Modding mods

Mar 28, 2010 18:58 UTC

Friday’s announcement that the administration is overhauling its mortgage modification program to encourage principal forgiveness shows they understand that unless folks have equity in their homes, mortgage defaults will continue in huge numbers. The plan is a decent one, and it appropriately would have lenders absorb the lion’s share of losses. Still, its an all-carrots approach that may be tough to get off the ground. And taxpayers would get even more deeply involved in housing finance.

If it doesn’t work, regulators have a stick to force lenders to take losses, which I describe at the end.

First, let’s consider the size of the foreclosure problem. I chatted with Sean Dobson, CEO of Amherst Securities, and he quantifies the foreclosure crisis as 12 million at-risk households. Seven million have already stopped paying their mortgage, another five million are so deep under water, they likely will. Meanwhile, only 1.5 million homes have been liquidated, that is, they’ve been repossessed from a delinquent borrower and sold off to a buyer capable of making monthly payments. In other words, we’re in the bottom half of the first inning of this crisis.

Foreclosure is rarely the preferred solution. Borrowers lose their homes, of course. And for lenders it can be a relatively expensive solution. It’s generally cheaper for all concerned to make the mortgage payment manageable, either by allowing the borrower to do a short sale or lowering his payment to something he can afford.

But it matters how payments are lowered. Extend and pretend gimmicks — lowering rates, adding missed payments to the loan balance (“capitalization”), term extensions — are the most popular modifications as the table below from the latest Mortgage Metrics report demonstrates. However, these still leave borrowers with negative equity and a huge incentive to walk away. (Meanwhile principal forgiveness dropped dramatically from Q3 to Q4.*)

(Click here to enlarge in new window)

Screen shot 2010-03-28 at 11.17.56 AM

But these adjustments don’t result in sustainable modifications, which is the whole point…

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Screen shot 2010-03-28 at 11.20.49 AM

Twelve months after modification, nearly 60% of modified borrowers are re-defaulting. Yes, more recent mods are performing better, but research shows that without forgiving principal, defaults will stay high.

Treasury’s new approach is a big step forward.

First, it will encourage lenders to write off principal, both investors who hold most first mortgages via mortgage-backed securities and banks that mostly hold second mortgages on their balance sheet.

First mortgages will be written down to 97.75% of the home’s current value, giving previously under water borrowers new skin in the game. These mortgages will be refinanced under FHA. On the one hand, that’s good since FHA loans verify income and are fully documented. On the other, that’s still not much equity and FHA mortgages have been defaulting at higher than average rates (compare the tables on pages 14 and 15 in the MM report).

At the same time, homes with second mortgages (about half of the 3-4 million targeted by Treasury’s program) would have to be written down so that total house debt (first mortgage + second) is no higher than 115% of the home’s value. Banks would be paid 10-20 cents for every dollar of principal they forgive on second mortgages, which means they eat the lion’s share of losses. Yeah, this still leaves these borrowers under water, but at least they’ll be much closer to the surface.

Another good feature: it won’t target all at-risk borrowers, just those who are current on their mortgage. This is important because the previous iteration of HAMP only allowed defaulted borrowers to qualify for government sponsored mods. Of course that gave them a big incentive to quit paying. Nor will the principal forgiveness come up front, it will be earned over a few years as long as borrowers stay current.

The biggest problems are that this will cost taxpayers an estimated $14 billion while using the public’s balance sheet to absorb even more mortgage debt. Is that a reasonable price to help arrest the foreclosure crisis? Depends on how big the indirect impact on taxpayers would be if it were allowed to spin out of control.

(For those who want to see details of how this will work in practice, be sure to read the fact sheets published by Treasury.)

Theoretically, this program should get some traction since it benefits all concerned.

  1. Investors/banks holding first mortgages are big winners. While working on my second mortgages column, I spoke with a spokesman for the Mortgage Investors Coalition, which says it represents investors holding $100 billion worth of MBS. The plan announced on Friday is precisely what his group was pushing.
  2. Of course it’s good for borrowers.They get debt forgiveness.
  3. And even banks should buy into it since many of their second mortgages are worth very little.** This plan at least gives banks something.

That said, it could be very difficult to coordinate all the parties in question in order to get these modifications done. That’s the key risk according to Dobson: execution.

He notes that if these carrots don’t get lenders moving, regulators have a stick at their disposal. They could simply force banks to hold capital against the portion of mortgage debt no longer backed by a property’s value. This would effectively make them recognize losses up front.

They should probably do that anyway. Though banks have raised lots of equity capital over the past year, it’s probably not enough considering the losses still embedded on their balance sheets.

————–

*Why did principal reductions suddenly fall in Q4? This is just a hunch, but I bet it had something to do with Wells Fargo. They have a huge pile of option ARMs via their acquisition of Wachovia. Because these were marked down when they were purchased, it costs Wells nothing to write off principal. They made a push to do that in Q3 I believe, which may have slowed down in Q4.

Option ARMs are the deepest under water mortgages, by the way, and the most common recipients of principal forgiveness according to the MM report.

**Loan balances are paid back when houses are sold or refinanced at prices above the value of the debt. If the debt exceeds the value of the home, however, the borrower has to stump up the cash. That’s exceedingly rare, so the second mortgage may get written off while the first takes a haircut. In practice, second mortgages may still be worth something. Since they are recourse loans, they can be sold to investors for cents on the dollar. In any case, they’re not worth what banks say they’re worth.

COMMENT

What is the hit to someones credit rating if they go through this process?

Posted by jaybo43 | Report as abusive

Bank failure Friday, also 80 is the new 95

Mar 26, 2010 22:29 UTC

A bit of news to go with this week’s failures. FDIC said it will cut the amount of losses it absorbs on failed bank assets sold to acquirers. Here’s the Reuters story by Karey Wutkowski. More from Paul Miller at FBR Research:

We expected 95/5 loss sharing to be eliminated at some point as acquirers gained better clarity into the actual losses on these portfolios, and acquirers’ bids on failed banks have become more competitive in recent months as that clarity into losses materialized. When elimination of 95/5 becomes effective, the FDIC loss-sharing agreement will be 80/20 for the entire loan portfolio.

The change to the loss-sharing agreement will have the biggest impact on the FDIC, in our view, as it will simplify failed bank transactions for them. Regulators will no longer have to use resources to determine where the appropriate 80/20 to 95/5 loss sharing thresholds should lie, and on the margin the cost to the deposit insurance fund (DIF) should decrease as the FDIC will absorb a lesser percentage of losses on really bad portfolios.

For details on loss sharing, see here. But in a nutshell, FDIC will now guarantee up to 80% of the losses on assets subject to loss-share agreements, down from 95%. This will cut the amount that potential acquirers are willing to bid for failed banks, reducing the Deposit Insurance Fund’s take on the front-end, but I’m sure FDIC has done the math and higher loss guarantees are costing the DIF more over time.

On to tonight’s failures….two more in Georgia. which accounts for about one-sixth of all bank failures since 2008 according to Wutkowski. Blame speculative lending, in particular on CRE.

#41

–Failed bank: Desert Hills Bank, Phoenix AZ
–Regulator: Arizona Department of Financial Institutions
–Acquiring bank: New York Community Bank, Westbury NY
–Vitals: at 12/31, assets of $496.6 million, deposits of $426.5 million
–Transaction: loss-share on $325.9 million assets
–Estimated DIF damage: $106.7 million

#40

–Failed bank: Unity National Bank, Cartersville GA
–Regulator: OCC
–Acquiring bank: Bank of the Ozarks, Little Rock AR
–Vitals: at 12/31, assets of $292.2 million, deposits of $264.3 million
–Transaction: loss-share on $206.1 million assets
–Estimated DIF damage: $67.2 million

#39

–Failed bank: Key West Bank, Key West FL
–Regulator: OTS
–Acquiring bank: CharterBank, West Point GA
–Vitals: at 12/31, assets of $362.9 million, deposits of $343.3 million
–Transaction: loss-share on $263.1 million assets
–Estimated DIF damage: $123.3 million

#38

–Failed bank: McIntosh Commercial Bank, Carrollton GA
–Regulator: Georgia Department of Banking and Finance
–Acquiring bank: Centennial Bank, Conway AR
–Vitals: at 12/31, assets of $88.0 million, deposits of $67.7 million
–Transaction: loss-share on $75.8 million assets
–Estimated DIF damage: $23.1 million

COMMENT

There isn’t a making your way around the possibility that eco-friendly, puppy pleasant shoes are high-priced in comparison to the alternative kind. But as a swelling heart and soul, you ought to consider this value onto your satisfaction. Individually, I’d rather bleed a bit of money when compared with wear an issue that bled an increased amount of another thing..

Report shows strategic defaults increasing

Mar 26, 2010 13:01 UTC

How widespread are strategic defaults? Laurie Goodman and her team at Amherst Mortgage Insight yesterday released a report that shows they are indeed on the rise and for reasons we might suspect: negative equity and a more borrower-friendly environment.

The second reason should be kept in mind as we consider President Obama’s soon-to-be-announced plan to encourage principal reduction. If the plan is structured so that it gives incentives to default in order to secure principal forgiveness, well, expect defaults to spike.

Strategic default isn’t necessarily synonymous with mailing your keys to the bank and walking away. It may simply mean a borrower choosing to stop payments to the bank when economic incentives would have him do so. Amherst has come up with a novel metric to measure strategic default — the “default transition rate.” DTR looks at the percentage of borrowers who’ve never been more than one payment behind on their mortgage suddenly missing two payments in a row.

Lo and behold, negative equity leads more folks to strategically default, regardless of their credit score and whether they took out a liar loan:

Screen shot 2010-03-26 at 12.05.37 AM

The x-axis measures combined loan to value ratios (CLTV). In other words, combine the balance of all mortgages attached to a property (e.g.: a first mortgage + a home equity loan) and compare that to the property’s value. CLTV over 100% means more is owed on the house than it is worth. Yes, there’s a higher default rate for more poorly written mortgages (lower FICOs, low/no documentation), but even those that are well-underwritten (high FICOs and verified income) show spiking strategic defaults as equity goes negative. In other words, more folks who could pay their mortgage are choosing not to.

Even more interesting are other charts that demonstrate borrowers…

…are intentionally defaulting to take advantage of the [HAMP] modification program. Or at least to take advantage of extra time living in the house rent free, courtesy of the modification program.

Screen shot 2010-03-26 at 12.17.27 AM

(Click here to enlarge in new window)

This is one of many charts they have showing that, for all types of mortgages, the strategic default rate is actually higher for owner-occupied homes than non-owner occupied because, they argue, owner-occupieds are eligible for modification under HAMP whereas non-owner occupieds are not. And the difference appears to be more pronounced above a debt to income ratio of 31%.

Why 31%? Because that’s the ratio at which owner-occupiers qualify for a HAMP modification.

Amherst concludes:

Borrowers respond to their economic incentives. This has always been the case, be it for refinancing or for defaulting on mortgages that are deeply underwater. Over the past year, however, property values have been largely steady, but the environment has become much more kind to borrowers. There have been foreclosure moratoriums, the emergence of the HAMP modification effort, and the attendant increases of time spent in the delinquency/foreclosure pipeline, as well as a stretching out of the liquidation process in judicial states. As a result, borrowers can stay in their home rent free for a much longer period than was previously the case. However, few of these benefits apply to investor properties. Thus, when we look at the difference pre- and post-HAMP in the behavior of owner-occupied borrowers versus that of non-owner occupants—we find a dramatic difference in performance. Owner-occupied borrowers behave far worse than their non-owner occupied counterparts.

COMMENT

The only reason the banks would want your house in foreclosure is if you have a lot of equity in it and they can profit when they sell it. Otherwise they don’t want it. Like a previous poster said they have you go on a temporary modification and you pay for several months then they say “no” to the permanent modification. They are screwing the homeowners and so is the government. They should have let market correct itself 3 years ago when the bubble burst no matter how painful. This artificial prop up of the housing collapse is the cause of the prolonged financial mess. I personally didn’t want to bail out Wall street, the banks and AIG. This is just the beginning of the housing mess. The banks have so many liabilities if they were to put them in the correct column on their balance sheet they would fail like the rest of the banks that went under. So they actually like this limbo status of the foreclosures they have on their books. They take all the money and write offs the government is throwing at them and on paper they still look profitable. When they are forced to show us their cards the other shoe will drop. Also debt collection agencies are jumping on the band wagon more than before. They are illegally obtaining judgments on debts they don’t own and the courts in New Jersey is letting them. The Special Civil Part of the Law Division. There is never any proof at all and the judges are committing treason on the people. The debt collectors are putting liens on people’s houses and the poor home owners are now trying to deal with these sharks in addition to their foreclosures. The debt collectors send clerks to the courthouse to check for foreclosures and then starts sending them fake bills like they own your GE money bank credit card. It is unbelievable. I had to go to court to fight Pressler & Pressler aka New Century Financial Services,Inc aka Midland Funding aka Palisades Collections and I thought I was on Candid Camera. They couldn’t produce one iota of evidence and wanted me to provide them with all my statements, the contract etc. so they could use it against me. The judge agreed with them. New Jersey is corrupt. Oh one last thing the judge’s name is Judge Crook. ( I swear this isn’t made up).

Posted by deedee3003 | Report as abusive

Ambac regulator threads CDS needle

Mar 25, 2010 23:26 UTC

Cross-posted from today’s NYT.

Wisconsin’s insurance watchdog is requiring holders of credit-default swap contracts written by Ambac Financial, the troubled bond insurer, to take losses. It suggests what might have been done with the American International Group in different circumstances.

Ambac got into trouble selling CDS protection on what proved to be toxic mortgage-backed bonds. As those bonds have gone bad, the protection buyers have been demanding payments — and receiving them in full, to the tune of $120 million a month. The problem for the regulator was that this cash outflow was on track to drain Ambac dry, leaving other policy-holders with no protection. Since Ambac also insures lots of municipal bonds, the fallout could have been felt across the United States.

So Sean Dilweg, the Wisconsin insurance commissioner, is pushing the troubled CDS contracts and some other losing policies into a segregated account that his department will try to wind down, a process known as rehabilitation. Meanwhile he has secured court approval to halt the payouts Ambac has been making.

Part of the plan is to cut a deal with the CDS counterparties. Dilweg expects they’ll get cash worth about 25 cents per dollar of coverage. They’ll also receive so-called surplus notes which could eventually yield more if the rehabilitation works out. Some holders of CDS contracts won’t be happy. They were supposed to get paid quickly even if Ambac ended up in rehabilitation. But others, including banks like Citigroup, are thrilled with the deal as they’ve already written off much of their exposure. Now they’ll get a little cash back.

New York’s former insurance regulator, Eric Dinallo, similarly negotiated big haircuts with CDS counterparties of monolines he regulated. He brokered a deal between XL Guarantee and Merrill Lynch, for instance, where Merrill took 13 cents on the dollar in exchange for tearing up CDS contracts. But AIG’s counterparties were notoriously paid out in full following the government’s 2008 bailout. The reasons include the complexity of the giant financial and insurance conglomerate and the fact that Tim Geithner’s Treasury and AIG’s various regulators lacked the legal power to dictate a wind-down.

Reforms working their way through the U.S. Congress are designed to give watchdogs that kind of power. Had they had it back in 2008 — along with the guts to take control of AIG’s massive book of bad assets at the peak of a crisis — the course of the bailout, and even the crisis, might have been a lot different.

COMMENT

As a colleague of mine used to say with tongue in cheek, “If there’s no time now to do it right, there’ll be plenty of time to fix it later.”

Posted by walt9316 | Report as abusive

How long will negative equity last?

Mar 25, 2010 21:23 UTC

First American CoreLogic tries to answer the question for ten housing markets with the following chart (for an enlarged chart, see here):

neg equity estimate

So, for instance, the average Bostonian homeowner (the green triangle) will again reach positive equity in 2017. Here is a quote from FACL’s detailed press release.

Figure 1 projects the amount of negative equity using First American CoreLogic short-term forecasts and a baseline view of long-term price trends nationally through 2020. It also takes into account the amortization assumptions described below for ten markets.

For the typical underwater borrower in the U.S. it will take until late 2015 or early 2016 for negative equity to disappear.

In certain markets, it will take another five to 10 years or even longer to return to positive equity. For example, Detroit is not projected to recover even by 2020, because of its depressed economy.

In markets with low shares of negative equity, the recovery time will still be long because the few borrowers that are upside down are deeply in negative equity and these are typically not high appreciation markets. Although house price appreciation will, over time, offset negative equity, amortization (the paying down of loan balances) will in most cases be a more significant remedy to negative equity.

Over the next 10 years, the average loan balance will decrease by an annual rate of 3.3%; meanwhile home price are expected to increase at a 3% annual rate over the next decade.

I think 3% annual house price increase may be aggressive. If you think the Fed can successfully reflate the economy, that may be possible. But the sheer level of debt we have to work off probably means debt deflation will keep a lid on house prices for many years.

COMMENT

That doesn’t even address “effective negative equity” as Hanson put it recently: being able to sell your house, cover the debt, the agent fees, and the costs of buying another house.

Also, it seems that they’ve assumed that former high price growth areas will return to being high price growth areas despite what we would HOPE is a lack of exotic financing.

Finally, I surprised at the negative equity for Dallas in this. Avg home prices haven’t fallen very much in the market, but the level of negative equity on the chart suggests a 10% or more price drop (and everyone starting out with 100% financing). Seems sketchy.

Posted by Beezlebufo | Report as abusive

Afternoon Links 3-25

Mar 25, 2010 20:58 UTC

Must-Read: Debunking Michael Lewis subprime short hagiography (NakedCapitalism) Worth reading the whole piece. Lewis, it must be said, is a storyteller first, a journalist second. Witness his habit of hyperbolizing his subject matter. In Moneyball, the Oakland A’s success was attributed to on-base percentage. He mentioned, but completely underplayed, the fact that they had the best pitching staff in the majors. In The Blind Side, his description of Michael Oher’s size made him out to be the second coming of Paul Bunyan. At 309 lbs, he’s not even the biggest guy on the Ravens line. And Healtheon wasn’t exactly The New New Thing after all…

Social Security to see payout exceed pay-in this year (Walsh, NYT) A year ago this wasn’t supposed to happen till the end of the decade, then the estimate was revised down to 2016. Now it’s this year. Yet still we’re not including our unfunded entitlement obligations in our calculation of the national debt. Speaking of which…

Treasurys slide after tepid auction (Zeng, WSJ)

Bernanke signals asset sales may have bigger role in exit plan (Lanman/Torres, Bloomberg) Would be happy to be proved wrong here, but even if the Fed unwinds some of these positions (or simply lets them run-off as mortgages are prepaid), my bet is that they’ll use continued deflationary pressures to justify future asset purchases.

Q4 mortgage metrics report (OCC/OTS) Oodles of data on mortgage performance. I’ll have a post on this later.

State regulators take over part of Ambac’s book (Wilchins/Comlay, Reuters) Ambac’s CDS counterparties will get about 25 cents of cash on the dollar from this deal, with more coming later potentially. When Eric Dinallo was Chairman of the NY Dept of Insurance, he forced counterparties to settle for pennies as well (see Merrill accepting 13 cents on the dollar for contracts sold by XL Guarantee). Compare to Tim Geithner, who paid out 100 cents to AIG’s counterparties.

Casting TBTF the movie (HuffPo) A very clever slideshow. I think Ben Kingsley as Bernanke is my favorite choice. Who’s seen Sexy Beast? That’s the portrayal of the Fed Chair we need. ;)

Why didn’t I think of this? (imgur)

First post-crisis bank IPO could offer play on failure

Mar 25, 2010 02:03 UTC

Cross-posted from today’s NYT.

As FDIC’s problem bank list balloons, healthy institutions are gearing up to capitalize on others’ misfortune. Such may be the case of First Interstate BancSystem, the first bank to launch an initial public offering since 2007. Look for the bank to use the proceeds of its offering to pick off failed brethren.

The Montana-based bank raised about $130 million of capital after fees. While not a big offering, it was the first debut of a U.S. bank since 2007 — demonstrating that distress in the sector may be creating opportunities for the healthy. With FDIC expecting the number of bank seizures in 2010 to surpass the 140 seized last year, the supply of bank carcasses seems endless for canny vultures.

First Interstate boss Lyle Knight salivated over that prospect during a recent investor presentation, noting that he’s “particularly excited” about FDIC-assisted transactions. And after the IPO raised tangible common equity 30 percent to 6.4 percent of tangible assets, the 42 year-old family-owned bank has fresh capital to pounce.

That may not seem like a lot of firepower, but First Interstate’s low risk, low-cost funding model, combined with its conservative lending, means it probably has plenty of room to keep regulators comfortable. The IRA Bank Monitor, which rates all FDIC-insured institutions, grades the bank “A plus” based on low loan default rates and high risk-adjusted returns on capital, among other metrics.

True, at $14.50, the offering priced near the low end of the range and below pre-offering book value per share of $16.73. The discount could reflect the bank’s high level of goodwill and the fact that the bank’s family owners retain control via super-voting Class B shares. But with the shares up 8 percent in their first day of trading, investors clearly see opportunity.

Indeed, for those hoping to play the bank failure trade, First Interstate may appeal. Other publicly-listed institutions that have purchased banks out of FDIC receivership have seen their shares jump. For instance, shares of Georgia’s Ameris Bancorp have surged 86 percent since it announced its second failed bank acquisition in November.

COMMENT

At least somebody is trying to stand on their own legs and the private sector in return shows confidence in it.

Posted by Ghandiolfini | Report as abusive

Lunchtime Links 3-24

Mar 24, 2010 16:32 UTC

BofA to start reducing mortgage principal (Lawder, Reuters) It’s good news that BofA is looking at principal reduction, but this announcement is limited to only a small portion of ultra-toxic loans extended by Countrywide (now a unit of BofA). And BofA isn’t doing this out of the goodness of its heart, they’re doing it because of a settlement with Massachusetts Attorney General Martha Coakley. Here’s BofA’s press release.

Average homeowner in Obama foreclosure program under water (Nasiripour, HuffPo) This is another reason why principal forgiveness is likely the future of mortgage mods. But banks and their investors should be the ones forced to eat losses. Hopefully Treasury isn’t roped into some gimmick to subsidize principal writedowns.

Fitch downgrades Portugal on budget concerns (Reuters) In related news, the euro hit a 10-month low

Mindich counts on Film Dept IPO to recover defaulted debt (Weiss, Bloomberg) Would note that since we warned folks to stay away from this IPO (scroll down to “Box Office Blues”), they’ve significantly scaled back the amount they want to raise. They’ve also pushed the offer date back and are likely to do so again. This time they’re blaming Easter/Passover. Also noticed yesterday that they called on Gerard Butler to pitch the stock for their roadshow presentation. ‘cuz that’s who you should be trusting for advice on buying stocks….

First bank IPO since 2007 — FIBK (Yahoo Finance) I saw the Film Dept roadshow while investigating this company, which IPO’d today. If you watch their roadshow presentation, you’ll see that the CEO is salivating over the possibility of buying failed banks. That’s proved a winning recipe for other banks like ABCB, up 90% since they bought their second failed bank last November.

74 institutions miss TARP dividend payments (SNL) Up from 55 last quarter. Not included are the three TARP recipients that failed, nor those who missed other payments owed to TARP, nor AIG…

Capitalism (imgur)

Bully gets cracked by caped crusader (Break.com) Nerds everywhere wonder where this guy was when they were in school!

Bush shakes hands with Haitian, wipes it on Bill Clinton’s shirt (YouTube)

Time for your own car (ht CyberSquirt)

COMMENT

If you expect banks to write off principle, you’ll get a lot more cooperation if you allow them to recover some losses in the future with an equity stake.

And remember to support your local small bank so that it can finally make its TARP payment.

Posted by Beezlebufo | Report as abusive

U.S. banks pay lip service to second mortgages

Mar 24, 2010 14:29 UTC

Cross-posted from today’s NYT.

JPMorgan this week became the latest in a trickle of big banks willing to modify second mortgages for some struggling U.S. borrowers. While it’s a baby step in the right direction, it won’t do much to fix America’s foreclosure woes.

Second-lien loans, essentially top-up mortgages, look like a good place to start addressing the problem of borrowers who can’t keep up with payments. After all, second liens are subordinate to first mortgages. So when it comes to cutting interest or principal payments, they should logically come first.

But the U.S. government has primarily tackled first mortgages — and hasn’t got that far even there. The Home Affordable Modification Program (HAMP), which is designed to facilitate mortgage payment reductions, is aimed at several million struggling borrowers. Of 1.4 million trial modifications offered so far, only 170,000 have resulted in adjustments that the program sees as “permanent”.

And even these look anything but permanent since they still leave borrowers paying an average of 60 percent of their before-tax income towards debt and house expenses (see slide 6). That’s not close to a sustainable level of debt, so defaults down the road look inevitable.

That ought to focus banks’ attention on their second-lien loans. There may be little or no chance many of them will ever be repaid. But banks have avoided writing down second liens because accounting rules allow them to consider the loans to be performing so long as borrowers make interest payments.

It’s easy to understand why the banks are kicking the issue down the road. According to Amherst Securities, of $1.05 trillion in outstanding second liens, commercial banks hold $767 billion. Bank of America, Citigroup, JPMorgan and Wells Fargo alone hold $442 billion of them.

A government modification program for second liens known as 2MP, a companion for the HAMP program, was first put forward a year ago. But Bank of America, Wells Fargo and now JPMorgan have only recently joined. Nor is it likely to reach many borrowers since it targets only those few who achieve “permanent” modifications under HAMP.

Assuming around half distressed homeowners have second mortgages, this would cover some 85,000 second liens, only scratching the surface of the 19 million junior liens — with an average principal balance of $57,000 — that First American CoreLogic estimates are outstanding.

It’s good news that banks are finally willing to discuss second lien modifications. But to keep more struggling U.S. borrowers in their homes — a better outcome for banks and borrowers alike than foreclosure — banks need to forgive loan principal on a much larger scale so that borrowers again have skin in the game.

COMMENT

Who cares about second mortgages? I wonder how the vacation home market is faring? It can’t be good.

Posted by Story_Burn | Report as abusive

Lunchtime Links 3-23

Mar 23, 2010 15:32 UTC

Existing home sales decline in February (Calculated Risk) NAR used the word “ease” in its headline…

White House nudges banks to forgive principal (Hagerty, WSJ) Shahien was right

Cries of “Hey, That’s my jet” don’t deter high-end repo men (Frank, WSJ)  Flashback: The story of Nick Popovich, the “Learjet repo man”

Google gets legal greenlight from EU for trademark keywords (Eaton, Fast Company) The story that they shut their mainland China portal is making bigger headlines, but this ruling could have a bigger impact on Google’s business. China didn’t generate much revenue for them.

The perks of being a Goldman kid (Dealbook) … can include a fat salary working for Daddy’s bank…

The Democrats rejoice (David Brooks, NYT)

Inside the bank job (Elstein, Crain’s NY Business) The story of the man behind failed Park Avenue Bank. (ht Felix)

Lehman scandal: where’s the follow up? (Rosner/Spitzer, New Deal 2.0)

ride

COMMENT

I have also seen this news goolge,Google gets legal greenlight from EU for trademark keywords,The story that they shut their mainland China portal is making bigger headlines, but this ruling could have a bigger impact on Google’s business. China didn’t generate much revenue for them. I’m agree
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Posted by mckelly | Report as abusive

Lunchtime Links 3-22

Mar 22, 2010 14:15 UTC

Interest-rate deals sting cities, states (Lucchetti, WSJ) Most of these municipal swaps were structured so that municipalities could lock in low rates. They were borrowing at a floating rate and that meant they carried significant interest-rate risk if rates went up. To lock in their rates, the municipalities “swapped” their floating rate for a fixed one, agreeing to pay a dealer a fixed rate and receive a payment based on a floating rate in return. It was a hedge to avoid higher interest costs if rates went up. But they went down. So now the payment they receive, based on the floating rate, is ultra low, while the fixed rate they locked in is relatively higher.

Obama pays more than Buffett as U.S. risks AAA-rating (Kruger/Keough, Bloomberg) If the U.S. ever did default, Berkshire debt wouldn’t be a safer place to hide…

(Schizophrenic) IMF gives debt warning to the wealthiest nations (Bradsher/Chan, NYT) At the same time, they’ve been telling wealthy nations that fiscal stimulus must be continued in order to prop up aggregate demand. Can’t have it both ways guys…

Option ARMs pose threat to housing market (Reckard, LA Times) Nothing new here, but a well-written piece that explains the option ARM problem, and why California is ground zero. It ends with a typical extend/pretend anecdote…a homedebtor had his mortgage payments frozen for 2 years, then 5, then 10. He’ll make a dent in his principal over time, but house prices won’t rise enough over that time to give him equity. So when 10 years is up, the loan is still likely to go bad. Meanwhile, the bank (in this case FDIC, which took over the assets in receivership) is stuck holding a modified loan that will lose mucho value if rates ever go back up…

WSJ aims to win over NYT’s local audience (Perez-Pena, NYT) The paper’s A section has become largely useless. The partisan editorials/op-eds were always easy to ignore, but at least the rest of the section was thick with great business journalism. Now it’s all general interest stuff one can find elsewhere. No, Rupert can’t do that better than the Sulzbergers, which is why I’ll be trading my WSJ subscription for the NYT (or FT)…

Good news alert: Bank levies gain traction in the UK and Germany (Reuters) Too-big-to-fail banks must be penalized in a way that increases their funding costs. Their TBTF status gives them access to cheaper funds in the market, which helps them grow even larger. Bank levies can be an important countermeasure.

House approves sweeping healthcare overhaul (Whitesides/Smith, Reuters) Be careful what you wish for…

Solution to online credit card fraud (imgur)

India-Pakistan border closing ceremony (YouTube) Wacky…

Swingless golf clubs…

COMMENT

Rolfe, as a student, I was wondering if you could do a piece on the new health-care legislation. I want to hear your opinion on it from a fiscal perspective, as well as what differentiates it from what we have now. Thanks.

Posted by grmanny | Report as abusive

Bank failure Friday

Mar 19, 2010 20:23 UTC

Three more in Georgia….

#37

—Failed bank: State Bank of Aurora, Aurora, MN
—Regulator: Minnesota Department of Commerce
—Acquiring bank: Northern State Bank, Ashland, WI
—Vitals: assets of $28.2 million, deposits $27.8 million
—Transaction: loss share on $21.3 million of assets
—Estimated DIF damage: $4.2 million

#36

—Failed bank: First Lowndes Bank, Fort Deposit, AL
—Regulator: Alabama Banking Department
—Acquiring bank: First Citizens Bank, Luverne, AL
—Vitals: assets of $137.2 million, deposits $131.1 million
—Transaction: loss share on $104.1 million of assets
—Estimated DIF damage: $38.3 million

#35

—Failed bank: Bank of Hiawassee, Hiawassee, GA
—Regulator: Georgia Department of Banking and Finance
—Acquiring bank: Citizens South Bank, Gastonia, North Carolina
—Vitals: assets of $377.8 million, deposits $339.6 million
—Transaction: loss share on $232.6 million of assets
—Estimated DIF damage: $137.7 million

#34

—Failed bank: Appalachian Community Bank, Ellijay GA
—Regulator: Georgia Department of Banking and Finance
—Acquiring bank: Community and Southern Bank, Carrollton GA
—Vitals: assets of $1.01 billion, deposits $917.6 million
—Transaction: loss share on $798.6 million of assets
—Estimated DIF damage: $419.3 million

#33

—Failed bank: Advanta Bank, Draper UT
—Regulator: Utah Department of Financial Institutions
—Acquiring bank: None
—Vitals: assets of $1.6 billion, deposits $1.5 billion
—Transaction: Payout
—Estimated DIF damage: $635.6 million

#32

—Failed bank: Century Security Bank, Duluth GA
—Regulator: Georgia Department of Banking and Finance
—Acquiring bank: Bank of Upson, Thomaston GA
—Vitals: assets of $96.5 million, deposits of $94.0 million
—Transaction: loss share on $81.5 million of assets
—Estimated DIF damage: $29.9 million

#31

—Failed bank:American National Bank, Parma OH
—Regulator: OCC
—Acquiring bank: National Bank and Trust Co, Wilmington OH
—Vitals: assets of $70.3 million, deposits of $66.8 million
—Transaction: loss share on $49.8 million of assets
—Estimated DIF damage: $17.1 million

Check back for updates.

Afternoon Links 3-19

Mar 19, 2010 20:00 UTC

Fed loses its (first) appeal (Glovin/Van Voris, Bloomberg) Bloomberg is fighting the good fight. But there are many battles yet to wage in this legal war…

Cuomo probes pension “spiking” (Chon, WSJ) Looting, pure and simple.

Good news alert: Derivative credit exposure declines (OCC) It’s still too high, nor does this trend negate the need for tough derivatives regulation. The full report is here.

“We should take out the baseball bat on Paul Krugman” — Roach (Anstey/Li, Bloomberg) I don’t think Krugman’s off-base about China manipulating its currency. But he is dangerously wrong in advising Americans not to save…

Housing: price to rent ratio (Calculated Risk) House prices are falling again, though slowly. CR argues has data showing we’re closer to the bottom than the top.

Bair considers extending TAG (fdic.gov) In a speech today, Bair said FDIC is looking at extending the program that offers unlimited deposit insurance for non-interest bearing transaction accounts. It had been schedule to expire June 30. She also complained that the Dodd bill has loopholes that could make bailouts possible, in particular the Fed’s 13(3) emergency lending authority. Funny, the one big bailout loophole actually applies to FDIC, which the Dodd bill empowers to extend debt guarantees.

Reuters chart: U.S. home sales and the 30-year fixed rate (Culp, Reuters) Interesting chart, though it might be more precise to say that low mortgage rates aren’t sufficient to drive house prices up. They certainly provide support…

Bernie Madoff beat up in prison (Searcey/Efrati, WSJ) The incident was in December, but WSJ confirmed that, no, Bernie didn’t fall out of bed.

The world’s only immortal animal (Nelson, Yahoo)

Ultimate revenge? (Ashford, heraldsun)

Stick ‘em up…

cute-funny-animals-01_7RqQtWY3mrAI

Why is Goldman willing to lose so much on deposits?

Mar 19, 2010 17:29 UTC

Writing my Hotel California column earlier this week, I came across the following interesting tidbit in Goldman’s 10-K (page 206):

The amount deposited by the firm’s depository institution subsidiaries held at the Federal Reserve Bank was approximately $27.43 billion and $94 million as of December 2009 and November 2008, respectively, which exceeded required reserve amounts by $25.86 billion and $6 million as of December 2009 and November 2008, respectively.

This seems a good indicator of the lack of lending opportunities in the economy. But I’m curious: Goldman is probably losing a lot of money parking customer deposits on reserve at the Fed. Why do it?

But first let me try to explain what’s happening here…

Goldman has a bank subsidiary — GS Bank USA — which collects deposits via brokerage accounts. It doesn’t have any bank branches anywhere. And Goldman has grown these deposits a fair bit, from an average of $13 billion in 2007 to $35 billion in 2009.

This is odd for two reasons.

First, Goldman doesn’t have much use for deposits that I can see. They can’t be used to fund investment banking activities.

And clearly they don’t see many good lending opportunities for these deposits. If they did, they wouldn’t park such a big proportion at the Fed, where they lose money.

[Aside: a common misconception is that holding reserves at the Fed is profitable for banks since the Fed now pays interest on reserves. But this ignores the other side of the balance sheet. Banks, after all, have to pay for the deposits that they then put on reserve at the Fed. Math in next paragraph]

Excess reserves held on deposit at the Fed pay 0.25%. But the average interest rate Goldman paid on U.S. deposits in 2009 was 1.06%, implying a negative net interest margin of 0.81%.

Multiply -0.81% by total excess reserves of $25.9 billion held at December 2009, and you get an implied annualized loss of $210 million. That’s a decent chunk of change.*

Another reason these deposits might not make good loans is old-fashioned asset-liability maturity mismatch. Brokerage deposits aren’t sticky like retail deposits. They chase the highest return in the market. Short duration (“hot money”) deposits tied up in longer-duration illiquid loans is a recipe for bank failure.

Now, certain folks might use this as an excuse to bash Goldman (“why aren’t they lending to the real economy!”), but that’s wrongheaded. Don’t get me wrong: I’m no fan of Goldman Sachs. But the problem isn’t that banks are lending too little today, it’s that they lent way too much yesterday. The chief lesson of the financial crisis is that irresponsible lending has dire consequences for the economy. Better that banks err on the side of safety and soundness….better that they lose money parking reserves at the Fed than chase risk making dodgy loans.

But the original question still stands. If Goldman can’t find anything profitable to do with deposits, why keep collecting them?

——————–

*A couple caveats here. The rate Goldman is paying on deposits could be lower today than the average in 2009. Also, to lose $210 million, Goldman would have to hold this balance at the Fed — at a NIM of -.81% — for a full year.

(ht frog)

COMMENT

shame on the fake democracy of US,It’s all about money not politics

Posted by officestory | Report as abusive

Hog Wild for a Buyout?

Mar 18, 2010 23:00 UTC

Cross-posted from today’s NYT.

Could Henry Kravis handle a hog? Harley-Davidson’s shares revved up this week on talk of a leveraged buyout, and Mr. Kravis’ firm, Kohlberg Kravis Roberts, was one name mentioned. The iconic motorcycle maker can absorb plenty more debt, but the price tag and the cyclical nature of the business mean a deal would be no easy ride.

Harley has roared back to life. At around $28 apiece, Harley’s shares are more than triple their recession low, including Tuesday’s 6 percent bounce. Figure any deal would require a premium of at least 30 percent, and the implied equity valuation would be about $8.5 billion.

The company is expected by analysts to generate earnings before interest, tax, depreciation and amortization (EBITDA) of $950 million in 2011. Strip out Harley’s financing arm for simplicity and adjust for its $1.7 billion of cash, and that price tag would peg its enterprise value at a little more than 5.8 times EBITDA.* Rich, yes, but not outrageous.

Of course, any Harley buyer would scrutinize the financial services unit, which is used to extend credit to the Milwaukee manufacturer’s customers. It had $5.1 billion of receivables at the end of last year, and heavy borrowing at the parent company would risk trashing the finance arm’s ability to fund itself.

But with careful structuring, there seems to be room to gear up. Only $600 million of Harley’s $5.7 billion of debt relates to the manufacturing part of the business, according to Wells Fargo estimates. For leveraged buyouts, depending on the deal, banks are starting to stretch to debt multiples of 5.5 times EBITDA.

Putting such high leverage on a business as cyclical as Harley’s could turn it into the next Simmons, yet banks are slowly but surely loosening underwriting standards for buyouts. Anyway, at that multiple, KKR or another private equity buyer could borrow some $4.6 billion, meaning they’d need to throw in about $3.9 billion of equity or 46 percent of the total price — a big but feasible sum.

This back-of-the-envelope scenario suggests any buyout would run close to the limits. But the idea of Mr. Kravis or another buyout baron cruising off with Harley isn’t entirely hog-wild. But just because a deal can be done doesn’t mean it should be.

———-

*The presence of Harley’s finance company means the valuation isn’t straightfoward. Multiple analysts told me that, from a buyout shop’s perspective, you’d ignore the finance company debt (=$5.1 billion of total debt at 12/31 of $5.7 billion) as it’s backed by receivables. So we have market cap = $6.6 billion, debt = $600 million, cash = $1.7 billion….EV (6.6 + .6 – 1.7) = $5.5 billion, or 5.8x ’11 consensus EBITDA of $950 million.

COMMENT

A Harley is such a huge expense that only Hollywood stars buy one with cash. Since everyone else gets a loan and a hog is a completely discretionary purchase, sales should be a good indicator of whether or not Joe Public really is serious about reducing his debt load. Paying many thousands of dollars for a machine that, in much of the U.S., sits unused in a garage for half the year would not seem to be the act of a cautious consumer. We’ll see.

Posted by Chicagoboy | Report as abusive
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