Friday, 10 July 2009 01:00

Green Shoots are Being Fertilized by Brown Turds in the Mortgage Markets

I have recently finished my scan of potential new investments and short candidates. I have started splitting the scans into financial and non-financial companies since the financial numbers have been looking so bad, they actually skew the scan. I am also relatively heavily weighted in financials, and am concerned about short term pops due to financials putting out accounting gains on top of significant economic losses, all allowable due to the government and the FASB succumbing to lobbying pressure. Economic losses will bear out in the end, but this seemingly highly manipulated market has shown a proclivity to part significantly from the fundamentals, dot.com era style.

Alas, as I update the open source mortgage default model to compare the month of March 2009 with that of April 2009, I see that mortgages have not only continued their downward plunge in economic value, that plunge has significantly accelerated in many cases. There are some indications where the delinquencies have moderated or reversed, but I am assuming the mortgage modification efforts have allowed many banks to reclassify the status of enough delinquent loans to skew the results upwards. The foreclosures in all classes have spiked, and this spike should be even sharper in the upcoming months as the cessation of the moratorium on foreclosures works its way through the system. My thoughts on the effects of mortgage modifications on the delinquency rate is an assumption, and not backed empirically, but I am confident on my bearish perception of those who participated in the biggest ponzi scheme this country has ever known. This ponzi scheme is NOT housing or mortgage based. It is credit and lending based. There was never a subprime crisis, it was an underwriting crisis! That means that what we have seen in the housing and the subprime/Alt A mortgage markets will be replicated in the auto loan, leasing, commercial mortgage, credit card, consumer and commercial loan markets as well. As you can see, I am still very bearish on lenders, and that bearishness is now proving to be more profitable in the manufacturing, services and industrial sectors than in the banking industry.

To explain, the banking industry and Wall Street's foibles have now worked their way down to Main Street. There unwillingness and inability to lend after just lending to practically every entity that should never have received the amount and type of credit that they did receive during a hot asset bubble has created a rash of insolvencies. I have found several insolvent, and near insolvent companies, with significant debt rollover and obligations due within 5 months (I will be releasing previews to these opinions with a week to subscribers). Of course, if the lending markets are as willing to lend as CEOs and government officials contend, and if the economic shoots of recovery are as green as the media and the anti-Reggie pundits allege, then these companies should find fruitful and willing lending markets in which to rollover their debt and finance their obligations. I doubt so very seriously, but then again, I never went for the Green Shoot Sh1t any way. More like Brown Turds of Fertilizer.

Now that banks are officially stingy as hell in the lending department and the securitization industry as the largest source of credit in the world is officially busted, the companies, entities and individuals that they showered with imprudent credit are going to see the insolvent side of hell as:

The combination of zombie construction projects still being erected (see Who are ya gonna believe, the pundits or your lying eyes?), a year after the start of a recession during the worst global (and national) credit crisis in history, and an extant glut of housing, apartment, retail, commercial and office space, standing on top of historically near-peak unemployment, form the backdrop to mortgage delinquencies that appear to not even be near their zenith being held by banks that aren't willing to lend.

Alt A loans:

Geographic breakdown of Alt A loans

geo_alt_a_delinquencies.png

Source: New York Fed

I have warned about Alt A loans in the beginning of the year - see The banking backdrop for 2009. As of April 30, 2009 there were nearly 2 mn Alt A loans outstanding, each with an average balance of $321,293, representing $651 bn (down from $658 bn in March 2009) of total Alt A loans (avg FICO score of 705). California with 43.8% of total Alt A loans (avg FICO score of 709) had the largest share of Alt A loans followed by Florida (9.4% of total Alt A with avg FICO score of 700) and New York (5.6% of Alt A loans with avg FICO score of 704).

Alt A Gross Charge off's: The root cause of the credit crisis is still getting worse, net-net!

In April 2009 36.7% of Alt A loans had least one late payment in the past one year, up from 35.8% in March 2009. Florida had the highest percentage of late payments with nearly 49.5% (48.5% in March 2009) of Alt-A loans with at least one late payment over the past one followed by Nevada (45.1%) and California (42.7%).

In April 2009 Alt A loans 30-89 days past due declined to 8.2% compared with 9.1% in March (this may be due to loan modification efforts which have reclassified the status of delinquent loans). Alt A loans 90+ days past due increased by a modest 20 basis points to 8.9% from 8.7% in the month of March. California and Nevada with 11.6% and 10.7% of Alt A loans 90+ days past due had the highest delinquency rates in U.S.

Total Alt-A loans past due (pro rata share, based on weighted average with weights based on average loan outstanding at each state) stood at 17.1% as of April 31, 2009 compared with 17.7% in March 2009. Although delinquent loans declined marginally by 60 basis points, Alt A loans under foreclosure increased 100 basis points to 9.3% in April 2009. REO loans stood at 3.4% of total loans in April 2009.

Overall 30.5% of Alt-A loans had high risk of default in April 2009 compared with 30.41% in March 2009.

Alt A loans 30-89 days past due

alt_a_past_due.png

Source: New York Fed

Alt A loans 90+ days past due

alt_a_90_days_past_due.png

Source: New York Fed

Current LTV:

To predict the current LTV for Alt-A loans we have used LTV at origination in conjunction with housing price decline for each of the states where loan was originated and loan vintage.

As housing prices continued to decline, current LTV for Alt A loans increased to 119% in April 2009 versus 116% in March 2009.

Alt A loans
State LTV at origination Housing price decline Current LTV
CA 78% -39% 127%
FL 81% -36% 128%
NY 77% -15% 91%
NJ 79% -27% 109%
WA 84% -6% 89%
VA 83% -27% 113%
MD 82% -28% 113%
IL 84% -23% 109%
AZ 81% -45% 149%
MA 78% -16% 93%
GA 87% -17% 105%
CO 86% -9% 94%
NV 83% -49% 164%
TX 86% -4% 90%
Total 81% -25% 119%

Source: FDIC, Boom Bust Blog analysis

To determine net charge-offs for Alt-A loans we have considered recovery rate based on historical recovery rates along with current LTV's. The table below presents summary of recovery rates used to determine net charge-offs'.

Current LTV

Recovery rate

Basis

Greater than

120%

8.9

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

Greater than

110%

14.9%

Greater than

100%

21.0%

(average recovery rate since 1976)

Greater than

90%

28.0%

Less than

<90%

35.0%

(highest recovery rate since 1976)

Source: FDIC, Boom Bust Blog analysis

(The above recovery rates are based on average recovery rates since 1976. These recovery rates could be on a conservative side considering recovery rate for banks declined to 8.9% in 2008, according to latest DIC data.)

Net Charge offs:

Alt A loans
State Total Loans past due Foreclosed Loans REO loans Gross Charge offs Recovery Rate Net Charge offs
CA 12% 11% 5% 36% 9% 32%
FL 9% 23% 3% 42% 9% 39%
NY 8% 8% 1% 26% 28% 19%
IL 6% 11% 4% 29% 21% 23%
TX 3% 2% 1% 11% 35% 7%
NJ 7% 13% 1% 30% 21% 24%
MI 6% 4% 7% 25% 9% 23%
MD 10% 7% 3% 29% 15% 25%
MA 8% 8% 2% 26% 28% 19%
PA 5% 4% 1% 17% 15% 14%
OH 4% 6% 2% 19% 21% 15%
AZ 8% 9% 5% 30% 9% 27%
Total 17.1% 9.3% 3.4% 30.5% 20.3% 26.6%

Source: New York Fed FDIC, Boom Bust Blog analysis

Overall net charge off for Alt-A loans (cumulative 2 years assuming current delinquent and foreclosed loans turn into expected charge-off over a two year time horizon) is expected to reach as high as 26.6%, up from 25.6% estimated in March 2009. (Primarily off lower recoveries and increased LTV partially offset by marginal decline in delinquencies)

Subprime loans:

As of April 30, 2009 there were nearly 2.56 mn subprime loans outstanding, each with an average balance of $180,999 representing $461 bn of total subprime loans (avg FICO score of 617). Total value of subprime loans declined to $461 bn in April 2009 compared with $467 bn in March 2009.

Geographic breakdown of Subprime loans

geo_subprime_breakdown.png

California and Florida together constituted nearly 25.5% and 10.5% of total subprime loans. As of April 30, 2009 nearly 39% of subprime loans in U.S had FICO score less than 600.

Average FICO score

subprime_average_fico_score.png

Subprime Gross Charge off's:

Nearly 64.3% of subprime loans had at least one late payment over the past one year compared with 64.0% in March 2009. This is a phenomenally high number that truly has no precedent that I know of in American history. The real problem is that not only is it horrible, it is getting worse month by month, despite significant government effort and rhetoric to stem the tide.

In April 2009 subprime loans 30-89 days past due declined to 14.2% over 15.3% in March 200 while loans 90+ days past due remained flat at 14.6% (again, I suspect that loan modification programs that reclassify the status of a loan may be responsible for this reduction). Massachusetts and Tennessee had the highest 90+ days past due at 19.8% and 18.6%, respectively.

Total subprime loans past due declined to 28.2% in April 2009 from 29.8% in March 2009. However, subprime loans under foreclosure increased to 12.6% from 12.1% in the previous month (and I suspect this will spike in the upcoming months as the foreclosure moratorium cessation works its way through the system) while REO loans declined to 5.8% in April 2009 from 6.3% in. March 2009. It will be interesting to see how the increase in unemployment affects these numbers in the upcoming months.

Subprime loans 30-89 days past due

subprime_30-89_days_past_due.png

Source: New York Fed

Overall 49.2% of subprime loans had high risk of default in April 2009 compared with 50.8% in March 2009.

Subprime loans 90+ days past due

subprime_90_days_past_due.png

Source: New York Fed

Current LTV:

To predict the current LTV for subprime loans we have used LTV at origination in conjunction with housing price decline for each of the states where loan was originated and loan vintage.

As housing prices continued to decline current LTV for subprime loans increased to 118% in April 2009 from 115% in March 2009.

Subprime
State LTV at origination Housing price decline Current LTV
CA 80% -39% 130%
FL 83% -36% 129%
NY 81% -15% 94%
IL 87% -22% 112%
TX 84% -4% 87%
NJ 81% -27% 111%
MI 87% -43% 153%
MD 83% -28% 115%
MA 82% -16% 97%
PA 84% -26% 114%
OH 88% -19% 108%
AZ 83% -47% 155%
Total 84% -25% 118%

Source: FDIC, Boom Bust Blog analysis

To determine net charge-offs for subprime loans we have considered recovery rate based on historical recovery rates along with current LTV's. The table below presents summary of recovery rates used to determine net charge-offs'.

Current LTV

Recovery rate

Basis

Greater than

120%

8.9

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

Greater than

110%

14.9%

Greater than

100%

21.0%

(average recovery rate since 1976)

Greater than

90%

28.0%

Less than

<90%

35.0%

(highest recovery rate since 1976)

Source: FDIC, Boom Bust Blog analysis

(The above recovery rates are based on average recovery rates since 1976. These recovery rates could be on a conservative side considering recovery rate for banks declined to 8.9% in 2008, according to latest DIC data.)

Net Charge offs:

Subprime
State Total Loans past due Foreclosed Loans REO loans Gross Charge offs Recovery Rate Net Charge offs
CA 16% 15% 11% 55% 9% 2%
FL 13% 28% 6% 59% 9% 1%
NY 15% 15% 3% 47% 28% 2%
IL 13% 16% 8% 52% 15% 1%
TX 10% 4% 2% 32% 35% 1%
NJ 15% 21% 4% 54% 15% 1%
MI 16% 6% 11% 51% 9% 0%
MD 17% 12% 7% 51% 15% 0%
MA 20% 12% 5% 52% 28% 1%
PA 13% 8% 2% 39% 15% 0%
OH 13% 12% 5% 44% 21% 1%
AZ 17% 14% 11% 56% 9% 0%
Total 28.2% 12.6% 5.8% 49.2% 16.6% 41.9%

Source: New York Fed FDIC, Boom Bust Blog analysis

Overall net charge offs for subprime loans (cumulative 2 years assuming current delinquent and foreclosed loans turn into expected charge-off over a two year time horizon) is expected to reach as high as 41.9%, up from 41.4% estimated in March 2009. (Primarily off lower recoveries and increased LTV partially offset by marginal decline in delinquencies)

Prime mortgage delinquencies appear to be the next shoe to drop:

Mortgage delinquencies

mortgage_trends.png

Source: S&P, Mortgage Banker Association, Bloomberg

Delinquencies in the U.S continue to increase without any signs of revival. In the month on May 2009, mortgage foreclosures for prime loans increased to 5.94% up from 5.46% in April 2009 and 4.89% in March 2009 while mortgage foreclosures for Alt -A loans spiked to 9.78% from 9.0% and 8.0% in April and March 2009, respectively. Overall mortgage foreclosures in U.S for all loans increased to 10.12% in May 2009 from 9.56% in April 2009 as U.S housing prices continued to decline with S&P Case Shiller index declining 0.60% month-on-month in April 2009 and 2.2% in March 2009. This is actually very bearish, indeed.

Trends in delinquencies - U.S banks

trends_in_us_banking.png

Source: FDIC

Trends in U.S banking industry:

Notice the difference in exposure now as compared to the S&L crisis era (1987 to 1993). We have literally three times as many loans to go bad while the delinquency trend is already about to surpass that era, and we are not even finished this downcycle - not by a long shot!

U.S bank's net interest margin

us_bank_net_interest_margin.png

Source: FDIC

Despite significant government welfare and ZIRP policies, net interest margins (lending related profitability gross of credit issues) are at a 33 year low!

In 2008 total loans (net of unearned income) increased 2.2% to $6,682 bn while delinquent loans (including 30-89 and 90+ days past due) and nonaccrual loans increased by a whopping 74% and 132% to $199 bn and $137 bn. respectively. Delinquent loans as percentage of total loans increased to 2.99% at the end of 2008 while nonaccrual loans increased to 2.0% of total loans. Gross charge-offs as percentage of total loans increased to 1.46% at the end of 2008 while recoveries as percentage of charge offs declined to 9.0% in 2008 compared with 18% in 2007. Resultantly net charge offs increased to 1.33% of total loans from 0.58% in 2007. U.S bank's net interest margin has declined consecutively since early 1990's falling to 2.95% in 2008 from 4.23% in 1993.

Relevant links:

Contributed Reading:

  1. Debt - Thoughts On A Global Problem (Part 1),
  2. Banking out of Control (Part 2)

Recommended Reading - The Asset Securitization Crisis:

  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 - counter-party failure will open up another Pandora's box (must read for anyone who is not a CDS specialist)
  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. Municipal bond market and the securitization crisis - part 2 (should be read by whoever is not a muni expert - this newsbyte may be worth reading as well)
  7. 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
  8. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
  9. More on the banking backdrop, we've never had so many loans!
  10. As I see it, these 32 banks and thrifts are in deep doo-doo!
  11. A little more on HELOCs, 2nd lien loans and rose colored glasses
  12. Will Countywide cause the next shoe to drop?
  13. Capital, Leverage and Loss in the Banking System
  14. Doo-Doo bank drill down, part 1 - Wells Fargo
  15. Doo-Doo Bank 32 drill down: Part 2 - Popular
  16. Doo-Doo Bank 32 drill down: Part 3 - SunTrust Bank
  17. The Anatomy of a Sick Bank!
  18. Doo Doo Bank 32 Drill Down 1.5: Wells Fargo Bank
  19. GE: The Uber Bank???
  20. Sun Trust Forensic Analysis
  21. Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street
  22. Goldman Sachs Forensic Analysis
  23. American Express: When the best of the best start with the shenanigans, what does that mean for the rest..
  24. Part one of three of my opinion of HSBC and the macro factors affecting it
  25. The Big Bank Bust
  26. Continued Deterioration in Global Lending, Government Intervention in Free Markets
  27. The Butterfly is released!
  28. Global Recession - an economic reality
  29. The Banking Backdrop for 2009

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Last modified on Friday, 10 July 2009 01:00