Monday, 25 May 2009 20:00

More Bank Bull Dookey? Featured

Written by
Rate this item
(0 votes)

I reckon these last 11 or so weeks as being akin to the bubble, wherein obviously overvalued companies with no (or even negative earnings),murky future revenue drivers, and impaired balance sheets were being hyped by sell side shills to levels that many purely fundamental investors, and basically those who simply know how to count, deemed damn near impossible. A lot of apparently smart people, ex. George Soros and Julian Robertson (the two biggest macro investors of that period - the Quantum and Tiger Funds), got wiped out trying to short thoe skeletal value stocks as they soared through the stratosphere. For a while, it looked like the shills were smart and the people who knew now to count weren't so smart. Well, as reality gained a foothold, the shill stocks and the entire market collapsed, never to regain those bubble highs. Unfortunately, those famous guys that knew how to count didn't stick in long enough. If I am not mistaken, Soros missed the market crash by a matter of months!!!

Well, here is a simple formula to aid those that know how to count, and may even enlighten those shill followers who don't know how to count...

 A decrease in residential real estate prices, such as that illustrated by the Case Shiller index leads to > home values = lower loan collateral = higher bank losses in event of default = higher propensity to default (walk away).

PLUS (+)

Low business activity leads to > corporate profits > employment which leads to higher defaults & lower consumer spending which leads to lower global GDP > lower banking profits = where we are right about now... And in yesterday's news...

JPMorgan $29 Billion WaMu Windfall Found by Turning Bad Loans Into Income  - The question remains here is did they mark the loans down enough to compensate for the future drop in home prices. My research says, "No!". See Home Prices Tumble by Record 19.1%: 9:08 AM, May 26, 2009, The Standard & Poor's/Case-Shiller National Home Price index released Tuesday reported home prices tumbled by 19.1 percent in the first quarter, the most in its 21-year history
Home Prices in 20 U.S. Cities Decline More Than Forecast Amid Foreclosures

Lowest Libor Hides `Exceptionally Wide' Spreads by Banks Hoarding Deposits - Despite the banks upgrading each other in a I'l scratch your back you scratch mine solidarity session, they still don't trust each other enough to put their money where their mouth is, despite the fact that they are more than willing to out YOUR money where their mouth is! The banks have a vey valid reason not to trust each other. The current bane to the banks balance sheet is still residential and commercial mortgages. The lower the collateral is valued behind these mortgages and the lower the paying power of the mortgagees, the less these mortgages (and associated derivative products) are worth. The banks should know full well by now, as I do, that both the collateral and the paying power of the borrower have a long ways to fall, despite the fact that they have fallen considerably already. This means that those banks that may be in trouble if real estate falls a lot more (damn near all of the banks), WILL be in trouble! Hence, why lend freely to someone who you know is in a bad way because they are in the same situation that you are in - a bad way!

Now, back to this JP Morgan "Windfall" story. At first glance, this accounting treatment will in fact have a positive impact on WFC's books as mentioned in the Bloomberg article above. Of the $122 billion in option ARM's, WFC has already marked down these loans by 37% with an estimated cash flows of around $90 billion in due course. However, based on our assumptions on the bank's loan losses (using our proprietary version of the government's "SCAP" stress testing methodology powered, ironically, by the Fed's own data), even under the optimistic case scenario, loan losses will be well over $132.4 billion which will create a void (loss) of nearly $40 billion. Therefore, it remains unlikely that the change in purchase accounting will lead to WFC overcoming the loan losses that we have estimated under the base and even the optimistic case scenarios. Keep in mind that we have already breached the base case scenario and the adverse case scenario of the Treasury's bank stress test in terms of unemployment, the Case Shiller index as already breached the base case scenario by dropping 19% thus far this year (adverse case for the government is 21%). It is almost guaranteed that the adverse case scenario for home prices will be breached by the next release of the price indexes. The trends are obvious and quit clear. From a fundamental and macro perspective, banks are still in very big trouble, even using our government's guidelines.

A portion taken from the latest WFC forensic analysis is case is point:

The value of Wells Fargo's pick-a-pay portfolio (Alt-A home loans) is US$93.2 billion of which US$39.7 billion or 42.6% are impaired loans. The principal balance of the impaired loans is US$61.6 billion. This loan has the highest probability of risk and could eventually result in a complete write-down (ie.100%) if property values continue to fall at the current rate (or close to it) much longer - or if the ability to sell foreclosure or REO properties dampens. To exemplify this, let's assume a 110% Alt-A loan written on a California property in 2006 that has declined 50% in value and still dropping currently results in a 220+% LTV property. Using dollar figures, a homeowner gets a $110,000 loan for a $100,000 home that is currently selling at foreclosure for $50,000. After 3 years of negative amortization from missed payments and skipped "pick-a-pay" payment options, an additional $5,000 is added to the principal, plus $4,000 in transaction and sales costs. The bank now has a $41,000 property on the books that it has lent $110,000+ against. This is a nearly 64% loss. As home values drop further, the loss widens. If this loan were a second or third lien, it would be totally wiped out upon any sales transaction, due to its junior position (assuming the superior liens were 30 LTV or higher, which is quite likely). Currently, the LTV in the majority of the states written 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. This does not take into consideration the additional principal most likely tacked onto the loans as a result of negative amortization that occurs when the payor chooses to pay the minimum payment, skips a payment or is in default - an occurrence which is most likely becoming increasingly common.


Impaired loans


Unpaid principal balance

Current LTV %

Carrying value

Carrying value to current value











New Jersey















Other states










Even after what appears to be an aggressive write-down of loan values, practically all legacy loans on WFC's books are overvalued when marked to actual home prices! Banks failed to anticipate the precipitous drop in home prices before the bubble, during the bubble, and they are still doing so after the bubble. Home prices are nowhere near bottoming out.


Notice how Detroit has now significantly surpassed the 1998 pricing level to the downside. This doesn't even take into consideration the fact that two of the three largest employers in that region are either in or going into bankruptcy, with 10,000's of jobs on the line through the ripple effect. A similar situation is occurring in Ohio. These numbers also fail to take into consideration what is happening with condo construction in the dense urban areas (a topic that I will get to in detail in my next post). The dramatic rate of decline is even more evident when one looks at the indices from a % change perspective.


I have delved into this topic in extreme detail in the latest forensic analysis of Wells Fargo wherein nearly the entire loan portfolio was compared to the respective statewide delinquencies, defaults, losses and recovery rates provided by the Fed and the FDIC - available to all paying subscribers:

pdf  WFC Investment Note 22 May 09 - Retail 2009-05-27 01:55:50 554.15 Kb

pdf  WFC Investment Note 22 May 09 - Pro 2009-05-27 01:56:54 853.53 Kb


Read 4238 times Last modified on Tuesday, 26 May 2009 22:16
Reggie Middleton

Resident Contrarian Badass at BoomBustBlog (you can call me Editor-in-Chief)...

Disruptor-in-Chief at, where we're ushering the P2P Economy.
Login to post comments