Sunday, October 31, 2010

Christopher Whalen: Big Bank Short?

This is the home-page of writer and investment banker Christopher Whalen. Christopher, his wife Pamela, and their West Highland White Terrier, live at the top of Red Hill in the Village of Croton-on-HudsonNew York. He is the cofounder of Institutional Risk Analytics,  the Torrance, CA, provider of bank and company ratings, custom analytics and consulting services for auditors, regulators and financial professionals.  Christopher is the author of the new book, "Inflated: How Money and Debt Built the American Dream." Click image for more information.
Christopher edits The Institutional Risk Analyst, a weekly news analysis and commentary on risk and the global political economy. He contributes articles on the Reuters and Zero Hedge web sites. Chris is a member and former regional director of Professional Risk Managers International Association (PRMIA). He is a member of the Herbert Gold Society, a fellow at the Networks Financial Institute at Indiana State University, and a member of the Economic Advisory Committee of the Financial Industry Regulatory Authority (FINRA).
Including the two most recent presentations: 

Saturday, October 30, 2010

Storm Passed or Quiet Before?

No Bank Failures But One Credit Union Liquidation

Friday, October 29, 2010 - 10:30 PM by Ken - Bank Deals Guy

This is another Friday without a bank failure which is a surprise after last week's busy Friday in which 7 banks were closed. The total number of bank failures for 2010 remains at 139. However, one credit union was liquidated today. The NCUA issued a late press release today with the news that The Union Credit Union of Spokane, Washington was liquidated. It was a small credit union with just $11.9 million in assets.

That brings the total number of credit unions liquidated this year to 17. The NCUA arranged for two credit unions, Numerica and Alaska USA, to purchase and assume TUCU's assets and liabilities. According to the NCUA, "TUCU members will experience no interruption of service and immediately become members of Numerica Credit Union." The NCUA gave no indication if any members will lose uninsured deposits.

The FDIC did have some activity today. It released its September Enforcement Actions. The enforcement actions included 30 consent orders and 5 prompt corrective actions. PCAs are usually a very serious sign of an unsafe and unsound condition of the bank.

Thursday, October 28, 2010

A Less Rosy View: 'U.S. Bank Failures Trend in Slow Motion'

Stock-Markets / Credit Crisis 2010

Oct 27, 2010 - 12:59 PM
Every Friday evening a few more banks are closed — seized by the various state banking regulators and handed over to the Federal Deposit Insurance Corporation (FDIC) for liquidation. This all happens rather quietly, barely making the news. We're told these bank failures are no big deal. No reason to panic. The names of the banks change over the weekend and many customers don't notice the difference.
We've only had 294 failures this cycle, but it is a big deal: adjusted to current dollars, the Depression banking crisis was $100 billion, the S&L crisis was $923 billion, and the current crisis is nearly $8 trillion.
So while FDIC chairwoman Sheila Bair said the current crisis would be "nothing compared with previous cycles, such as the savings-and-loan days," it's actually much bigger, because the financial sector had grown to be nearly half the economy by 2006 — as measured by the earnings of the S&P 500.
But the question is, Why haven't there been more bank failures? In 2008, there were 25 failures, last year there were 140, and so far this year 129 have been seized on Friday nights. The greatest real-estate bubble in history has popped — first residential and now commercial — and we only have 294 failures?
It takes easy credit to make a real-estate bubble and it was America's commercial banks that provided most of it. It's estimated that "half the community banks in America remain overleveraged to commercial real estate, and the possible losses that remain are about $1.5 trillion," according to bank-stock analyst Richard Suttmeier.
The Moody's Commercial Property Price Index (CPPI) has fallen 43.2 percent since its peak in October 2007. Raw-land and residential-lot values have fallen even further. Almost 3,000 of the 7,830 banks in the United States are loaded with real-estate loans where the collateral value has fallen over 40 percent, and yet less than 300 banks have failed?
We all know what's happened to the residential-property market, but to illustrate how bad the situation is for the commercial market, over 8 percent of commercial mortgages that have been packaged into bonds are delinquent; more than $51.5 billion of such loans are at least 60 days late on payments compared with $22 billion a year ago.
If anything the commercial property market would seem to be getting worse. Losses on loans packaged into US commercial-mortgage-backed securities totaled $501 million in August — more than double the $245 million in April, and over 10 times the $41 million in losses of a year ago.
Past-due loans and leases at the nation's banks and S&Ls increased 16.2 percent from second quarter 2009 to the second quarter of this year. Restructured loans and leases increased nearly 54 percent.
Over 7 percent (7.32 percent) of all real-estate loans were 90 days or more past due, which included construction and development loans, of which 16.87 percent were noncurrent at midyear.
"While the banks are being propped up, capital is diverted from businesses and entrepreneurs."

Even the collective real-estate-loan portfolio of the 105 largest banks is 8.64 percent noncurrent (or over 90 days past due) and the big banks' construction-and-development portfolio is nearly 19 percent noncurrent.
These delinquency numbers are bad anyway you look at it. So, they must be reflected in bank's profit numbers, right? Well, no. Second-quarter earnings by the nation's banks were the highest in 3 years — nearly $22 billion.
Based on these numbers, FDIC chair Sheila Bair claims, "The banking sector is gaining strength. Earnings have grown, and most asset quality indicators are moving in the right direction, putting banks in a stronger position to lend."
And bankers must figure the coast is clear: they are cutting their provisions for bad debts. Yes, at a time when one out of four Americans has a sub-600 FICO score, a quarter of all homeowners are underwater on their mortgages, and commercial real estate is hitting the ditch, banks are dipping into their loan-loss reserves to report profits.
To illustrate, bankers have cut their ratio of loans to reserve coverage almost in half — that is the amount reserved divided by noncurrent loans (90 days past due or more and loans on nonaccrual). This ratio has declined from 120 percent in March of 2007 to 65.1 percent at June 30 of this year.
Banks added a total of $40.3 billion in provisions to their loan-loss allowances in the second quarter: that is the smallest total since the first quarter of 2008 and is $27.1 billion less than the industry's provisions in the second quarter of 2009.
So, the banking industry made $21.6 billion in Q2 by not putting as much away for loan losses.
By the way, of the $21.6 billion in second-quarter profits, $19.9 billion was earned by the 105 largest banks in the country. The other $1.7 billion in profits was spread between the other 7,725 banks.
So the big banks are backing off on putting money in reserve and booking big profits only months after being rescued by government TARP moneys (by the way, 91 banks are behind on making their TARP payments to the government). More importantly, these banks were the primary beneficiaries of accounting-rule changes in April of 2009 — amendments to FASB rules 157, 115, and 124, allowing banks greater discretion in determining at what price to carry certain types of securities on their balance sheets and recognition of other-than-temporary impairments.
"The new rules were sought by the American Bankers Association, and not surprisingly will allow banks to increase their reported profits and strengthen their balance sheets by allowing them to increase the reported values of their toxic assets," according to James Kwak, coauthor of 13 Bankers: The Wall Street Takeover and the next Financial Meltdown.
So the banks get some accounting breaks and are aggressively reporting profits at the expense of putting money in loan-loss reserves; still, why haven't there been more failures?
Earlier this year, Elizabeth Warren and her Congressional Oversight Panel did a report that indicated 2,988 banks were in trouble because of real-estate concentration in their loan portfolios.
Ms. Warren noted that office vacancies had increased 25 percent since 2006–2007, apartment vacancy was up 35 percent, industrial was up 45 percent, and retail vacancy had increased 70 percent since 2006–2007. The report said the recovery rate for defaulted real-estate loans was 63 percent last year. Land-loan recoveries were only 50 percent. Development-loan recoveries were even worse at 46 percent.
Another banking expert who sounded a warning signal about the banking industry was bank analyst Chris Whalen, who, a year ago, estimated the number of troubled banks to be 1,900. The FDIC itself said there were 829 problem institutions on its top-secret radar by June 30, 2010 — almost exactly double the 416 announced by the FDIC a year ago at midyear. By all indications the pace of closures should be speeding up. But instead we see these numbers:
3rd Q 200950 closures
4th Q 200944 closures
1st Q 201041 closures
2nd Q 201045 closures
3rd Q 201041 closures

Sheila Bair has said many times that the peak in bank failures will be the third quarter of 2010. What's the holdup?

Why aren't more banks being closed?

1. Maybe there's nobody there who knows how to make a deal.

After all, the FDIC's main deal maker, Joe Jiampietro, left suddenly in August. Jiampietro came to work at the deposit insurer after working at JP Morgan Chase and UBS. He and his partner Jim Wigand sold more than $508 billion in assets including WaMu and Corus. The New York Times reported that Wigand and Jiampietro did good work for the government, "by acting like bankers, not bureaucrats."
Wigand worked at the FDIC for a couple decades. The fresh blood was Jiampietro. He was the eyes and ears in the markets and advised on the biggest and most complex deals, meeting with bank execs, hedge-fund managers and other big investors to get their feedback on deal terms and other agency policies.
These two started hatching deals with companies like Rialto (a division of homebuilder Lennar). Rialto bought a 40 percent share of $1.2 billion in loans from failed banks for 40 cents on the dollar, with the FDIC carrying a loan for $1 billion of the deal at zero interest for seven years.
They also came up with the FDIC's Securitization Pilot Program. Barron's reported that the FDIC has $37 billion of bad bank assets to sell, but that the loans would only fetch 10 to 50 cents on the dollar. But US-guaranteed FDIC senior certificates enable "the FDIC to push much of the losses off its books, thanks to the US guarantee of principal and interest." The notes are backed by loans (remember the ones worth 10 to 50 cents on the dollar) but ultimately the losses could be absorbed by Uncle Sam.
Ex–Federal Savings and Loan Insurance Corporation regulator William Black says the FDIC is selling the equivalent of Treasury bonds without congressional approval and the deposit insurer should be selling bad assets. "It hides the economic substance of what's really happening — an unlimited taxpayer bailout," Black contends. The FDIC disagrees.

2. Maybe it's politics.

Bill Bartmann, publisher of the Bartmann Bank Monitor Report, says the FDIC isn't closing banks faster because of politics.
"They (FDIC) are waiting until November to drop the other shoe," Bartmann claims. He says 500 banks will be closed in 2011 after the mid-term elections have been completed.
"'Deposit insurance' is simply a fraudulent racket."
– Murray Rothbard

Are bank failures political? Shorebank in Chicago was kept alive for months: "Senior Obama adviser Valerie Jarrett served on a Chicago civic organization with a director of the bank, and President Obama himself has singled out the bank for praise in lending to low-income communities." But the politically connected bank was finally seized on August 20th, when the FDIC finally found a single buyer for the failed bank — Urban Partnership, which includes "American Express Co., Bank of America Corp., Citigroup, Ford Foundation, GE Capital's equity investments arm, JPMorgan Chase & Co., Key Community Development Corp., Morgan Stanley, Northern Trust Corp., PNC Investment Corp., Goldman Sachs Group Inc., and Wells Fargo & Co. Former First Chicago executives who joined ShoreBank in recent months will run the bank."

3. Maybe the number of bidders for bad banks has dried up.

The juicy deals Jiampietro and Wigand were making last year are over, the Wall Street Journal reports. According to Keefe Bruyette & Woods (KBW), acquiring banks were booking 4.5 percent capital gains on deals done in 2009. That is now down to 2.5 percent.
Investors are halting efforts to bid on the failed banks, saying the economics no longer make sense. A group led by former FDIC Chairman William Isaac recently ended a push to raise $1 billion for bidding on failed banks in the U.S. Southeast, in part because of lower returns on potential deals, Mr. Isaac said. Another group, of former Wachovia Corp. executives hoping to launch Charlotte, N.C.-based Union National Bank, recently pulled its federal charter application because bank-failure bargains are becoming tougher to find, a spokesman said. …
"In the current environment our view is that FDIC-assisted transactions are not really attractive entry points," the Union National spokesman added.
But while some are paying up for failed banks, others who were able to grab bargain deals earlier in the crisis say they are done for now. Tiny Sunwest Bank in Tustin, Calif., for example, snapped up assets from three failed institutions with discounts as high as 44%. The deals doubled the bank's assets to $658 million and increased its head count from 68 to 140. Chief Executive Glenn Gray said he doesn't expect to be a bidder anytime soon, acknowledging how the pricing has changed.

4. Or maybe the FDIC just doesn't have the money to close banks.

The FDIC Deposit Insurance Fund has already spent over $19 billion this year, which is well above the $15.33 billion prepaid assessments that it collected from banks for all of 2010.
The situation is probably worse than the FDIC is letting on, according to ex-regulator William Black. "The FDIC is sitting there knowing that it has both the residential disaster and the commercial real estate disaster [and] knowing it doesn't have remotely enough funds to pay for it."
Black is not surprised there aren't more failures, but he says that we should be upset there are not more bank failures. The industry has used its political muscle to get Congress to extort the financial accounting standards board to gimmick the accounting rules so that banks do not have to recognize their losses.
Black claims the Prompt Corrective Action law, which mandated closure of insolvent financial institutions, is being ignored.
The FASB rule changes I mentioned earlier have allowed banks to value assets at inflated bubble values that have nothing to do with their real value. Thus, reported bank capital is greatly inflated. According to Black, even insolvent banks are reporting lots of capital.
Black, the author of The Best Way to Rob a Bank Is to Own One, contends that the FDIC is "intentionally keeping foreclosures down because it knows it does not have enough money to pay off depositors who are insured by the FDIC."
Maybe that's why suddenly the expected losses on some of the bank closures in the third quarter were considerably below historical norms. The FDIC estimated the expected losses as a percentage of assets for three banks that were seized on August 20th — Sonoma Valley bank, Los Padres Bank and Butte Community Bank — to be 3 percent, 1 percent and 3.5 percent, a fraction of the average expected percentage loss for 2009 closures, which was 22 percent, and for 2010 closures, which was 23 percent.
Black told Aaron Task of Yahoo! Finance that this delaying in liquidating insolvent banks will make ultimate losses grow. It's a "Japanese-type strategy of hiding the losses," which will result in a lost decade or two.
"Geithner and Summers were selected and promoted because they are willing to be wrong."
– William Black

While the banks are being propped up, capital is diverted from businesses and entrepreneurs.
Black says, "Well I said it from the beginning, Geithner and Summers were selected and promoted, and the same is true with Bernanke, because they are willing to be wrong and have a consistent track record of being wrong. That's useful for senior politicians but disastrous for the country."
The FDIC is required to maintain a Deposit Insurance Fund (DIF) of 1.25 percent of insured deposits. As of June 30 of this year, the DIF held negative 15.2 billion, standing behind $5.4 trillion in insured deposits. That's negative 0.28 percent. In its second-quarter banking profile, the FDIC noted the 10 basis-point improvement in the DIF from the first quarter, when the DIF was at negative 0.38 percent.
However ValuEngine's Richard Suttmeier calculates that the DIF is currently $33.66 billion in the hole or negative 0.62 percent
But don't be afraid, Chris Dodd and Barney Frank have taken care of everything. The Dodd-Frank Wall Street Reform and Consumer Protection Act not only made the increase in deposit insurance of $250,000 permanent, but it requires the FDIC "to take steps necessary to attain a 1.35 percent reserve ratio by September 30, 2020."
So, in a decade, the FDIC will have $1.35 standing behind every $100 you have in the bank — promise — you have Chris and Barney's word on it.

A Fraudulent Racket

But can deposit insurance really be considered insurance? Can insolvent banks hide their losses with the help of their friends in government and at the same time have an arm of the government that itself is insolvent cover their losses — and call it insurance?
Insurable risks, such as death, accidents, or health emergencies are homogeneous, replicable, random events that can therefore be grouped into homogeneous classes and predicted in large numbers. However, market events are inherently unique and heterogeneous; they are not random but influence each other; so they are not insurable and not subject to grouping into these homogeneous classes measurable in advance. It is for the entrepreneur to assume the uninsurable risks of the marketplace.
"If no business firm can be insured," Murray Rothbard writes, then an industry consisting of hundreds of insolvent firms is surely the last institution about which anyone can mention "insurance" with a straight face. "Deposit insurance" is simply a fraudulent racket, and a cruel one at that, since it may plunder the life savings and the money stock of the entire public.
As far as the lack of bank failures, "a dearth of bank failure should rather be treated with suspicion," Murray wrote, "as witness the drop of bank failures in the United States since the advent of the FDIC. It might indeed mean that the banks are doing better, but at the expense of society and the economy faring worse."
So are banks lending out that deposit money the FDIC is insuring? No, loan balances continue to fall, down $96 billion in the second quarter.
But they are loading up in one area — derivatives. You remember those things (essentially side bets between two parties on the value of a particular asset or the direction of interest rates). Warren Buffett called them "financial weapons of mass destruction." Société Générale's Jerome Kerviel orchestrated the largest bank fraud in world history via derivatives trading (a £3.6 billion loss). Arthur Leavitt said "derivates are something like electricity; dangerous if mishandled, but bearing the potential to do good."
Well, banks have increased their collective derivative exposure from $209 trillion a year ago to $224 trillion. Ten years ago, banks had less than $40 trillion in derivative exposure. But I'm sure bankers know how to handle these things.
The 20 years prior to 2008 were a boom for banks, morphing in size to gargantuan proportions on the ricketiest capital structure the world has ever seen. The needed correction is equally huge, and the FDIC can't stop it. The government agency might delay the cleansing for years, keeping themselves and the zombie banks they regulate in business. But, ultimately, the deposit insurer will fail along with the banks it regulates, going the way of the FSLIC, which insured savings-and-loan deposits. It was recognized as insolvent in 1986.
Douglas French is president of the Mises Institute and author of Early Speculative Bubbles & Increases in the Money Supply. He received his masters degree in economics from the University of Nevada, Las Vegas, under Murray Rothbard with Professor Hans-Hermann Hoppe serving on his thesis committee. See his tribute to Murray Rothbard. Send him mail. See Doug French's article archivesComment on the blog.

The Rosy View: More lenders are going bust but most of them are minnows

Bank failures in America

More but merrier

Oct 28th 2010 | NEW YORK

THE sound of banks being shuttered hasn’t been this loud since the savings-and-loan crisis in the early 1990s. Any day now the number of failures in America this year will surpass last year’s total of 140, the highest count since 1992.
Yet the worst may be over. Though the numbers are high, most banks being seized these days by the Federal Deposit Insurance Corporation (FDIC) are tiny. Measured by assets this year’s crop is set to be roughly half the size of last year’s and less than a third that of 2008 (see chart). “We’ve turned the corner in terms of the system’s vulnerability, if not in terms of raw units,” says Gerard Cassidy of RBC Capital Markets.
The FDIC’s deposit-insurance fund, which is financed through levies on lenders and is used to absorb losses incurred by failed banks’ depositors, is crawling back from the brink. During the crisis the fund slumped from a surplus of over $50 billion to a deficit of $21 billion. That is now $15 billion and shrinking.
There is more competition for bank assets from private investors these days, giving the FDIC more options to offload portfolios. Interest may grow further if, as expected, a group of private-equity firms that snapped up Florida’s BankUnited soon pockets a handsome profit floating it on the stockmarket. The FDIC is also planning to securitise and sell seized commercial-property loans. And it is suing more than 50 executives at failed banks in a bid to recover $1 billion.
All of this is good news for the survivors. The FDIC recently scrapped a rise in deposit-insurance premiums that was supposed to kick in next year, after scaling down the fund’s expected losses over the next four years by $8 billion. It expects the number of failures to start falling next year. It helps that regional banks have cut down their most toxic assets. The stock of loans to developers is down from $630 billion to $380 billion.
Banks can expect to pay more for deposit insurance in future, however. To comply with the Dodd-Frank act, the FDIC must raise the fund’s size to 1.35% of the industry’s total deposits by 2020, up from a statutory minimum of 1.15% now. It plans to go a lot further after that.

Exit Strategy: BankUnited IPO

OCTOBER 28, 2010, 1:50 PM ET

Blackstone: FDIC Would Support BankUnited IPO

By Shasha Dai,  Wall Street Journal

During a conference call with reporters today to discuss quarterly results, Blackstone Group President Tony James didn’t deny media reports that BankUnited Financial Corp. is contemplating an initial public offering. An IPO filing, which is expected this week, would come just over one year after the acquisition of the bank by a consortium of which Blackstone is part.
When asked about the swift trip to the public market and possible implications given the Federal Deposit Insurance Corp.’s wariness of private investors’ commitment to their bank investments, James said, “We are working closely with the FDIC on this. We wouldn’t do anything that the FDIC isn’t supportive of.”
“The raising of equity capital would strengthen the bank further,” James said. “And the FDIC likes that aspect of things.”
James said being public would also give BankUnited additional currency to purchase failed banks that are too small for stand-alone acquisition. “An IPO would give BankUnited the wherewithal and capital base to do that,” he said.
Andrew Gray, an FDIC spokesman, said he doesn’t have immediate comment on the matter since the IPO isn’t official yet.
Private equity-backed companies are lining up to go public, in part because funds that are nearing the end of their investment period are looking to sell down their holdings and return money to investors. According to a recent report from Ernst & Young LLP, PE-backed companies account for nine of the ten largest pending IPOs. But the huge backlog caused some to wonder whether all the IPO candidates would be table to get out of the gate - and if so, at what prices.
Later on the call, James qualified his comments by saying, “It is not clear whether the IPO will happen. If it doesn’t, we would be acquiring [smaller banks] with a more limited capital base.”
 - with reporting by Amy Or.

Saturday, October 23, 2010

Regulators shut down 7 banks

By the CNN Wire Staff

(CNN) -- Bank regulators closed seven banks Friday, bringing the total of number of bank failures for the year to 139, the Federal Deposit Insurance Corporation said.
Friday marked the largest number of banks closed since July 23, when the FDIC also closed seven banks, according to the FDIC's website.
The closed banks are the First Arizona Savings in Scottsdale, Arizona; First Bank of Jacksonville, Jacksonville, Florida; The First National Bank of Barnesville, in Barnesville, Georgia; First Suburban National Bank in Maywood, Illinois; The Gordon Bank in Gordon, Georgia; Hillcrest Bank in Overland Park, Kansas; and Progress Bank of Florida in Tampa, Florida.
All deposits were taken over by other financial institutions for six of the seven banks.
The FDIC said it couldn't find a financial institution to take over the banking operations of First Arizona Savings.
"As a result, checks to depositors for their insured funds will be mailed on Monday, October 25," the FDIC said in a statement about First Arizona Savings on Friday.
First Arizona Savings had $272.2 million in assets and $198.8 million in deposits.
First Bank of Jacksonville had $81 million in assets and $77.3 million in deposits.
The First National Bank of Barnesville had $131.4 million in assets and $127.1 million in deposits.
First Suburban National Bank had $148.7 million in assets and $140 million in deposits.
The Gordon Bank had $29.4 million in assets and $26.7 million in deposits.
Hillcrest Bank had $1.65 billion in assets and $1.54 billion in deposits.
Progress Bank of Florida had $110.7 million in assets and $101.3 million in deposits.

Friday, October 22, 2010

Realpoint: September 2010 CMBS Delinquency Report

Monthly Delinquency Report - Commentary

2010 Realpoint LLC

Executive Summary

In September 2010, the delinquent unpaid balance for CMBS continued to exhibit moderate monthly growth having increased by an additional $801.2 million, up to $62.19 billion from $61.39 billion a month prior (a 1.3% increase). This followed only $551.8 million in growth from July to August 2010 and $387.9 million in growth from June to July 2010 – optimistically showing signs of slowdown from earlier this year, as it remained well below the average growth per month of $3.14 billion experienced from January through June of 2010. On the other hand, outside of a slight decrease in both the 30-day and 90+-day categories, the remaining delinquency categories each increased, fueled by further delinquency degradation and credit deterioration. Despite ongoing loan liquidations, modifications and resolutions, the distressed 90+-day, Foreclosure and REO categories as a whole grew by $1.16 billion (2.4%) from the previous month after falling for the first time in almost three years from July to August 2010. Having grown in aggregate for 31 straight months prior to such decline, these distressed categories remain up $30.07 billion (153%) in the past year (up from only $19.69 billion in September 2009). Overall, the delinquent unpaid balance is up 96% from one-year ago (when $31.73 billion of delinquent unpaid balance for September 2009), and is now over 28 times the low point of $2.21 billion in March 2007.

The total unpaid balance for CMBS pools available for review for the September 2010 remittance was $773.61 billion, down from $773.98 billion in August 2010. Both the delinquent unpaid balance and delinquency percentage over the trailing twelve months continue to trend upward ... but at a moderated pace. The resultant delinquency ratio for September 2010 of 8.04% (up only 1.4% from the 7.93% reported a month prior) is over two times the 3.94% reported one-year prior in September 2009 and over 28 times the Realpoint recorded low point of 0.283% from June 2007.

The continued increase in both delinquent unpaid balance and percentage is now being impacted by the rapid growth in liquidations on a monthly basis and a potential slow-down in the reporting of new delinquency for the remainder of 2010.

Both liquidation activity and average loss severity has been on the rise over the trailing 12-months, especially in the past few months of 2010. Another $521.6 million in loan workouts and liquidations were reported for September 2010 across 58 loans, at an average loss severity of 47.5%. Eighteen of these loans, however, at $176.2 million experienced a loss severity near or below 1%, most likely related to workout fees, while the 40 loans at $345.5 million experienced an average loss severity near 68%. This activity followed $583.5 million in loan workouts and liquidations for August 2010 across 95 loans, at an average loss severity of 51.8%, and a substantial $1.035 billion in loan workouts and liquidations for July 2010 across 200 loans, at an average loss severity of 54.1%. Such activity marked the highest monthly liquidation amount tracked by Realpoint. Year-to-date in 2010, $5.53 billion in loan workouts and liquidations have been reported across 897 loans, at an average loss severity of 51% - including $4.15 billion in the past six-months alone.

Most noteworthy on a go forward basis, the $4.1 billion Extended Stay Hotel loan from the WBC07ESH transaction remained 90+-day’s delinquent in September 2010 but will reach  resolution with the October remittance. On May 28, 2010, Paulson & Co., Centerbridge Partners LP and Blackstone Group LP won a bankruptcy auction bid for the Extended Stay Hotel chain at $3.925 billion ($53,375/key). The U.S. Bankruptcy court approved the auction in June 2010 and the sale to Centebridge closed in September 2010, with certificate-holder distributions made in October 2010. Approximately 92% of the senior trust debt is expected to be paid in full, while the delinquent unpaid balance for CMBS would be reduced by $4.1 billion. Actual payoff and realized loss figures continue to be reported with October 2010 distributions.

Thursday, October 21, 2010

Bloomberg: Banks Face Two-Front War on Bad Mortgages, Flawed Foreclosures

Bloomberg News

Oct 21 (Bloomberg) -- Shoddy mortgage lending has led bankers into a two-front war, pitting them against U.S. homeowners challenging the right to foreclose and mortgage-bond investors demanding refunds that could approach $200 billion.

While federal regulators and state attorneys general have focused on flawed foreclosures, a bigger threat may be the cost to buy back faulty loans that banks bundled into securities. JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup Inc. have set aside just $10 billion in reserves to cover future buybacks. Bank of America alone said this week that pending claims jumped 71 percent from a year ago to $12.9 billion of loans.

Investors such as Bill Gross’s Pacific Investment Management Co. contend that sellers are obligated to repurchase some mortgages because of misrepresentations such as overstatements of borrowers’ income or inflated appraisals. Their case may be bolstered by probes in 50 states into whether banks used documents that were also flawed to conduct foreclosures. Neither dispute is likely to be resolved quickly.

“It’s going to be trench warfare with years of lawyering,” Christopher Whalen, managing director of Institutional Risk Analytics, said in a telephone interview from White Plains, New York. “The banks can’t afford to lose.”

The biggest risks for banks may be loans packaged into mortgage-backed securities during the housing bubble, of which $1.3 trillion remain. The aggrieved bondholders include government-controlled firms Fannie Mae and Freddie Mac, bond insurers and private investors.

Fannie, Freddie

Fannie Mae and Freddie Mac, the largest mortgage-finance companies, may be owed as much as $42 billion just on loans they bought directly from lenders, according to Fitch Ratings. On top of that, investors in private mortgage bonds, including them, may collect as much as $179.2 billion, Christopher Gamaitoni, vice president of research at Compass Point Research & Trading LLC in Washington, said in an August report. That brings the total to more than $220 billion.

Pimco, BlackRock Inc., MetLife Inc. and the Federal Reserve Bank of New York are seeking to force Bank of America to repurchase mortgages packaged into $47 billion of bonds by its Countrywide Financial Corp. unit. In a letter to the bank, the group cited alleged failures by Countrywide to service the loans properly.

“It enhances the likelihood of claims coming to fruition,” said Gamaitoni, a former senior financial analyst at Fannie Mae.

Repurchase Obligations

Bank of America, which acquired Countrywide, the biggest U.S. mortgage lender, in 2008, faces potential repurchase obligations of $74 billion, according to an August report by Branch Hill Capital, a San Francisco hedge fund, which is betting against the Charlotte, North Carolina-based company’s shares. Potential claims consist of $21.8 billion to Fannie Mae and Freddie Mac, $45 billion for investors in mortgage bonds and $7.2 billion for insurance companies, Branch Hill said.

Bank of America has $4.4 billion in reserves for claims on $12.9 billion of loans, the company reported Oct. 19, and has already resolved claims on more than $14 billion of loans.

The company will “defend our shareholders” by disputing any unjustified demands that it repurchase mortgages, Chief Executive Officer Brian T. Moynihan said in an interview on Bloomberg Television. Most claims “don’t have the defects that people allege.”

JPMorgan took a $1 billion third-quarter expense to increase its mortgage-repurchase reserves to about $3 billion. Citigroup raised its reserves to $952 million in the third quarter, from $727 million in the previous period. Wells Fargo reduced its repurchase reserves to $1.3 billion, from $1.4 billion in the second quarter.

‘Overstated’ Issues

“These issues have been somewhat overstated and to a certain extent, misrepresented in the marketplace,” Wells Fargo Chief Financial Officer Howard Atkins said yesterday on the bank’s third-quarter earnings call. “Our experience continues to be different than some of our peers in that our unresolved repurchase demands outstanding are actually down.”

So far, most lenders have resisted large-scale settlements, agreeing only to paybacks after defects are discovered in individual loans. Investors have in some cases been stymied in their efforts to examine individual loan files by mortgage-bond trustees, which administer the securities.

In July, the Federal Housing Finance Agency, the government conservator of Fannie Mae and Freddie Mac, issued 64 subpoenas demanding loan files to assess the possibility of breaches in representations and warranties by securities issuers.

Plaintiff Claims

The most common issues with the mortgages bundled into securities were borrowers who didn’t occupy the homes and inflated appraisals that distorted the loan-to-value ratio, according to lawsuits filed by the Federal Home Loan Banks in Seattle and San Francisco. A sampling of 6,533 loans in 12 securitizations by Countrywide found 97 percent failed to conform to underwriting guidelines, according to a lawsuit filed Sept. 29 by Ambac Assurance Corp. in New York state Supreme Court.

Richard M. Bowen, former chief underwriter for Citigroup’s consumer-lending group, said he warned his superiors of concerns that some types of loans in securities didn’t conform with representations and warranties in 2006 and 2007.

“In mid-2006, I discovered that over 60 percent of these mortgages purchased and sold were defective,” Bowen testified on April 7 before the Financial Crisis Inquiry Commission created by Congress. “Defective mortgages increased during 2007 to over 80 percent of production.”

Analysts’ Estimates

Some analysts say that the losses will be manageable by the banks. Last week, Mike Mayo, an analyst at Credit Agricole Securities USA in New York, estimated a cost of $20 billion for repurchases. Goldman Sachs Group Inc.’s Richard Ramsden said a worst-case scenario would be $84 billion.

U.S. Representative Brad Miller, a North Carolina Democrat on the House Financial Services Committee, says he asked Treasury Secretary Timothy Geithner in a recent hearing whether the government included mortgage-repurchase losses in the so- called stress tests of banks conducted last year, because he was expects that they will be growing. Geithner couldn’t immediately answer, and Miller assumes they weren’t.

“It appears the banks have contractually promised the mortgages met specific requirements, and also it certainly appears not all of them did,” Miller said. “In all likelihood a great many of them didn’t.”

The other front in the battle is the potential cost to banks of improper documentation used in foreclosures. Attorneys general in all 50 states are jointly investigating foreclosure procedures, including the use of so-called robo-signers who didn’t check the material they were signing. Litigation costs for such cases may reach $4 billion, while a three-month delay in foreclosures would add an additional $6 billion to industry expenses, FBR Capital Markets estimated in an Oct. 19 report.

Document Errors

Foreclosure document errors also can be used to push for repurchases.

The total amount of loans that the four biggest banks may need to buy back because of flawed paperwork could be “on the order of” about $25 billion, said Paul Jablansky, a senior debt strategist at Stamford, Connecticut-based RBS Securities Inc. With these demands to investigate breaches of contracts, “it’s relatively objective, the loan files are either complete or not, and the missing files are either material and adverse, or not.”

To settle disputes with homeowners about attempts to foreclose, banks may offer borrowers more generous loan modifications, potentially including principal reductions, said Frank Pallotta, managing partner of Loan Value Group, a mortgage-consulting firm in Rumson, New Jersey.

‘Going to Cost Them’

“The potential for owners to challenge lenders on foreclosure improprieties certainly is there,” Pallotta said. “Even if it turns out that the banks were right in 99 percent of these foreclosures, the additional diligence on their part, going forward, is going to cost them more money.”

The litigation over buybacks, also known as putbacks, can also pit big banks against each other. Last month, Deutsche Bank AG, acting as a trustee, refiled a lawsuit over misrepresented mortgages in $34 billion of Washington Mutual Inc. mortgage securities, with $165 billion in original balances.

The new suit in the U.S. District Court for the District of Columbia included JPMorgan as a defendant, after the Federal Deposit Insurance Corp. said that JPMorgan was wrongly claiming its insurance fund had agreed to cover the liabilities, according to the amended complaint.

JPMorgan Balks

JPMorgan, which bought most of WaMu after it failed in 2008, is balking at turning over loan files to the trustee, according to the suit. “Based on the limited information available to” Deutsche Bank, including evidence of WaMu’s shoddy practices found in internal documents released in a Senate investigation, either JPMorgan or the FDIC owes investors $6 billion to $10 billion, according to the complaint.

About 26 percent of mortgages underlying securities without government backing are at least 60 days late, in foreclosure proceedings or already backed by seized homes, according to data compiled by Bloomberg. Typical prices for the most-senior bonds tied to so-called Alt-A mortgages, whose borrowers often failed to document their pay or plan to live in properties, fell to as low as 33 cents on the dollar in March 2009, before rallying to 64 cents last week, according to Barclays Capital Inc. data.

Like WaMu, many lenders that originated the mortgages have gone out of business, making litigation more complex, said Kurt Eggert, professor of law at Chapman University in Orange, California. And top executives at the surviving companies, such as the CEOs of Bank of America and Citigroup, have been replaced.

“It’s troubling that the people who caused the problem have walked away and left everybody else to fight over who gets stuck with the tab,” Eggert said in a telephone interview. “It’s like a massive game of dine and dash.”

To contact the reporters on this story: John Gittelsohn in New York at Jody Shenn in New York at 2380 or

To contact the editor responsible for this story: Kara Wetzel at .