This is the 10th installment of Reggie Middleton on the Asset Securitization Crisis - a comparison of today's credit crisis to the S&L debacle.

The Asset Securitization Crisis Analysis roadmap to date:

  1. Intro:
    The great housing bull run – creation of asset bubble, Declining
    lending standards, lax underwriting activities increased the bubble – A
    comparison with the same during the S&L crisis
  2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
  3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
  4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  5. Municipal bond market and the securitization crisis – part I
  6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
  7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
  8. More on the banking backdrop, we've never had so many loans!
  9. As I see it, these 32 banks and thrfts are in deep doo-doo!

  10. A little more on HELOCs, 2nd lien loans and rose colored glasses

Will Countrywide be the next shoe to drop?

We have started on Countrywide counterparty research and are looking carefully into both BAC and CFC’s latest financial statements trying to find details on the CDS agreements which could throw some light on the counterparties and the ones who have significant credit exposure to CFC.

From BAC’s perspective, many market participants are now expecting it to renegotiate the proposed $4 billion deal for CFC acquisition at $0-$2 per share. In the first quarter of 2008, BAC’s first quarter profit declined 77% to $1.21 billion, or 23 cents a share against the market expectations of 41 cents per share. In 1Q 08, the bank has written down $1.47 billion of collateralized debt obligations (CDOs) and $439 million of loans. Furthermore, the bank increased its provision for credit losses to $6.01 billion in 1Q 08 from $1.24 billion as credit costs increased in the home-equity, small-business and homebuilder portfolios. The bank’s net charge offs almost doubled to $2.72 billion in 1Q 08 as compared to $1.43 billion in 1Q 07. These delinquincies and charge offs are understated for many banks. Those who are
feeling too much heat are doing things such as purposely
under-reporting delinquincies and charge offs, preferring instead to
let people live in their houses without paying rather than take the
accounting hit of reporting the bad news, exstending the period in
which accounts are qualified as charge offs, knowingly allowing
servicing companies to operating at a decided lag in reporting
delinquincies, etc.
So far, BAC has written down $14.8 billion in credit losses and is working to replenish the capital base. In the month of April and May 2008, the bank sold almost $6.7 billion in perpetual preferred stocks which includes $2.7 billion of preferred stocks in May 2008 at a coupon rate 8.2%, and $4.0 billion in April 2008 at a coupon rate of 8.125%. The bank had also sold $6.0 billion of preferred stock in January 2008 at a coupon rate of 8.0%.

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On the other hand, CFC has credit risk on its balance sheet in the form of loan portfolio, subprime securities, home equity line of credit (HELOC) securities, warranties on loans sold, and loans held outside of banking operations. At the end of 1Q 2008, CFC had a $95 billion loan portfolio comprising $28 billion of option Adjustable rate mortgages (ARMs), $14 billion in Home equity line of credit (HELOC), $20 billion in second liens, and $19 billion of hybrid ARMs

BAC, in a recent filing with the SEC mentioned that there was no assurance that any of CFC's outstanding debt would be redeemed, assumed or guaranteed.. Paul Miler, an analyst with Friedman, Billings, Ramsey, in a recent note said that BAC is likely to renegotiate the purchase price the deal in the range of $0-$2 per share, as CFC’s loan portfolio continues to deteriorate so much that it currently has negative equity. Considering that BAC is already having enough trouble to handle on its own books, it is highly likely that it may renegotiate or walk out of the proposed deal. (http://www.housingwire.com/2008/05/05/bofa-countrywide-deal/)

If the deal does not go through, a number of market players will suffer - such as the monoline insurer I analyzed a few months back (see Reggie Middleton on Assured Guaranty) as well as MBIA and AMBAC, both of whom I have performed extensive analysis and shorts on last year and the beginning of this year. See:

  1. A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton.
  2. Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion Market Cap
  3. Follow up to the Ambac Analysis
  4. Bill Ackman of Pershing Square - How to save the Monolines

for more info. The additional writedowns of the investment banks and their excessive leverage
puts them at risk to suspect counterparties. This was illustrated using
hedgefunds (Banks, Brokers, & Bullsh1+ part 2) and monolines. I actually used the list of Ambac clients to (successfully) look for short candidates. Assured Guaranty is highly exposed to Countrywide through HELOCs. AGO, in its 1Q 2008 report mentioned that it has a net par outstanding of $2.0 billion for transactions with CFC of which $1.4 billion were written in the financial guaranty direct segment. AGO, in its earnings call said it has underwritten some BBB rated HELOCs, the largest of which were the two Countrywide transactions in the direct segment which comprised 90% of AGO’s direct HELOC exposure.

AGO believe the possible range of losses from its countrywide exposure is $0-$100 million, after tax. Considering that a decent proportion of thee HELOCs represent the potential for 100% losses with no recoveries due to their geographic location and high LTVs, I really believe AGO is understating their exposure to loss a tad bit.

As for the other two insurers who I have alleged to be effectively insolvent last year, let's take a glance at their CDS exposure (this excludes all municipal exposue which is on the rise for risk of loss, see Municipal Credit Risk and the Asset Securitization Crisis, part 2).

image004.gif

The Partial Cost of Monoline ABS Failure
Par Equity Exposure Ratio
Bear Stearns $15,673,088,703 $11,793,000,000 132.90% icon BSC ABS inventory
Morgan Stanley $22,956,101,796 $31,269,000,000 73.41% icon MS ABS Inventory pdf
Lehman Brothers $3,151,328,632 $22,490,000,000 14.01% icon LEH ABS Inventory
Citigroup $8,100,028,623 $127,113,000,000 6.37% icon C ABS Inventory
Countrywide $12,639,385,566 $15,252,230,000 82.87% icon CFC ABS Inventory
Wells Fargo $4,700,835,231 $47,738,000,000 9.85% icon Wells Fargo ABS Inventory
Goldman Sachs $18,673,869,328 $42,800,000,000 43.63% icon GS ABS Inventory
WaMu $7,658,982,498 $23,941,000,000 31.99% icon WaMu ABS Inventory
Merrill Lynch $10,224,387,634 $38,626,000,000 26.47% icon ML ABS Inventory
Centex $511,740,636 $3,197,130,000 16.01% icon CTX ABS Inventory
Wachovia $5,328,228,928 $76,872,000,000 6.93% icon Wachovia ABS Inventory
Totals $118,950,151,688 $477,918,010,000 24.89%

I believe that if Countrywide were to go bankrupt, it would probably drag a monoline of two down the tubes with it. Since these guys are so incestuous, in that they have a tight knit ring that reinsures each other in lieu of sending the risk outside of the circle - adverse selection and risk concentration is rampant - that is in my humble opinion of course. If a big monoline or two go down, they may drag a big bank or two down with them. We have already .lost Bear Stearns, just as I predicted in October and January (see Is this the Breaking of the Bear?). Looking at the equity exposure chart above, the Riskiest Bank on the Street is next in line (see Reggie Middleton on the Street's Riskiest Bank - Update).

For those that don't know, AGO, MBIA and Ambac use credit default swaps to guarantee these deals. I have posted and entire background analysis on the CDS market and believe that this may be the the next shoe to drop in this Asset Securitization Crisis (see my list of posts on the crisis here , and the CDS market here). This is a huge, unregulated market rife with cowboy style counterparty credit risk management, if any at all. The market dwarfs the markets of US stocks, mortgage securities and US treasuries by a multiple of at least 2. The Fed does not want this to come tumbling down.

As you can see, this is a huge market and Bank of America has the 3rd largest exposure in the WORLD (that's right, the WHOLE WIDE WORLD).

In addition, they have the 3rd highest concentration of subinvestment grade risk. The company in the front of this list was paid at leat $50 billion by the government to take in an insolvent bank. I really wonder what deal BAC will be able to cut, or is the CDS risk posed from a Countrywide collapse not great enough??? Exactly how many banks does the Fed plan on bailing out? If you have been following my series and blog and are willing to read everything in detail until the end of the series, you should come to the conclusion that there is going to be a lot of bailing out needed.

To make a long story short, if BAC does go forward with this Countrywide deal with no back stop and concessions from the guys with the green ink powered helicopter, I am going to rocket them to the top of my short list and will probably go to them for a HELOC to fund the short on a more reliabe basis than brokerage margin accounts! We are looking out for more information on who could be the other players to suffer the most if BAC-CFC deal doesn’t go through. I’ll keep you updated through intermittent posts as time permits.

Published in BoomBustBlog
Tuesday, 27 May 2008 01:00

Bank Burn

From the WSJ :

Already burned by bad mortgages on their books, lenders now are feeling rising heat from loans they sold to investors.

Unhappy buyers of subprime mortgages, home-equity loans and other real-estate loans are trying to force banks and mortgage companies to repurchase a growing pile of troubled loans. The pressure is the result of provisions in many loan sales that require lenders to take back loans that default unusually fast or contained mistakes or fraud.

[Chart]

The potential liability from the growing number of disputed loans could reach billions of dollars, says Paul J. Miller Jr., an analyst with Friedman, Billings, Ramsey & Co. Some major lenders are setting aside large reserves to cover potential repurchases.

Countrywide Financial Corp., the largest mortgage lender in the U.S., said in a securities filing this month that its estimated liability for such claims climbed to $935 million as of March 31 from $365 million a year earlier. Countrywide also took a first-quarter charge of $133 million for claims that already have been paid.

The fight over mortgages that lenders thought they had largely offloaded is another reminder of the deterioration of lending standards that helped contribute to the worst housing bust in decades.

Such disputes began to emerge publicly in 2006 as large numbers of subprime mortgages began going bad shortly after origination. In recent months, these skirmishes have expanded to include home-equity loans and mortgages made to borrowers with relatively good credit, as well as subprime loans that went bad after borrowers made several payments.

Many recent loan disputes involve allegations of bogus appraisals, inflated borrower incomes and other misrepresentations made at the time the loans were originated. Some of the disputes are spilling into the courtroom, and the potential liability is likely to hang over lenders for years...

... Repurchase claims often are resolved by negotiation or through arbitration, but a growing number of disputes are ending up in court. Since the start of 2007, roughly 20 such lawsuits involving repurchase requests of $4 million or more have been filed in federal courts, according to Navigant Consulting, a management and litigation consulting firm. The figures don't include claims filed in state courts and smaller disputes involving a single loan or a handful of mortgages.

In a lawsuit filed in December in Superior Court in Los Angeles, units of PMI Group Inc. alleged that WMC Mortgage Corp. breached the "representations and warranties" it made for a pool of subprime loans that were insured by PMI in 2007. Within eight months, the delinquency rate for the pool of loans had climbed to 30%, according to the suit. The suit also alleges that detailed scrutiny of 120 loans that PMI asked WMC to repurchase found evidence of "fraud, errors [and] misrepresentations."

PMI wants WMC, which was General Electric Co.'s subprime-mortgage unit, to buy back the loans or pay damages. Both companies declined to comment on the pending suit.

Lenders may feel pressure to boost reserves for such claims because of the fear they could be sued for not properly accounting for potential repurchases, says Laurence Platt, an attorney in Washington. At least three lawsuits have been filed by investors who allege that New Century Financial Corp. and other mortgage lenders understated their repurchase reserves, according to Navigant.

Published in BoomBustBlog

I have identified 32 banks that are $@%%. It's really as simple as that. I have been publishing the research that I used to build my investment thesis. Thus far we have:

  1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
  2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
  3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
  4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  5. Municipal bond market and the securitization crisis – part I
  6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
  7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
  8. More on the banking backdrop, we've never had so many loans!

 

I am almost prepared to start listing more of my commercial banking shorts, but before I do I want to delve even further into the educational realm so there is no doubt as to why I am as bearish as I am. For those who can't wait to see my ultimate shorts, I will give you the complete list of what I call the "Deep Doo-Doo Banks". These are the banks that are steeped pretty deep in it. Are you ready? Can you handle the pressure? Okay, here we go!

Wells Fargo - Popular Inc - SunTrust - KeyCorp - Synovus Financial Corp - Marshall & Ilsley - Associated Banc - First Charter - M&T Bank Corp - Huntington Bancshares - BB&T Corp - JPM Chase - U.S. Bancorp - Bank of America - Capital One - Nara Bancorp - Sandy Spring Bancorp - PNC - Harleysville National - CVB Financial - Glacier Bancorp - First Horizon - National City Corp - WAMU - Countrywide - Regions Financial Corp - Citigroup - Wachovia Corp - Zions Bancorp - TriCo Bancshares - Fifth Third Bancorp - Sovereign Bancorp

Now, I already release some of my work on one of the banks, chosen due to paper thin capitalization - along with a different view on leverage. Keep in mind, for the purposes of this blog, I'm just a resourceful individual investor - albeit one that is very lucky to date (this post was before Bear Stearns dropped 98%). Therefore, no one, and I really mean no one, should be taking my opinions on this blog as investment advice. It is not intended as such and should not be percieved as such.

Published in BoomBustBlog
Wednesday, 21 May 2008 01:00

The process and pain of reintermediation

The following excerpt amplifies the anecdotal point that I made in my recent post on commercial bank loans . In particular, the amount of securitized loans banks have created, the increasing amount they started holding for thier own account, and the abrupt disruption of the market which pretty much forced them to keep everything. Keep this chart in mind as you read through William Dudley's speech.

The primary benefit of securitization was the virtualization of the bank's balance sheet. Through securitization, banks were able to underwrite a vast amount of risk relative to their balance sheet capacity, by selling off the risk to the open markets. Despite this, banks have steadily increased the amount of risk kept on (and off, through SPEs) their books over the last 20 years, with a forced increase of this concentration in 2007 when the securitization market simply shut down - cutting off the liquidity spigot for these assets. Starting at about 2004 near the height of the securitization bubble , banks increased the pace of securitized asset retention.

image046.png

Excerpt from the New York Fed web site :

May You Live in Interesting Times: The Sequel

William C. Dudley, Executive Vice President

Remarks at the Federal Reserve Bank of Chicago's 44th Annual Conference on Bank Structure and Competition, Chicago

Exhibits (slides) PDF

I gave a speech last October entitled “May You Live in Interesting Times.” In that speech I listed a number of events that I never, ever expected to see. These included AAA-rated mortgage backed securities selling at 85 to 90 cents on the dollar, asset-backed commercial paper backstopped by real assets and a full bank credit support yielding more than unsecured commercial paper issued by the same bank, and a Treasury bill auction that almost failed at a time that there was a flight to quality into Treasurys going on.

The list has gotten much longer since then. To mention just a few: AAA-rated collateralized debt obligations (CDOs) that may turn out to be worthless; monoline guarantors, some still with AAA ratings, but with credit default swap spreads higher than many non-investment grade companies and a major investment bank’s demise in a few short days in March.

The number of liquidity facilities developed and introduced by the Federal Reserve is another list that has gotten much longer. Policymakers have responded to the persistent pressures in funding markets by introducing several new liquidity tools.

Today, I want to focus on what we’ve been up to in terms of these liquidity-providing innovations. Before I begin in earnest let me underscore that my comments represent my own views and opinions and do not necessarily reflect the views of the Federal Reserve Bank of New York or of the Federal Reserve System.

Let me first define the underlying problem. The diagnosis is important both in influencing the design of the liquidity tools and in assessing how they are likely to influence market conditions.

As I see it, this period of market turmoil has been driven mainly by two developments. First, there has been significant reintermediation of financial flows back through the commercial banking system. The collapse of large parts of the structured finance market means that banks can no longer securitize many types of loans and other assets. Also, banks have found that off-balance-sheet exposures—such as structured investment vehicles (SIVs) or backstop lines of credit that are now being drawn upon—are adding to the demands on their balance sheets.

Second, deleveraging has occurred throughout the financial system, driven by two fundamental shifts in perception. On one side, actual risks—due to changes in the macroeconomic outlook, an increase in price volatility, and a reduction in liquidity—and perceptions about risks—due to the potential consequences of this risk for highly leveraged institutions and structures—have shifted. Many assets are now viewed as having more credit risk, price risk, and/or illiquidity risk than earlier anticipated. Leverage is being reduced in response to this increase in risk.

On the other side, the balance sheet pressures on banks have caused them to pull back in terms of their willingness to finance positions held by non-bank financial intermediaries. Thus, some of the deleveraging is forced, rather than voluntary.

In some instances, these two forces have been self-reinforcing: In March, the storm was at its fiercest. Banks and dealers were raising the haircuts they assess against the collateral they finance. The rise in haircuts, in turn, was causing forced selling, lower prices, and higher volatility. This feedback loop was reinforcing the momentum toward still higher haircuts. This dynamic culminated in the Bear Stearns illiquidity crisis.

During the past eight months, the financial sector as a whole has been trying to shed risk and to hold more liquid collateral. This is a very difficult task for the system to accomplish easily or quickly for two reasons. First, the financial sector, outside of the commercial banking system, is several times bigger than the banking system. So, with some hyperbole, you are, in essence, trying to pour an ocean through a thimble. Second, this process of deleveraging tends to push down asset prices for less liquid assets. The decline in asset prices generates losses for financial institutions. Capital is depleted, increasing the pressure on balance sheets.

One consequence of this reintermediation and deleveraging process has been persistent upward pressure on term funding rates. For example, the spreads between 1- and 3-month LIBOR and the comparable overnight index swap rates have widened sharply during this period. The overnight index swap rate is the expected effective federal funds rate over the stated maturity of the swap. As shown in the two exhibits on page two, this pressure on term funding rates has occurred in the United States, Euroland, and the United Kingdom. It is a global phenomenon.

In fact, the increase in LIBOR to overnight indexed swap (OIS) spreads may understate the degree of upward pressure on term funding rates. Note that after a Wall Street Journal article on April 16 questioned the veracity of some of the LIBOR respondents and the British Bankers Association threatened to expel any banks that they discovered had been less than fully honest—LIBOR spreads increased further.

The foreign exchange swap market indicates that the funding costs for many institutions may be even higher than suggested by the dollar LIBOR fixing. As shown in the next slide, the funding cost of borrowing dollars by swapping into dollars out of euros over a 3-month term is about 30 basis points higher than the 3-month LIBOR fixing.

So what explains this rise in funding pressures more precisely? Some have argued that the rise in term funding spreads reflects increased counterparty risk; others that the rise stems from a reduction in appetite of money market funds to provide term funding to banks. Over the past eight months, there is some validity to both of these arguments. But neither explanation provides a very satisfactory explanation.

Credit default swaps spreads for major commercial banks have narrowed considerably over the past two months. This indicates that counterparty risk assessments are improving—yet LIBOR-OIS spreads widened over this period. Thus, it is hard to pin this widening in LIBOR-OIS spreads on an increase in counterparty risk.

Similarly, the notion that money market mutual funds have lost their appetite for term bank debt has not been particularly compelling recently. The split of money market fund assets between Treasury-only versus prime money market funds has been relatively stable, the weighted average maturity of the funds has been increasing, and prime funds have increased their allocation to both foreign and domestic bank obligations. In contrast, when there was a flight to quality to Treasury-only money market funds last August, this was a more compelling explanation.

So what has been driving the recent widening in term funding spreads? In my view, the rise in funding pressures is mainly the consequence of increased balance sheet pressure on banks. This balance sheet pressure is an important consequence of the reintermediation process. Although banks have raised a lot of capital, this capital raising has only recently caught up with the offsetting mark-to-market losses and the increase in loan loss provisions. At the same time, the capital ratios that senior bank managements are targeting may have risen as the macroeconomic outlook has deteriorated and funding pressures have increased.

The argument that balance sheet pressure is the main driver behind the recent rise in term funding spreads is supported by what has been happening to the relationship between other asset prices—especially the comparison of yields for those assets that have to be held on the balance sheet versus those that can be easily sold or securitized. Consider, for example, the spread between jumbo fixed-rate mortgages and conforming fixed-rate mortgages, which is shown in the next slide. As can be seen, this spread has widened sharply in recent months, tracking the rise in the LIBOR/OIS spreads.

Why is this noteworthy? Jumbo mortgages can no longer be securitized, the market is closed. Thus, if banks originate such mortgages, they have to be willing to hold them on their balance sheets. In contrast, conforming mortgages can be sold to Fannie Mae or Freddie Mac. Because the credit risk of jumbo mortgages is likely to be comparable to the credit risk of conforming mortgages, the increase in the spread between these two assets is likely to mainly reflect an increase in the shadow price of bank balance sheet capacity.

If this is true, then the same balance sheet capacity issue is likely to be an important factor behind the widening in term funding spreads. After all, a bank has a choice. It can use its scarce balance sheet capacity to fund a jumbo mortgage or to make a 3-month term loan to another bank.

If balance sheet capacity is the main driver of the widening in spreads, this suggests that there are limits to what the Federal Reserve can accomplish in terms of narrowing such funding spreads. After all, the Fed’s actions cannot create bank capital or ease balance sheet constraints materially.

That said, the Fed can reduce bank funding risks by providing a safe harbor for financing less liquid collateral on bank and primary dealer balance sheets. Reducing this risk may prove helpful by lessening the risk that an inability to obtain funding would force the involuntary liquidation of assets. The ability to obtain funding from the Fed reduces the risk of a return to the dangerous dynamic of higher haircuts, lower prices, forced liquidations, and still higher haircuts that was evident in March.

In essence, the Federal Reserve’s willingness to provide liquidity against less liquid collateral allows the reintermediation and deleveraging process to proceed in an orderly way, which reduces the damage to weaker counterparties and funding structures. One can think of the Federal Reserve’s actions as smoothing and extending the adjustment process—not preventing it—so that the adjustment causes less damage to the financial system and less pernicious macroeconomic consequences.

The Federal Reserve has introduced three

Published in BoomBustBlog

At the end of 1Q2008, PNC’s leverage (total assets / total equity) stood at 9.7x against an average leverage of 10.0x for its peers (US regional banks). However, on adjusting for intangibles PNC’s leverage increases significantly to 25.7x and comprates negatively against its peer group average of 21.8x owing to a higher proportion of intangibles to its shareholders’ equity (around 65%). Take note that in our analysis we highlighted PNC’s poor regulatory capital ratios vis-à-vis its peers. If we were to exclude the intangibles for the entire peer group, PNC’s regulatory ratios would be even worse off in comparison with its peers due to its higher proportion of intangible to shareholders’ equity. This is simply an alternative way of expressing what I hope was thoroughly articulated in the PNC analysis, the adequacy of PNC’s capital is lacking.

Although in 1Q2008 PNC’s reported EPS of $1.10 per share compared to $1.26 in 1Q2007, PNC’s reported net income for 1Q2008 included several non-recurring gains, totaling $244 mn (including gain on sale of Hilliard Lyons of $114 mn, Visa redemption gain of $95 mn, BlackRock LTIP shares mark-to-market adjustment of $37 mn). Despite Mercantile, ARCS and Albridge acquisitions, PNC’s fee based income excluding the impact of extraordinary gains declined 19.1% in 1Q2008 over 1Q2007. Excluding the impact of these one time items, PNC’s adjusted EPS declined to $0.67 versus $1.26 in 1Q2007. Thus we believe that although PNC’s reported numbers represent quite the rosy outlook - an outlook which we failt to share, PNC’s core operating result remain under pressure.

Although PNC’s provisions at $188 mn and $151 mn for 4Q2007 and 1Q2008 were at low levels (which on its face seems to be a positive), expected higher charge-offs would warrant a higher allowance for provisions for PNC in the coming quarters since the bank’ has inadequate provisioning. In our analysis, we have commented on PNC’s inadequate provisioning for loan losses which seems a serious concern owing to expected rising NPAs/charge-offs

Published in BoomBustBlog

This is another installment of my series on the US banking system and the Asset Securitization Crisis. As a recap, let's draw a map to where we are currently.

Sections 1 through 5 are background material that is probably known to the professional in this arena, but will make good reading for the lay person. I used it to make sure I made judgments based on observable facts vs. media representation and/or personal bias. I feel the section on counterparty risk should be required reading for everybody, though. The report on PNC basically outlines, in full detail, why I chose that bank out of 329 others, to initiate my short foray into the regionals. Part 2 of the municpal report will be coming soon.

  1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
  2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
  3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
  4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  5. Municipal bond market and the securitization crisis – part I
  6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
  7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux

In the graph below, you will see that commercial banks have gorged themselves on consumer finance risk over the last 20 years. It is not just the investment banks that took chances with leverage and concentration.

Published in BoomBustBlog
Sunday, 18 May 2008 01:00

Additional data on PNC

Here are some additional tidbits of info on PNC's primary lending markets to serve as an adjunct to the PNC research I released the other day. Remember, this is all to be taken against the backdrop of the macro bank research that I released as well. If you haven't notice, when I take a short position, I am quite serious about it.

PNC Financial Services Group, citing the credit crunch currently roiling the financial services industry, shut down a program in December 2007 that offered home-equity loans via third-party mortgage brokers. PNC plans to close all brokered loans by Feb 29, 2008.release a couple of days ago. This is a trend among many, if not most banks. Reduce the risk and exposure to the HELOC market, and reduce or eliminate origination through brokers.

Links:

http://www.post-gazette.com/pg/07359/844273-28.stm

http://www.gazette.net/stories/123107/businew134530_32356.shtml

The branch network is located primarily in Pennsylvania, New Jersey, Washington, DC, Maryland, Virginia, Ohio, Kentucky and Delaware.

The following are the micro trends in those areas where PNC has just concentrated (by reducing broker production to zero):

2006 2007 2008
Pennsylvania (Aggregate) Personal Bankruptcies 77,587 40000 48020
House Price Index 144.2 147.4 144.3
Unemployment Rate 5.2 5.0 5.1
Housing Permits (total units) 44,019 40,300 38,840
-% change in bankruptcies -48.4% 20.1% Consumer financial lines pressured
-% change in housing permits -8.4% -3.6% Mortgage originations pressured
-% change in Housing price index 2.2% -2.1% Extant LTVs increased
Philadelphia metro division Personal Bankruptcies 11,439 6,899 7,244
House Price Index 219.1 222.6 217
Unemployment Rate 4.7 4.4 4.5
Pittsburgh Personal Bankruptcies 12,577 7,731 9,275
House Price Index 158.4 164.2 159.1
Unemployment Rate 4.9 4.3 4.9
Scranton/Wilkes-Barre MSA Personal Bankruptcies 2,114 1,162 1,362
House Price Index 171.8 182.2 177.3
Unemployment Rate 5.3 4.9 5.1
New Jersy Personal Bankruptcies 48,811 30,800 36,600
House Price Index 521.4 574.6 618
Unemployment Rate 4.4 4.7 4.9
Housing Permits (total units) 38,375 35,200 31,300
-% change in bankruptcies -36.9% 18.8% Consumer financial lines pressured
-% change in housing permits -8.3% -11.1% Mortgage originations pressured
-% change in Housing price index 10.2% 7.6% Extant LTVs decreased (this trend is reversing though)
Washington D.C. Personal Bankruptcies 12,071 8,927 10,758
House Price Index 278.8 280.2 267.2
Unemployment Rate 3.1 3.1 3.6
Housing Permits (total units) 27,958 22,402 17,505
-% change in bankruptcies -26.0% 20.5% Consumer financial lines pressured
-% change in housing permits -19.9% -21.9% Mortgage originations pressured
-% change in Housing price index 0.5% -4.6% Extant LTVs increased
Maryland - Baltimore Personal Bankruptcies 11,493 5,990 7,187
House Price Index 248.9 259.9 259.4
Unemployment Rate 4.10 4.00 4.60
Housing Permits (total units) 8,133 5,902 4,595
-% change in bankruptcies -47.9% 20.0% Consumer financial lines pressured
-% change in housing permits -27.4% -22.1% Mortgage originations pressured
-% change in Housing price index 4.4% -0.2% Extant LTVs increased
Ohio Personal Bankruptcies 133,522 70,000 84,000
House Price Index 268 277.1 286
Unemployment Rate 5.9 5.5 5.7
Housing Permits (total units) 47,401 43,050 41,310
-% change in bankruptcies -47.6% 20.0% Consumer financial lines pressured
-% change in housing permits -9.2% -4.0% Mortgage originations pressured
-% change in Housing price index 3.4% 3.2% Extant LTVs decreased (I expect trend to reverse though)
Delaware (Aggregate) Personal Bankruptcies 4150 2500 3100
House Price Index 451.4 496.8 531.3
Unemployment Rate 4.2 4.0 4.2
Housing Permits (total units) 8,195 7,000 6,460
-% change in bankruptcies -39.8% 24.0% Consumer financial lines pressured
-% change in housing permits -14.6% -7.7% Mortgage originations pressured
-% change in Housing price index 10.1% 6.9% Extant LTVs decreased (I expect trend to reverse though)
Wilmington Metro Division Personal Bankruptcies 2,025.30 1,504.80 1,700.40
House Price Index 213.2 220.2 212.5
Unemployment Rate 4.0 3.5 3.6
Kentucky Personal Bankruptcies 39,860 21,000 26,200
House Price Index 271.8 282.7 292.9
Unemployment Rate 6.1 5.8 5.9
Housing Permits (total units) 8,133 5,902 4,595
-% change in bankruptcies -47.3% 24.8% Consumer financial lines pressured
-% change in housing permits -27.4% -22.1% Mortgage originations pressured
-% change in Housing price index 4.0% 3.6% Extant LTVs decreased
PNC's regional profile Unemployement 4.7 4.6 4.9
-% change in bankruptcies -42.0% 21.2% Consumer financial lines pressured
-% change in housing permits -16.5% -13.2% Mortgage originations pressured
-% change in Housing price index 5.0% 2.1% Extant LTVs decreased slightly, with a general reversal in trend back to higher LTVs for the medium terms
Published in BoomBustBlog

 I fancy myself to be a pretty good investor. While I think I'm a pretty bright guy, I know I am not at the level of the rocket scientist known to be hired by the quant funds. While I am fairly creative, I am far from an artist. While I am not a high school drop out, I don't have a PhD. So, what makes me a good investor? I have this uncanny knack of being able to smell bullsh1t a mile away!

Now, for those banking CEOs, homebuilder CEOs (ex. Mr. Hovnanian), monoline CEOs and government officials (ex. Mr. Paulson), who claim that the worst is behind us - I can smell you guys!

I am starting to come clean on my commercial bank research and personal investment positions. I do not publish my research until after I have established
my positions, but I do release broader market and macro stuff early -
figuring it can do little harm.

So, I hear Paulson says the
worst is behind us!? I am assuming he is referring to the subprime
mess, and the capital market melee that followed. Well, I don't believe
the subprime mess is over, but if it is we still have to contend with
at least 5 other failing categories of bank products that are imploding
due to securitization imprudence - all rivaling or surpassing that of
subprime.

Let's go over my research trail on the Current US
Credit Crisis. Sections 1 through 5 are background material that is probably known to the professional in this arena, but will make good reading for the lay person. I used it to make sure I made judgments based on observable facts vs. media representation and/or personal bias. I feel the section on counterparty risk should be required reading for everybody, though. The report on PNC basically outlines, in full detail, why I chose that bank out of 329 others, to initiate my short foray into the regionals.

  1. Intro:
    The great housing bull run – creation of asset bubble, Declining
    lending standards, lax underwriting activities increased the bubble – A
    comparison with the same during the S&L crisis
  2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
  3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
  4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  5. Municipal bond market and the securitization crisis – part I
  6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital

Now, let's take a more mundane look at the banking sector in general. Looking at how much of the banking industry's portfolio is concentrated in real estate, one should be concerned when housing priced drop precipitously (no spell checker, and I'm tired). We are in much more heady territory than in the S&L crisis (started by CRE lending), and the housing price drop is much worse as well.

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Published in BoomBustBlog

To begin with, I would like to remind all that I am a private investor, not an analyst, nor a reporter or media professional. Hence, expect me to be short anything that I am bearish on, and long anything that I am bullish on. Very strong investment results are my goals, with the blog being a hobby. With that being said, I am bearish on the regional banking sector with large concentrations of commercial real estate, consumer finance and 2nd lien residential real estate risk. I screened about 330 S&Ls, regional and small/mid-cap banks and the finalist of this contest was... PNC. Below is my (textual) take on PNC. Later, I will post some other banks that I have looked at along with additional info on the state of the industry that emboldens me to hold short positions during this bear rally. I will also be posting updates on the homebuilders.

This analysis was very richly formatted with plenty of charts and graphs, hence I decided to leave most of it out of the blog post. Anyone who wishes to see it in its full fidelity should simply register (for free) and download the pdf version - icon PNC Report 050508 revised (711.95 kB 2008-05-15 12:26:16).

Published in BoomBustBlog

This is a DRAFT of part 4 of Reggie Middleton on the Asset Securitization Crisis – Why using other people’s money has wrecked the banking system: a comparison to the S&L crisis of 80s and 90s. As was stated in the earlier parts, I periodically have third parties fact check my investment thesis to make sure I am on the right track. This prevents the "hubris" scenario that is prone to cause me to lose my hard earned money. I have decided to release these "fact checks" as periodic reports. This installment covers consumer finance, an aspect at risk in the banking system that is both overlooked and underestimated, in my opinion.

I urge discourse, conversation and debate on this post and the entire series. To me, it is necessary to make sure the world is as I percieve it.

The Current US Credit Crisis: What went wrong?

  1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
  2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
  3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
  4. You are here => The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  5. To be Published: Credit rating agencies – an overhaul of the rating mechanisms
  6. To be Published: An oveview of my personal Regional Bank short prospects

And now, on to the report...

Reggie Middleton on the Asset Securitization Crisis and Consumer Finance

As with the mortgage market, the consumer lending market reported significant growth since the beginning of this decade largely due to lax lending standards of financial institutions, imprudent lending and poor assessment of payback abilities of customers and more importantly, securitization!!!

Consumer credit is generally classified as revolving and non-revolving. Revolving consumer credit includes credit card lending, lines of credit, home equity line of credit (HELOC) and similar products. These types of lending products do not have a fixed number of payments; there is a limit assigned to the borrower up to which he can borrow and pay the principal and interest within a certain period. The method of functioning in this case is very similar to that of a credit card.

On the other hand, non revolving consumer credit includes loans such as automobile loans, loans for mobile homes, education, boats, trailers, vacations, etc. Unlike revolving credit, these require fixed number of payment over a period of time. Over the last 27 years, non revolving credit on an average has constituted 68.8% of the total consumer credit market.

Consumer credit outstanding (US$ bn)

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Source: Statistical Releases of the US Federal Reserve

Growth in consumer credit registered its peak during the S&L crisis, as it grew 18.4% y-o-y to US$517.2 billion at the end of 1984. Over the last 20 years (1988 to 2007), total consumer credit outstanding in the US economy has grown at a CAGR of 6.7%, making it a US$2.57 trillion industry at the end of 2007.

The growth proceedings were dominated by revolving consumer credit (CAGR of 9.0%) due to the rising demand for HELOCs over the years, a result of the booming housing market. Moreover, with low interest rates in the earlier years, borrowers found it easy to get their credit limits enhanced. As opposed to this, non revolving credit grew at a lower CAGR of 5.7% over the same period simply due to the dominance of mortgage lending over other lending forms. The faster growth in revolving credit led to a change in the composition of the market. Revolving consumer credit constituted 37.3% of total consumer credit outstanding in 2007, from 25.2% in 1988.

Published in BoomBustBlog