%

Virginia

110%

25.7%

16.7%

17.1%

New York

87%

22.6%

35.0%

11.8%

Pennsylvania

111%

27.0%

16.7%

18.0%

North Carolina

85%

31.8%

35.0%

16.5%

Texas

91%

31.5%

28.2%

18.1%

Georgia

104%

30.4%

21.4%

19.1%

Arizona

139%

28.6%

12.0%

20.2%

Other

110%

28.6%

12.0%

20.2%

Real estate 1-4 family first mortgage

 

 

20.1%

Wells Fargo acquired home equity loans from Wachovia, which carries the highest default risk as its portfolio largely comprises second lien mortgages. The value of the home equity portfolio is US$128.9 billion.

 

Home equity portfolio

US$ mn

Core portfolio

 

California

31,784

Florida

12,067

New Jersey

8,086

Virginia

5,653

Pennsylvania

5,129

Other

56,342

Total core portfolio

119,061

Liquidating Portfolio

 

California

3,835

Florida

492

Arizona

233

Texas

179

Minnesota

122

Other

5,001

Total liquidating portfolio

9,862

Total core and liquidating portfolios

128,923

The value of Wells Fargo's pick-a-pay portfolio (home loans) is US$93.2 billion of which US$39.7 billion or 42.6% is impaired loans. The principal balance of the impaired loans is US$61.6 billion. This loan has the highest probability of risk and could result in complete writedown. Currently, the LTV in majority of the states is above 100%, with California and Arizona having the highest - 161% and 152%, respectively. Despite writing down US$21.9 billion, the carrying value at these two states hovered around 100%, implying high risk.

 

Pick-a-pay-portfolio

Impaired loans

 

Unpaid principal balance

Current LTV %

Carrying value

Carrying value to current value

California

42,216

152.0%

26,907

98.0%

Florida

6,260

129.0%

3,779

79.0%

New Jersey

1,750

101.0%

1,271

74.0%

Texas

475

76.0%

336

54.0%

Arizona

1,642

161.0%

987

99.0%

Other states

9,306

110.0%

6,397

77.0%

 Total

61,649

 

39,677

 

Methodology to compute loan loss rate: Real estate 1-4 family junior lien mortgage

Real estate 1-4 family junior lien mortgage comprises home equity line of credit (HELOC) and second/junior lien mortgage. Home equity carries a very high risk of default due to high LTV and being second lien mortgage. We segregated the loans into owner occupied and non-owner occupied based on the state-wise proportion published by FDIC. Thereafter, applying the respective default rate of each category we arrived at the weighted average default rate.

To determine net charge-offs, we have considered the recovery rate based on historical recovery rates applied in conjunction with the current LTV. The table below gives the recovery rates used to determine net charge-offs.

 

 

Current LTV

Recovery rate

Basis

Greater than

120%

12.0%

(recovery rates during 1990-1991, lowest since 1976)

Greater than

110%

16.7%

 

Greater than

100%

21.4%

(average recovery rate since 1976)

Greater than

90%

28.2%

 

Less than

<90%

35.0%

(highest recovery rate since 1976)

Source: FDIC and Boombustblog.com Analysis

We estimated the current LTV for home equity loans based on the housing price decline calculated using the Case-Shiller Index of each state and LTV at origination to determine the current LTV. Impaired loans have a two-year loss rate of 67.5%, while other loans have a loss rate of 56.4%. We have assumed impaired loans to have a 0% recovery rate in each of the states. The non-impaired home equity loans would have a loss rate of 56.4% for 2009 and 2010, while the Federal Reserve's estimated loss rate is 21-28% for the same period.

 

Real estate 1-4 family junior lien mortgage

High Risk Subprime ARM Loans (Low FICO and high LTV)

 

 

Current LTV

Owner Occupied

Non- Owner Occupied

Default rate

Recovery Rate

Loss Rate

Impaired Loans

 

65.0%

95.0%

 

 

 

California

128%

93.7%

6.3%

66.9%

0%

66.9%

Florida

124%

88.7%

11.3%

68.4%

0%

68.4%

New Jersey

108%

91.5%

8.5%

67.6%

0%

67.6%

Arizona

146%

91.9%

8.1%

67.4%

0%

67.4%

Other

112%

91.0%

9.0%

67.7%

0%

67.7%

Total Impaired Loans

 

 

 

 

 

67.5%

All other loans:

 

 

 

 

 

 

California

128%

93.7%

6.3%

66.9%

12%

58.9%

Florida

124%

88.7%

11.3%

68.4%

12%

60.2%

New Jersey

108%

91.5%

8.5%

67.6%

21%

53.1%

Virginia

111%

91.1%

8.9%

67.7%

17%

56.4%

New York

90%

92.0%

8.0%

67.4%

28%

48.4%

Pennsylvania

111%

90.0%

10.0%

68.0%

17%

56.6%

North Carolina

86%

88.3%

11.7%

68.5%

35%

44.5%

Texas

89%

91.6%

8.4%

67.5%

35%

43.9%

Georgia

105%

88.5%

11.5%

68.5%

21%

53.8%

Arizona

146%

91.9%

8.1%

67.4%

12%

59.3%

Other

112%

91.0%

9.0%

67.7%

17%

56.4%

Home equity portfolio

 

 

 

56.4%

 

Loan Charge-off in 2009

Pessimistic Case

Base Case

Optimistic Case

Assumptions

Commercial

2.44%

2.14%

1.84%

In the US, commercial and industrial loan charge-off was 1.76% in December 2008. The Federal Reserve has pegged this charge-off between 2.5% and 4%.

Other real estate mortgage

2.20%

1.80%

1.40%

Total real estate charge-off stood at 1.75% in Dec 2008.

Real estate construction

5.62%

5.12%

4.62%

Construction and land development charge-off stood at 5.12% in the US in 4Q 08.

Lease financing

0.89%

0.74%

0.47%

In the US, lease financing charge-off was 0.62% in 4Q 08.

Real estate 1-4 family first mortgage

12.03%

10.13%

11.03%

Computed based on state-wise loan rate.

Real estate 1-4 family junior lien mortgage

16.19%

28.18%

15.19%

Computed based on state-wise loan rate.

Credit card

15.47%

14.00%

12.28%

Wells Fargo charge-off on credit card stood at 10.13% in 1Q 09. Furthermore, Federal Reserve assumptions for the same stood at 9%-10%.

Other revolving credit and installment

4.00%

3.50%

3.00%

Wells Fargo's charge-off on revolving credit and installment stood at 3.1% in 1Q 09.

Foreign

0.68%

0.58%

0.48%

Our assumption is based on regression analysis. The charge-off on foreign loan stood at 0.4% at the end of 4Q 08.

 

Total losses based on the 1Q 2009 outstanding loan balance

Pessimistic Case

 Loan Portfolio (US$ million)

Outstanding Balance 1Q 2009

Loan losses in 2009 and 2010

Commercial and commercial real estate:

 

 

Commercial

191,711

9,355

Other real estate mortgage

104,934

4,617

Real estate construction

33,912

3,812

Lease financing

14,792

264

Total commercial and commercial real estate

345,349

18,049

Consumer:

 

 

Real estate 1-4 family first mortgage

242,947

51,643

Real estate 1-4 family junior lien mortgage

109,748

62,958

Credit card

22,815

7,059

Other revolving credit and installment

91,252

7,300

Total consumer

466,762

128,960

Foreign

31,468

926

Total Loans

843,579

147,934

Securities

1Q 2009

Total

Available for Sale 

223,581

13,652

Trading Account

46,497

VIEs & QSPEs exposure as on December 31, 2008

1,902,631

25,800

Total Loan Losses

 

187,386

 

Federal Reserve loan loss computation

Federal Reserve Computation (US$ billion)

Loan losses in 2009 and 2010

As % of loans

First Lien Mortgages

32.4

11.9%

Second/Junior Lien Mortgages

14.7

13.2%

Commercial and Industrial Loans

9

4.8%

Commercial Real Estate Loans

8.4

5.9%

Credit Card Loans

6.1

26.0%

Securities (AFS and HTM)

4.2

NA

Trading & Counterparty

NA

NA

Other

11.3

NA

Total Loan Losses

86.1

 

Capital to be raised

13.7

 

Capital to be raised - Impact on TCE

Capital to be raised US$ million

Min Tangible Equity Capital Ratio

Pessimistic Case

Base Case

Optimistic Case

2.25%

10,635

9,461

8,250

2.50%

14,009

12,865

11,684

2.75%

17,383

16,270

15,119

3.00%

20,757

19,674

18,553

3.25%

24,131

23,078

21,988

3.50%

27,505

26,482

25,422

3.75%

30,879

29,886

28,857

4.00%

34,253

33,290

32,291

4.25%

37,627

36,694

35,726

4.50%

41,001

40,098

39,160

4.75%

44,375

43,502

42,595

5.00%

47,749

46,906

46,029

Wells Fargo's current Tangible Common Equity (TCE) stands at 3.28%, which is significantly lower than the prescribed limit of 4%. According to our projection, the bank's TCE would fall to 1.56% at the end of 2010 after adjusting for accounting and economic losses of US$187.4 billion in the adverse case. (According to the Federal Reserve stress test, losses in the next two years would total US$86.1 billion, which is much lower than our assumption). Furthermore, resources other than capital available to absorb losses totaled US$60.4 billion, marginally higher than the Federal Reserve estimate of US$60.0 billion. Though the Federal Reserve resources available to absorb losses are similar, the loan losses estimate does not match. This is mainly due to Wells Fargo's huge off-balance sheet exposure of US$1.9 trillion in 1Q 08, up from US$1.79 trillion in 4Q 08, and home equity loan exposure of US$128.9 billion. Considering the massive anticipated losses in the next two years, Wells Fargo's capital would fall short by US$34.3 billion and not US$13.7 billion as shown by the SCAP result to maintain a TCE ratio of 4% in the pessimistic case. To increase the TCE to 4% in the optimistic case, Wells Fargo would have to raise US$32.9 billion to endure the recessionary pressure.

According to the press release, on May 9, 2009, Wells Fargo raised US$8.6 billion capital by issuing 392.15 million shares at US$22 per share. This diluted the earnings by around 8.4%. However, in the pessimistic case scenario, the bank would still be required to raise additional US$25.65 billion as a safeguard against a deeper recession.