The gentle man at PIMCO certainly expressed the opinion that at some point Bernanke would have to start lowering rates. Not that it would do any good, just that he would have to do it.
The context is that the second the poopy hit the fan after the dotcom bubble burst, Alan "I Trickle Down" Greenspan took interest rates to zero.
But that pesky dollar... And now the Chinese are starting an investment company which will be funded with 300-400 billion dollars to diversify out of...oh, no! United States Treasuries. Just when we needed them most, to quote the song.
Nope, Ben just can't lower rates.
We face a future of inoperative trickling, similar to the 30's I suspect.
(update for the 1st two month of 2007) but I can not find it. Is there a way to get cashflow out of that ?
DSL has many neg arm loans - in fact as I understand it their "profit" from neg-arm was more than their total profit (which in my book means they are looosing money but showing profits because of the amortization they make on the neg-arm mortgages)
Is there a general rule of thumb in the lending business, thrifts, concerning NPA. Is a certain number a red flag?
I suppose this question is about adequate reserves and how the FDIC weighs in. I know the FDIC/regulators are very interested in loan loss reserves. How is this number reached? Is there a hard rule or is it up to the regulators to decide a level by institution. Some institutions will need higher reserves and others not so high. Given the current credit tightening, declining RE values and rising delinquencies/defaults all will need to increase.
FDIC seems to be more concerned now. Can they force an institution to mark to market its loan portfolio?
Is there a general rule of thumb in the lending business, thrifts, concerning NPA. Is a certain number a red flag?
I suppose this question is about adequate reserves and how the FDIC weighs in. I know the FDIC/regulators are very interested in loan loss reserves. How is this number reached? Is there a hard rule or is it up to the regulators to decide a level by institution. Some institutions will need higher reserves and others not so high. Given the current credit tightening, declining RE values and rising delinquencies/defaults all will need to increase.
FDIC seems to be more concerned now. Can they force an institution to mark to market its loan portfolio?
Big Ben can if he has to and he will, bank your falling dollar on it.
Not only that but the treasury could issue 100 year zero interest zero coupon bonds that would be held by the FED bypassing the bond market to re-inflate the banking system if they had to. They will do what it takes, do you understand? We are a hell of a long way from that point though.
Jesus!
What is ridiculous is that traders somehow think that other builders are fine. They will wait until each and every of them will report a loss forward in April?
Barely, there really isn't a rule of thumb number on nonperforming assets.
All regulators understand that lending money to people always has some risks. Honestly, a regulator who finds a bank that doesn't have enough nonperforming assets will probably write it up for failing to invest depositor and shareholder money sufficiently to guarantee a rate of return at all.
The key is context. The regulators look at the averages in the industry, and the historical averages for that lender, and the current economic situation. A given percent of NPAs might be considered reasonable risk in a booming local economy, for instance, but unacceptable risk in a different macro or micro environment.
And, of course, the question is always what loans end up NPA. Any institution is expected to keep correlating its experience back to its new credit-granting policies, in order to make sure that if a certain class of loans is going bad at a higher than normal rate, it stops making, or severely limits making, that kind of loan. If the institution is doing that, the regulators are not necessarily going to have a cow over the NPA numbers.
They do, and should, have a cow if the clear link exists between credit policy (or loan operations standards) and NPAs, but institution just keeps making that kind of loans, or claims that it can just raise interest rates on new borrowers and come out even.
Finally, of course, it depends on the institution's capital and reserve adequacy. The stronger you are, the more dead weight the regulators will let you carry.
Speaking of non-performing assets, is there an official or semi-official estimate compiled by some respected outfit? I've read about non-performing assets on banks' books in China and Japan, but never US banks. From what I gather, the situation is still not nearly as bad as China or Japan (thank god). It'd be interesting to see those numbers.
Welcome comments from Tanta or other mort fin types (which I'm not)
yal -
RE: DSL, the non-cash interest earnings from the neg-ams shows up in:
Adjustments To Net Income (372,450)\t
Total non-cash interest earnings (neg am) for CY2006 totals $292,949,000. I think this is just north of 25% of total interest earnings.
IMHO, DSL is a story in the making (could be a bigger systematic issue) as follows:
a) DSLs $13.8B investment portfolio includes $11.2B (85%) of neg-am ARMS (NOTE: 80% of the investment portfolio has been qualified based on stated-income, verified assets, and another 9% underwritten with no verification of either income or assets (2006 10-K, page 21). (Also NOTE: 91% of 2005, and 81% of 2006 originations/purchases were done through outside brokers so stated income might be a bit generous.)
b) The interesting angle might be that due to neg-am caps (seems mostly 110% of original loan amount), or just being aged out of the 12 month teaser rate period, these loans will start to experience resets (hard numbers would be good here, but say 24-30 months after origination) at the higher rate.
c) Some (a big number here might get scary) borrowers might not be able to make the fully indexed payment and will be foreclosed (so maybe some flippers get burned).
d) Some (ditto the big number) borrowers might really want to keep their home and seek to restructure their loan, but DSL (with new FDIC guidance) will now to need to qualify them at the Fully Indexed Rate using Verified Income.
If the borrowers stated income is validated maybe not a problem. But remember, at least in DSLs case that >80% of the loans were originated by outside brokers.
Given the age of their portfolio I think this could get ugly over the next 3-6 months.
f) DSL also seems to have brushed the sub-prime assets into the closet.
1) I did a search on the DSL 2006 10-K, and the only mention of sub-prime is in the banking regulation boilerplate section under Subprime Lending Guidelines on page 13
2) Historically, where DSL previously used 'sub-prime' nomenclature in their 10-Qs and 10Ks, they are now using higher-risk (page 5 rate sheet), or dropping it all together as in no longer breaking out their loan portfolio by subpirme & prime. It's like sub-prime never existed.
This seems unusual, as their 3Q2006 10-Q reports a total of $692M sub-prime loans (table page 37) in their investment portfolio, of which $616M (89%) are neg-am ARMS (table page 32).
So to me DSL's starting to smell like my relatives do after violating the three day rule. (no need to comment on my relatives)
Not only that but the treasury could issue 100 year zero interest zero coupon bonds that would be held by the FED bypassing the bond market to re-inflate the banking system if they had to.
This is no longer an option given the amount of dollars & debt held overseas plus our dependence on imports. Otherwise, you might as well roll up your dollars and put'em in the bathroom.
Tanta, That sounds like witchcraft. Given the current tightening in credit and standards combined with declining asset values we could easily be in for a replay of 90-91 RTC * 5.
Nice post. Have you looked at FirstFed (FED)? Seems similar to my untutored eye. I have puts on them both, but with FED, you can do Jan 2008/9 LEAPS, giving you plenty of time for implosion.
Interesting blog post on brokerages being forced to take back loans. This is something I only recently became aware of. I guess it's a good thing for lenders, assuming there are many brokerages that can absorb the loss. Are there any publicly traded brokers to bet against?
LEND is down 10%. I already closed some of my puts, I buy far out of the money puts and at this point each 10% drop in the stock only nets me 2.5%, and that ratio falls with each drop.
Nice post. Have you looked at FirstFed (FED)? Seems similar to my untutored eye. I have puts on them both, but with FED, you can do Jan 2008/9 LEAPS, giving you plenty of time for implosion.
Interesting blog post on brokerages being forced to take back loans. This is something I only recently became aware of. I guess it's a good thing for lenders, assuming there are many brokerages that can absorb the loss. Are there any publicly traded brokers to bet against?
LEND is down 10%. I already closed some of my puts, I buy far out of the money puts and at this point each 10% drop in the stock only nets me 2.5%, and that ratio falls with each drop.
Ara Hovnavian, during the conference call, on how their customers finance their homes:
"Subprime volumes are nothing that we tracked before. We didn't really need to."
"No one in this room could tell you those numbers" (on what % of loans are neg am or stated).
Two questions for the CR comments board:
Before committing hundreds of millions to inventory, wouldn't you be concerned with the viability of your customer's financing?
If you were a wall street analyst, would you put any weight on the guidance produced by a mgmt team that didn't know how customers financed their purchases?
I read recently the mortgage defaults will not go into overdrive until August, 2007. By then it should be clear how deep the housing crater will be.
Q3 '07 will be sufficient to have cleared the crater rim and tell us if there is a bottom in sight. It won't be able to tell more than that. That will reflect the coming of age of the '06 1/1 ARMs, the '05 2/1 ARMs and the '04 3/1 ARMs in an environment of no refi escape hatches. IMO we keep blowing all the chances at a soft landing and now need to b real careful to just manage a hard landing. My definition of a hard landng is where there are deaths and injuries but I manage to walk away losing my luggage and delaying my travel plans at worst.
Haps, you're not kidding. No increase in reserves for Q4 last year and look what their NPAs are doing over the past 5 mos. They need to double the number so far. By the end of March it could be TRIPLE at this rate!
Non-performing
Assets as a %
of total assets
Jan Dec Nov Oct Sep
0.78% 0.68% 0.55% 0.47% 0.39%
Haps, you're not kidding. No increase in reserves for Q4 last year and look what their NPAs are doing over the past 5 mos. They need to double the number so far. By the end of March it could be TRIPLE at this rate!
Non-performing
Assets as a %
of total assets
Jan Dec Nov Oct Sep
0.78% 0.68% 0.55% 0.47% 0.39%
Hapsburger, that's great analysis. Just two things to add. Remember that noncash income in the form of negative amortization is as good as its collectability. The fact that it is still owed by the borrower does not make it uncollectable or even a problem--banks make money lending money. The problem, really, is that it can make an asset that looked great when it was originated become at risk, since neg am means an increasing LTV in the absence of appreciation, and may mean cash-flow problems on the borrower's part. (I say may mean because it is at least theoretically possible that the borrower is making minimum payments and using the difference to make a killing in the stock market. I don't happen to believe that, but that's the story some people tell.) End of the day, the idea is that assets that are negatively amortizing are at higher risk than assets that are amortizing, so that's what affects the collectability of the noncash interest income. Does that make sense?
The other thing is this:
b) The interesting angle might be that due to neg-am caps (seems mostly 110% of original loan amount), or just being aged out of the 12 month teaser rate period, these loans will start to experience resets (hard numbers would be good here, but say 24-30 months after origination) at the higher rate.
Remember that what causes negative amortization in the first place is a loan structure in which the accrual rate of interest increases, but the payment does not (and therefore the payment is not enough to satisfy all interest due; the interest shortfall is added to the balance). In other words, the whole idea of a neg am ARM is to "smooth out" the rate increases, so that the borrower doesn't get "shocked" by them. Therefore, the fact that these loans are negatively amortizing is telling you that they are already getting hit with rate increases. The negative amortization will continue until 1) the borrower elects to start making amortizing payments (not likely in most cases, we suspect) or 2) the amount of neg am hits 10% of the original loan balance, when the loan is "recast" and the borrower is forced to make amortizing payments. It's that recast that's going to kill them, not the rate increases--they're getting deeper into the hole each month precisely because they're already getting it on rate increases.
LEAPs are just long term oprions. Most options expire on some date within the next 6 months. LEAPs always expire in January and usually available 1 and 2 years out. So now there are 2008& 2009 LEAPs available.
There are two advantages. First, you don't have to time the market as you do with something expiring in a month or so. And second, if you hold it for a year, it's a L/T capital gain.
My LEND puts are LEAPS and most have been held for more than a year.
Generally only the larger stcks have LEAPs available. You can get them for FED, but not DSL.
I have had generally bad luck buying shorter term options.
LEAPs are just long term oprions. Most options expire on some date within the next 6 months. LEAPs always expire in January and usually available 1 and 2 years out. So now there are 2008& 2009 LEAPs available.
There are two advantages. First, you don't have to time the market as you do with something expiring in a month or so. And second, if you hold it for a year, it's a L/T capital gain.
My LEND puts are LEAPS and most have been held for more than a year.
Generally only the larger stcks have LEAPs available. You can get them for FED, but not DSL.
I have had generally bad luck buying shorter term options.
If you were buying shares in a homebuilder whose 10-K says they own a mortgage company that makes loans to people who buy houses and then management said they don't know nuthin' bout no customers gettin' financed with subprime credit, would you want your friends to talk you into selling those shares, or are you just drinking bong water?
But at Citigroup Inc.'s annual credit conference here, speakers and attendees say the turndown in the U.S. subprime market is turning up in investors' portfolios where they don't expect it, reflecting the increasingly connected global markets. Investors are realizing they may own more exposure to subprime-mortgage-loan pools than they thought.
That exposure is surfacing because of the way fixed-income investments can be layered. Banks sell asset-backed securities, known as ABS, backed by mortgages to investors. The ABS can ultimately end up in complex structures called collateralized debt obligations, or CDOs. Institutional investors invest in CDOs, sometimes not realizing they have subprime mortgages in them.
....
Individual ABS portfolios typically are diversified across U.S. regions. But when they are combined together into a CDO, the risk of losses is increased for even relatively senior note holders because many of the original ABS portfolios will have been affected by mortgage defaults.
This could be a big deal for the larger mortgage market and the economy if foreign investors start to shun CDOs.
One big question I've felt has been unanswered, are all these layers of derivatives spreading risk, or amplyfying it?
Bob, you're right about the benefits of LEAPs. What is important to consider is the price. LEAPs (PUTS)carry very high premiums, IMO. They come in as time passes, providing the stock doesn't drop. In general, stocks are expected to go UP. So for long term PUT options you are really going against the odds. You need to have a very strong hunch to overcome the premium. Most options expire worthless so it's a factor to consider when buying options with a high premium.
Of course DSL looks like it's set up for a serious whack. No LEAPs on DSL but there are AUG contracts available.
Bob, I'm going to go out on a limb here and suggest that if these derivative instruments have been sold all these years to people who have no more idea what kind of interest-producing assets back them than they know what is in the sausage down at Vinnie's Pizza Parlor and Slaugherhouse, we can safely conclude that risk has been dispersed, but not that it has necessarily been dispersed to the parties who can safely carry it.
The very thought of a bunch of institutional investors getting up on their hind legs and whining in front of the door because they didn't understand what those CDOs were, and couldn't or wouldn't or didn't read the forking prospectus, ought to be making everyone's hair catch fire. Either they're in no position to really take that risk, or they're just preparing excuses for laying it back on to the sellers of the derivatives. I can't wait to see what happens when the derivatives market starts to look like the mortgage market, with everybody trying to shove the turkeys back through the chain to the originator.
Hey, where's the guy who told us that NEW was getting bought today?
Is it too late for me to get in on the action? Yes? Damn. I guess I'll go with my other viable investing idea: a restaurant in the middle of a lake that you have to swim home from. And no lingering customers, we want to turn our tables fast.
If you buy far out of the money puts, they basically move opposite the stock ($1 down, $1 up.) They are only worthwhile if you think you can make 50-100%. If you short, your risks are much greater and you pay to borrow the shares.
I paid $24 for LEND 1/2008 puts with a strike of $70, when the share price was ca $46. If it fell 25%, I'd make 50%. So far it's fallen 66%. But now put is worth 3.5 times the share price and for each 10% drop I gain just 2-3%.
If you buy far out of the money puts, they basically move opposite the stock ($1 down, $1 up.) They are only worthwhile if you think you can make 50-100%. If you short, your risks are much greater and you pay to borrow the shares.
I paid $24 for LEND 1/2008 puts with a strike of $70, when the share price was ca $46. If it fell 25%, I'd make 50%. So far it's fallen 66%. But now put is worth 3.5 times the share price and for each 10% drop I gain just 2-3%.
Ah, Tanta, you are the Jane Hamsher (sanitized) of the mortgage world.
My uncle would have said, "sucking canal water up his ass".
As I look at the averages (S&P...), I do get the feeling that people are reluctant to be long over the weekend. Such a crazy world. There is even news on Saturdays.
The risk of the original bond has been dispersed, but then some hedge fund is writing CDS based on it. In some cases, the CDSs are written naked, to a factor of ten...
I just don't believe anyone has a handle on how who is holding how much risk.
Yeah, Bob, but that original article you quoted said CDOs, not CDSs. I got the impression that Today's New Story is that the institutional investors never got the memo on what assets were backing those CDOs. Great, they own securities they don't understand.
Bob, I like the exact opposite. If I have a good hunch, I go pretty far out of the money (yours are deep in the money). Once the shares get in the money they basically move along with the price. Contracts are much more reasonable and the gain is phenominal, however they usually expire worthless. The premium that I stand to lose is what I consider gambling money. I am no expert.
Do I understand it right when I say, put very simply, an ecomonic trap closing? The US is boxed into a corner. In order to help all the people getting into problems with their debts and mortgages the Fed needs to lower interest rates. Yet at the same time they need to do the opposite and raise them, to maintain capital inflows to finance the huge deficit and maintain spending. Is the choice between mass bancruptcy or a currency crisis? Was that also the situation in the 30's? Do we have a depression coming again?
barely, the principal advantage of Bob's strategy is that the deep in-the-money LEAPS have minimal premium and offer the advantages have limited downside (the cost of the premium) and no borrowing costs (such as dividend payouts).
In hindsight, I would have made better use of these than vertical or calendar spreads -- which always need to match a particular forecast (e.g., I had a vertical put spread on NEW that only yeilded the maximum return on my spread - which was ok, but it suffered me to miss out on about 80% of the rest of the decline and substantially higher profits).
Will the sub-prime meltdown allow the REIC to lure in more sheep?
It appears that the bottom is about to drop out of the market- This means a lot fewer sales. But it also means the sales that do go through will be for more expensive houses, possibly pushing the median existing home prices of those that sell UP. Does the NAR count foreclosure auctions in its statistics? If not, it could show rising prices even as the downturn really gets going!
umber2, If you look at Bob's trade and suppose he would have bot out-of-the-money PUTs, say $40/$35 when it was trading @ $46, probably ~$2 or less, and rode it down to $5 the gains would have been a jackpot.
The truth is, I do both, and sometimes on the same shares. I believe DSL & FED both look juicy. NDE is another one. I am hoping for a run for another shot. I love the leverage without the risk of shorts when I have a solid hunch. The RE market is in big trouble IMO, especially in CA where all of those lenders have a footprint. Now with the regulators weighing in heavily it seems like a no-brainer...
I have been following the subprime market since 11,2004 and I knew it would end badly, but even I am unnerved by what is unfolding. Right now I am guessing that if we escape from the housing crater it will be with 2 broken legs and a crushed pelvis. But what do I know, I only got 2 hours sleep last night.
Thanks for the comments Tanta. Your past posts have really helped me understand the DLS financials and this RE stuff in general.
I get your point about the accruing interest - which is normally fine if it's collectable. But...., given:
a) most originations are made by a third party, and
b) the % of borrowers dipping into the neg-am facility is starting to take off, and
c) the 110% cap was based on a potentially inflated, no longer current appraisal, and
d) 90% of the portfolio is underwritten on stated or no docs, and
e) Management has recently made an effort to obsfuscate the make-up of the investment portfolio,
I wonder just how good the assets are?
Perhaps in a previous world where you could get a mortgage on a fridigaire box (empty no less), maybe they could work through the problem loans or at least sell the REOs and come out ok.
But we now have this 'perfect storm' set of events from the Fremmont revised FDIC guidelines (goodbye stated income), and the secondary window bolted and nailed shut, and a Tsunami wave of foreclosures with dropping prices, and maybe vefified income will only qualify at 2001 prices anyway so with no savings who do we sell to?, and the workout scenario gets a little fuzzy.
Those neg-am appreciating assets might start lookig more like your prverbial black bananas. A bunch of em.
How very appropos, Brooklynite. On the thread above linked, I particularly savored the "Drunk AE" measure of a business's chance of escaping BK: if the AEs are "happy drunks," it means Wall Street is riding in to the rescue. If they're "morose drunks," it means everyone had better find another lender.
Do I recall correctly that the bounty-hunter who is shot by Hans Solo in the bar in Mos Eisley was called "Greedo"?
I'm not quite confident enough to go your way yet, but that's clearly the way people make big money from options. I would say though that FED JAN 08 $50 might be relatively riskless.
I do own some DSL AUG puts, but I'd feel better if the were Jan 08 LEAPs.
It was a no-brainer to short Amazon at $200, til it went to $400.
Rant away, Haps, I don't disagree with you in the slightest. I just think that the question the DSLs and FEDs of the world should be forced to answer is not why they book neg am as noncash income; it's why they think that income is really truly collectable. I still don't hear their managements answering the question of why, if those loan assets are so unimpaired, these borrowers have to keep negatively amortizing this fast. They got away with saying "don't worry" when the RE values were going up faster than the loan balance was negatively amortizing. Now that that's in question, they need to fish or cut bait.
Bob, I hear you on the no-brainer remark. The famous quote, "the market can remain irrational longer than you can remain solvent" burns me every time. Timing, given the institutional and HF traders' advantages, is tough. Long term options help get around those obstacles.
However, you'll have to admit that the insanity of the past couple of years is now going the other way in a hurry. Really picking up steam over the past 2 months. Can't be long now. AUG gives you 2 quarterly reports. I own some of those myself...
Keen-eyed viewers will spot a young Greedo as a playmate of young Anakin "I can fly a a pod with my eyes closed but can't act to save my life" Skywalker in the lamentable prequel Episode I.
The ignorance, avarice and narcissism in that place is just appalling. I have to hand it to "Nico" and the other (few) reasonable folks over there though, I'd go postal in that place.
as in the AMAZON eg above, remember folks buying a stock has a limit to what you could lose (the entire share value)... now, when you sell short, the possible liability is theoretically limitless (the stock could keep on rising and rising and rising...)
Anthony,
All I know is that Bernanke is inhibited from lowering interest rates by his concerns about the dollar...well, maybe not his concerns, maybe the concerns of our creditors.
To me, this is all very reminiscent of Argentina. Yes, I know all the differences. But our currency is very, very weak right now.
Question about classification of lenders. Most of the lenders who are now imploding are doing so because of EPDs from warehouse LOCs for wholesale of broker-generated mortgages, with the ultimate destination of securitization. A simpler description of these people has been "subprime lenders". The exception is FMT, which is a depository.
Now FED, DSL and BKUNA are depositories who are heavily into NegAm. It appears that the subprimers were not doing NegAm.
Question 1: is it a coincidence that only depositories are doing neg am or does this imply that neg am cannot be easily securitized and therefore you need deposits to fund them? Does this also not imply that depositories were not big on subprime, for the reason that the secondary market was so hungry and therefore depositories were pushed out (due to the amount of risk in subprime?). If this is wrong, what is behind this division, assuming i have it right?
Question 2: why do people only talk about FED, DSL and BKUNA? Is everyone else in the country who does NegAm essentially much smaller? Also, who are the biggest non-publicly-traded depositories?
I just read Mish's most recent post, in which he interviews a mortgage broker who claims never to have had a single repurchase or foreclosure in the last ten years.
My response is not printable on a family blog.
Look, if you originate 1000 prime-credit, full-doc, 80% LTV loans on first-rate collateral with a solid-gold appraisal, you will have at least 1 foreclosure in the following 10 years. This is a statistical certainty.
Maybe some broker doing 100 squeaky-clean anal-compulsive loans a year can get by with no foreclosures. And if you're not doing more than 100 loans a year, you probably have the time to make sure that each one is exactly perfect, so you'll never have to repurchase because you screwed something up. But forgive me for not being interested, in that case, in your opinions about how large financial institutions work.
(Full disclosure: Tanta has had to buy back loans in her day. The best one was the one that someone, ahem, sold to Freddie Mac. Freddie required repurchase almost immediately. I wasn't actually surprised by that, because I had, actually, just repurchased the loan from Fannie Mae a few days before I accidentally sold it to Freddie. I honest to Peat meant the loan to go into the bank's portfolio, but somehow I typed in the wrong code and it got allocated into a held for sale pool. Fortunately for me, that was one out of the just under a billion dollars worth of loans we sold to Freddie that year, and so I got forgiven both by my own boss and by Freddie Mac.)
Any way, my view of a mortgage lender who has never had a foreclosure is like my view of a trader who has never had a losing position. What were you long in, US Savings Bonds?
probert, neg am is not impossible to securitize, but it's hard to securitize. Nonetheless, there are plenty of securities out there with neg am ARMs in them. Lenders who are holding them in portfolio are choosing to do so.
Also, even the subprimers generally have been willing to recognize that combining negative amortization with subprime credit is insane. It's bad enough that they do interest only.
What freaks most of us out about the lenders you mentioned is that they're thrifts whose portfolios are 80-90-100% neg am, which is terrible risk concentration, and that they are also completely geographically concentrated in bubble markets (CA). That's just turbo-charging your risk.
More than 54,000 homeowners in the Chicago area were 60 days behind on their mortgage payments and in serious danger of going into default as of Dec. 31, 2006. That's 14.5 percent of an estimated 374,000 subprime loans in the greater Chicago standard metropolitan area, said Bob Visini, vice president-marketing, for LoanPerformance, a California-based subsidiary of First American Real Estate Solutions.
In Chicago the numbers of these early warning defaults increased 56 percent between year-end 2005 and year-end 2006, a higher percentage increase than posted nationwide, Visini said.
I've been skimming the comments today due to alot of other things going on. One comment on DSL (I didn't see this, but didn't read carefully either), the company recently signed change of control agreements (golden parachutes) with senior execs which some are taking as a sign that a sale of the company is near. Keefe was out with a report Monday to that effect. Wouldn't be at the top of my list of targets, but then again, I'm still trying to figure out why MS bought Saxon last fall and MER bought FF, so you can't completely discount a dumb-ass take out bid. Might argue for buying puts rather than going short.
Sounds like alarm bells are starting to ring in Washington:
"Bies Says Subprime Defaults Are `Beginning of Wave' (Update2)
March 9 (Bloomberg) -- U.S. Federal Reserve Governor Susan
Bies said banks' losses from risky home loans made at a low
introductory rates are just beginning.
Bies, who has been Fed's top banking policy official in her
tenure at the U.S. central bank, said today banks are likely to
see more missed payments and foreclosures as consumers with weak
credit histories begin to face higher monthly mortgage payments.
What's happening is the front end of this wave of teaser-
rate loans that are coming into full pricing,'' Bies said today
at a risk-management forum in Charlotte, North Carolina.So
what we're seeing in this narrow segment is the beginning of the
wave -- this is not the end, this is the beginning.'
"This means a lot fewer sales. But it also means the sales that do go through will be for more expensive houses, possibly pushing the median existing home prices of those that sell UP."
yal, good observation. This is already starting to happen in Sacramento. Sales volume is very sluggish but median price is actually increasing while volume on low-end housing is especially bad. Yet another reason why the median price indicator is so unreliable in terms of gauging what the actual market is doing.
thanks Tanta,
So then a follow-up: why have depositories not done more sizable amounts of subprime? (i.e. why are there not more FMT's out there?)
Is it because their cost of doing this is below that of the NFI's and NEW's of the world, who had access to a leverage machine? And if so, was that a consequence of FDIC regulations?
What I'm trying to get at is whether FED,BKUNA & DSL are essentially anomalies that the FDIC should be very worried about. Is their chance of imploding truly smaller than that of FMT? Furthermore, was the probability of FMT's subprime segment imploding equal to that of NEW imploding? (i.e. did FMT live on the edge as much as NEW of NFI, leveraged to the hilt and focused on ROIC?)
probert, my reading of the C&D against FMT remains this: they've got some sucky loans, and the regulators don't like that. But they wouldn't have been shoved up against the wall like that had they not also had incompetent management, non-existent operating controls, etc.
Most regulated institutions don't do majority subprime in their book of business precisely because the regulators know how risky it is and the standards for reserves, capital, operational controls, etc. are just too high. Besides, traditionally there was what we call "reputational risk" in doing subprime--your average depository didn't want to get a reputation in the marketplace of being a bottom-feeder. (That may be coming back, as we're getting over the last several years of attempts to glamorize no-holds-barred subprime lending.)
So anyway, I would be willing to bet that the FDIC and OTS are watching those OA thrifts quite carefully. I suspect, actually, that at least one of them has already been told to lay off the OA--I've noticed that portfolio concentrations in OA are coming down slightly, and I think it's possible that that's regulator-driven. The reason we might not know that is that unless the lender is doing something truly egregious, the regulators may still be in "guidance" mode with them instead of "enforcement" mode.
We should also bear in mind that FDIC's (and every other regulators') budgets for long, in-depth on-site safety and soundess examinations are pretty thin. And you can thank the Bush administration, whose priorities have not extended to making sure there's enough oversight. One of the things that worries me is the extent to which the regulators are hiring young fresh-out-college greenhorns to examine these institutions. I have nothing against young people, but they can get outfoxed by thrift managers who know how to manipulate them. Part of me wonders whether FMT just happened to get the last "Patrick Fitzgerald" left on FDIC's examination team.
And sometimes I wonder if the folks he claims are real, are really real or not.
The best comment I read there was the comment that it attracted folks that viewed markets as sorta of a religion. And like any religion, the true believers that worship at its altars, cannot be losers or risk the appearance that the gods are against them.
The next best quote from there was the poster that noted that when markets are going up, folks want the government to stay out. But when the markets are going down want protection.
Check how out-of-the-money puts are
priced with an option calculator that allows comparison of historical volatility with implied volatility derived from the option price. More liquid stocks have tradable options for Jan 2009, but these are cheap only deeply below the strike price.
FED has been in the WSJ for over a year, even then half it's pre-tax profits were from neg am.
Personally. I think th e ntire financial sector is going to take a hit. I'm not one of those people who think Citi is going under, but a lot of people were making a lot of money selling mortgages, packaging them into bonds, buying the bonds, insuring the bomds... The investment banks are already down substantially. It doesn't matter that they aren't exposed to much in loses, they're losing the fat transaction fees.
The best, last move of the dot-com era was buy the guy who sold about.com to Primmedia. This was well after the bubble burst. They paid in there own stock, but the price was fixed, if the value of their shares fell (which it did, partly because of the moronic deal they just made) the seller got proportionately more shares.
For this buble, I noominate the people who sold Golden West to Wachovia. Talk about timing!
One big question I've felt has been unanswered, are all these layers of derivatives spreading risk, or amplyfying it?
Both, in manner of speaking. Spreading the risk around gives the appearance of mitigation, thereby emboldening participants to take on even more risk. Throw in all the leverage, and you get considerable amplification, i.e., systemic risk.
Is the choice between mass bancruptcy or a currency crisis? Was that also the situation in the 30's? Do we have a depression coming again?
Yes, no, and yes. We hadn't yet ceded control of our currency to foreigners -- that's a recent development, and one of the reasons why this'll be a "Greater Depression".
I realize that many of the residential subprime and stated income loans have been problematic. However, there is a commercial lending benefit to keeping this loan type alive. Financial institutions like Ocean Capital in Rhode Island maintain an up close and personal policy with the commercial lending that they do to folks trying to start a business and who may not have a portfolio substantial enough to make them attractive borrowers to the big box lenders. Sometimes, you have to purchase the gas station, auto repair shop or motel to generate revenue. Subprime commercial lending is oftentimes the only opportunity for certain new business developoment and should be retained.
Ahhh, clean sheets.
The gentle man at PIMCO certainly expressed the opinion that at some point Bernanke would have to start lowering rates. Not that it would do any good, just that he would have to do it.
The context is that the second the poopy hit the fan after the dotcom bubble burst, Alan "I Trickle Down" Greenspan took interest rates to zero.
But that pesky dollar... And now the Chinese are starting an investment company which will be funded with 300-400 billion dollars to diversify out of...oh, no! United States Treasuries. Just when we needed them most, to quote the song.
Nope, Ben just can't lower rates.
We face a future of inoperative trickling, similar to the 30's I suspect.
Like tnhe tagline from Syriana . . . everything is connected.
Oh, gosh. Signs of bad times, really bad times. Really, really bad times.
Bakersfield Bubble: Wells Fargo, real estate does go DOWN!
Can some one who understand explain if indeed this indicate cashflow problem:
DSL: Cash Flow for DOWNEY FINANCIAL CP - Yahoo! Finance
There are changes in so many lines that I can not seea trend.
also, I tried to get cashflow situation from this:
Page expired - MSN Money
(update for the 1st two month of 2007) but I can not find it. Is there a way to get cashflow out of that ?
DSL has many neg arm loans - in fact as I understand it their "profit" from neg-arm was more than their total profit (which in my book means they are looosing money but showing profits because of the amortization they make on the neg-arm mortgages)
Thanks.
Being a realtor: a tough job, but someone's got to...flee it like the plague?
Bubble Meter: Realtor Membership Drops Significantly
ugh. "the".
I read recently the mortgage defaults will not go into overdrive until August, 2007. By then it should be clear how deep the housing crater will be.
Debt Slavery for all.
Tanta,
Is there a general rule of thumb in the lending business, thrifts, concerning NPA. Is a certain number a red flag?
I suppose this question is about adequate reserves and how the FDIC weighs in. I know the FDIC/regulators are very interested in loan loss reserves. How is this number reached? Is there a hard rule or is it up to the regulators to decide a level by institution. Some institutions will need higher reserves and others not so high. Given the current credit tightening, declining RE values and rising delinquencies/defaults all will need to increase.
FDIC seems to be more concerned now. Can they force an institution to mark to market its loan portfolio?
Tanta,
Is there a general rule of thumb in the lending business, thrifts, concerning NPA. Is a certain number a red flag?
I suppose this question is about adequate reserves and how the FDIC weighs in. I know the FDIC/regulators are very interested in loan loss reserves. How is this number reached? Is there a hard rule or is it up to the regulators to decide a level by institution. Some institutions will need higher reserves and others not so high. Given the current credit tightening, declining RE values and rising delinquencies/defaults all will need to increase.
FDIC seems to be more concerned now. Can they force an institution to mark to market its loan portfolio?
arbogast
Nope, Ben just can't lower rates.
Big Ben can if he has to and he will, bank your falling dollar on it.
Not only that but the treasury could issue 100 year zero interest zero coupon bonds that would be held by the FED bypassing the bond market to re-inflate the banking system if they had to. They will do what it takes, do you understand? We are a hell of a long way from that point though.
Jesus!
Hovnanian is tanking by 6%.
What is ridiculous is that traders somehow think that other builders are fine. They will wait until each and every of them will report a loss forward in April?
Will they wait until April?
Barely, there really isn't a rule of thumb number on nonperforming assets.
All regulators understand that lending money to people always has some risks. Honestly, a regulator who finds a bank that doesn't have enough nonperforming assets will probably write it up for failing to invest depositor and shareholder money sufficiently to guarantee a rate of return at all.
The key is context. The regulators look at the averages in the industry, and the historical averages for that lender, and the current economic situation. A given percent of NPAs might be considered reasonable risk in a booming local economy, for instance, but unacceptable risk in a different macro or micro environment.
And, of course, the question is always what loans end up NPA. Any institution is expected to keep correlating its experience back to its new credit-granting policies, in order to make sure that if a certain class of loans is going bad at a higher than normal rate, it stops making, or severely limits making, that kind of loan. If the institution is doing that, the regulators are not necessarily going to have a cow over the NPA numbers.
They do, and should, have a cow if the clear link exists between credit policy (or loan operations standards) and NPAs, but institution just keeps making that kind of loans, or claims that it can just raise interest rates on new borrowers and come out even.
Finally, of course, it depends on the institution's capital and reserve adequacy. The stronger you are, the more dead weight the regulators will let you carry.
Yield is up about 10 BP on the 10 Yr note ?
why are the longbonds tanking ?
the return to a normal curve so soon or more to it ?
Speaking of non-performing assets, is there an official or semi-official estimate compiled by some respected outfit? I've read about non-performing assets on banks' books in China and Japan, but never US banks. From what I gather, the situation is still not nearly as bad as China or Japan (thank god). It'd be interesting to see those numbers.
ACK!, the FDIC quarterly outlook (at fdic.gov) is a good source for industry-wide numbers.
Welcome comments from Tanta or other mort fin types (which I'm not)
yal -
RE: DSL, the non-cash interest earnings from the neg-ams shows up in:
Adjustments To Net Income (372,450)\t
Total non-cash interest earnings (neg am) for CY2006 totals $292,949,000. I think this is just north of 25% of total interest earnings.
IMHO, DSL is a story in the making (could be a bigger systematic issue) as follows:
a) DSLs $13.8B investment portfolio includes $11.2B (85%) of neg-am ARMS (NOTE: 80% of the investment portfolio has been qualified based on stated-income, verified assets, and another 9% underwritten with no verification of either income or assets (2006 10-K, page 21). (Also NOTE: 91% of 2005, and 81% of 2006 originations/purchases were done through outside brokers so stated income might be a bit generous.)
b) The interesting angle might be that due to neg-am caps (seems mostly 110% of original loan amount), or just being aged out of the 12 month teaser rate period, these loans will start to experience resets (hard numbers would be good here, but say 24-30 months after origination) at the higher rate.
c) Some (a big number here might get scary) borrowers might not be able to make the fully indexed payment and will be foreclosed (so maybe some flippers get burned).
d) Some (ditto the big number) borrowers might really want to keep their home and seek to restructure their loan, but DSL (with new FDIC guidance) will now to need to qualify them at the Fully Indexed Rate using Verified Income.
If the borrowers stated income is validated maybe not a problem. But remember, at least in DSLs case that >80% of the loans were originated by outside brokers.
Given the age of their portfolio I think this could get ugly over the next 3-6 months.
f) DSL also seems to have brushed the sub-prime assets into the closet.
1) I did a search on the DSL 2006 10-K, and the only mention of sub-prime is in the banking regulation boilerplate section under Subprime Lending Guidelines on page 13
2) Historically, where DSL previously used 'sub-prime' nomenclature in their 10-Qs and 10Ks, they are now using higher-risk (page 5 rate sheet), or dropping it all together as in no longer breaking out their loan portfolio by subpirme & prime. It's like sub-prime never existed.
This seems unusual, as their 3Q2006 10-Q reports a total of $692M sub-prime loans (table page 37) in their investment portfolio, of which $616M (89%) are neg-am ARMS (table page 32).
So to me DSL's starting to smell like my relatives do after violating the three day rule. (no need to comment on my relatives)
Oh yeah. And in the 4th Qtr 2006 they pretty much zeroed out their Loan Loss Accrual.
Guess that would have tanked the bottom line.
Not only that but the treasury could issue 100 year zero interest zero coupon bonds that would be held by the FED bypassing the bond market to re-inflate the banking system if they had to.
This is no longer an option given the amount of dollars & debt held overseas plus our dependence on imports. Otherwise, you might as well roll up your dollars and put'em in the bathroom.
Tanta, That sounds like witchcraft. Given the current tightening in credit and standards combined with declining asset values we could easily be in for a replay of 90-91 RTC * 5.
Hapsburger,
Nice post. Have you looked at FirstFed (FED)? Seems similar to my untutored eye. I have puts on them both, but with FED, you can do Jan 2008/9 LEAPS, giving you plenty of time for implosion.
Interesting blog post on brokerages being forced to take back loans. This is something I only recently became aware of. I guess it's a good thing for lenders, assuming there are many brokerages that can absorb the loss. Are there any publicly traded brokers to bet against?
LEND is down 10%. I already closed some of my puts, I buy far out of the money puts and at this point each 10% drop in the stock only nets me 2.5%, and that ratio falls with each drop.
Hapsburger,
Nice post. Have you looked at FirstFed (FED)? Seems similar to my untutored eye. I have puts on them both, but with FED, you can do Jan 2008/9 LEAPS, giving you plenty of time for implosion.
Interesting blog post on brokerages being forced to take back loans. This is something I only recently became aware of. I guess it's a good thing for lenders, assuming there are many brokerages that can absorb the loss. Are there any publicly traded brokers to bet against?
LEND is down 10%. I already closed some of my puts, I buy far out of the money puts and at this point each 10% drop in the stock only nets me 2.5%, and that ratio falls with each drop.
Ara Hovnavian, during the conference call, on how their customers finance their homes:
"Subprime volumes are nothing that we tracked before. We didn't really need to."
"No one in this room could tell you those numbers" (on what % of loans are neg am or stated).
Two questions for the CR comments board:
Bob_in_MA
tell me about LEAPS.
why are the longbonds tanking ?
Because recession fears are fading.
I read recently the mortgage defaults will not go into overdrive until August, 2007. By then it should be clear how deep the housing crater will be.
Q3 '07 will be sufficient to have cleared the crater rim and tell us if there is a bottom in sight. It won't be able to tell more than that. That will reflect the coming of age of the '06 1/1 ARMs, the '05 2/1 ARMs and the '04 3/1 ARMs in an environment of no refi escape hatches. IMO we keep blowing all the chances at a soft landing and now need to b real careful to just manage a hard landing. My definition of a hard landng is where there are deaths and injuries but I manage to walk away losing my luggage and delaying my travel plans at worst.
Bob_in_MA.
Been a bit busy working thru the DSL reports.
They're not extensively covered by the analyst community, and their stock seems to have been holding up well, but I have no clue why.
Loan originations are off 50% yoy.
Delinquencies, Non-Performing and REO are all up as well.
And dropping the 4th Qtr Loss accruals is really aggressive given the current environment.
I am not so well schooled in option but would welcome some info on the LEAPS.
Haps, you're not kidding. No increase in reserves for Q4 last year and look what their NPAs are doing over the past 5 mos. They need to double the number so far. By the end of March it could be TRIPLE at this rate!
Non-performing
Assets as a %
of total assets
Jan Dec Nov Oct Sep
0.78% 0.68% 0.55% 0.47% 0.39%
Haps, you're not kidding. No increase in reserves for Q4 last year and look what their NPAs are doing over the past 5 mos. They need to double the number so far. By the end of March it could be TRIPLE at this rate!
Non-performing
Assets as a %
of total assets
Jan Dec Nov Oct Sep
0.78% 0.68% 0.55% 0.47% 0.39%
Hapsburger, that's great analysis. Just two things to add. Remember that noncash income in the form of negative amortization is as good as its collectability. The fact that it is still owed by the borrower does not make it uncollectable or even a problem--banks make money lending money. The problem, really, is that it can make an asset that looked great when it was originated become at risk, since neg am means an increasing LTV in the absence of appreciation, and may mean cash-flow problems on the borrower's part. (I say may mean because it is at least theoretically possible that the borrower is making minimum payments and using the difference to make a killing in the stock market. I don't happen to believe that, but that's the story some people tell.) End of the day, the idea is that assets that are negatively amortizing are at higher risk than assets that are amortizing, so that's what affects the collectability of the noncash interest income. Does that make sense?
The other thing is this:
b) The interesting angle might be that due to neg-am caps (seems mostly 110% of original loan amount), or just being aged out of the 12 month teaser rate period, these loans will start to experience resets (hard numbers would be good here, but say 24-30 months after origination) at the higher rate.
Remember that what causes negative amortization in the first place is a loan structure in which the accrual rate of interest increases, but the payment does not (and therefore the payment is not enough to satisfy all interest due; the interest shortfall is added to the balance). In other words, the whole idea of a neg am ARM is to "smooth out" the rate increases, so that the borrower doesn't get "shocked" by them. Therefore, the fact that these loans are negatively amortizing is telling you that they are already getting hit with rate increases. The negative amortization will continue until 1) the borrower elects to start making amortizing payments (not likely in most cases, we suspect) or 2) the amount of neg am hits 10% of the original loan balance, when the loan is "recast" and the borrower is forced to make amortizing payments. It's that recast that's going to kill them, not the rate increases--they're getting deeper into the hole each month precisely because they're already getting it on rate increases.
Bob_in_MA,
Is that because the puts are still well out of the money?
LEAPs are just long term oprions. Most options expire on some date within the next 6 months. LEAPs always expire in January and usually available 1 and 2 years out. So now there are 2008& 2009 LEAPs available.
There are two advantages. First, you don't have to time the market as you do with something expiring in a month or so. And second, if you hold it for a year, it's a L/T capital gain.
My LEND puts are LEAPS and most have been held for more than a year.
Generally only the larger stcks have LEAPs available. You can get them for FED, but not DSL.
I have had generally bad luck buying shorter term options.
LEAPs are just long term oprions. Most options expire on some date within the next 6 months. LEAPs always expire in January and usually available 1 and 2 years out. So now there are 2008& 2009 LEAPs available.
There are two advantages. First, you don't have to time the market as you do with something expiring in a month or so. And second, if you hold it for a year, it's a L/T capital gain.
My LEND puts are LEAPS and most have been held for more than a year.
Generally only the larger stcks have LEAPs available. You can get them for FED, but not DSL.
I have had generally bad luck buying shorter term options.
The Hovnanian mgmt talk like used car salesmen.
David, you need to add a third question.
Here's something in the WSJ: Some investors may own more exposure to subprime-loan pools than they thought:
But at Citigroup Inc.'s annual credit conference here, speakers and attendees say the turndown in the U.S. subprime market is turning up in investors' portfolios where they don't expect it, reflecting the increasingly connected global markets. Investors are realizing they may own more exposure to subprime-mortgage-loan pools than they thought.
That exposure is surfacing because of the way fixed-income investments can be layered. Banks sell asset-backed securities, known as ABS, backed by mortgages to investors. The ABS can ultimately end up in complex structures called collateralized debt obligations, or CDOs. Institutional investors invest in CDOs, sometimes not realizing they have subprime mortgages in them.
....
Individual ABS portfolios typically are diversified across U.S. regions. But when they are combined together into a CDO, the risk of losses is increased for even relatively senior note holders because many of the original ABS portfolios will have been affected by mortgage defaults.
This could be a big deal for the larger mortgage market and the economy if foreign investors start to shun CDOs.
One big question I've felt has been unanswered, are all these layers of derivatives spreading risk, or amplyfying it?
Bob, you're right about the benefits of LEAPs. What is important to consider is the price. LEAPs (PUTS)carry very high premiums, IMO. They come in as time passes, providing the stock doesn't drop. In general, stocks are expected to go UP. So for long term PUT options you are really going against the odds. You need to have a very strong hunch to overcome the premium. Most options expire worthless so it's a factor to consider when buying options with a high premium.
Of course DSL looks like it's set up for a serious whack. No LEAPs on DSL but there are AUG contracts available.
Bob, I'm going to go out on a limb here and suggest that if these derivative instruments have been sold all these years to people who have no more idea what kind of interest-producing assets back them than they know what is in the sausage down at Vinnie's Pizza Parlor and Slaugherhouse, we can safely conclude that risk has been dispersed, but not that it has necessarily been dispersed to the parties who can safely carry it.
The very thought of a bunch of institutional investors getting up on their hind legs and whining in front of the door because they didn't understand what those CDOs were, and couldn't or wouldn't or didn't read the forking prospectus, ought to be making everyone's hair catch fire. Either they're in no position to really take that risk, or they're just preparing excuses for laying it back on to the sellers of the derivatives. I can't wait to see what happens when the derivatives market starts to look like the mortgage market, with everybody trying to shove the turkeys back through the chain to the originator.
Hey, where's the guy who told us that NEW was getting bought today?
Is it too late for me to get in on the action? Yes? Damn. I guess I'll go with my other viable investing idea: a restaurant in the middle of a lake that you have to swim home from. And no lingering customers, we want to turn our tables fast.
"Hey, where's the guy who told us that NEW was getting bought today?"
It's all coming from the BO thread below. All the NEW AE's seem unconcerned. FWIW...
WHATS GOING ON WITH NEW CENTURY
Related article on Bloomberg, Subprime Mortgage Bonds Extend Drop as Dealers Cut CDO Funding.
barely,
If you buy far out of the money puts, they basically move opposite the stock ($1 down, $1 up.) They are only worthwhile if you think you can make 50-100%. If you short, your risks are much greater and you pay to borrow the shares.
I paid $24 for LEND 1/2008 puts with a strike of $70, when the share price was ca $46. If it fell 25%, I'd make 50%. So far it's fallen 66%. But now put is worth 3.5 times the share price and for each 10% drop I gain just 2-3%.
Related article on Bloomberg, Subprime Mortgage Bonds Extend Drop as Dealers Cut CDO Funding.
barely,
If you buy far out of the money puts, they basically move opposite the stock ($1 down, $1 up.) They are only worthwhile if you think you can make 50-100%. If you short, your risks are much greater and you pay to borrow the shares.
I paid $24 for LEND 1/2008 puts with a strike of $70, when the share price was ca $46. If it fell 25%, I'd make 50%. So far it's fallen 66%. But now put is worth 3.5 times the share price and for each 10% drop I gain just 2-3%.
"drinking bong water"
Ah, Tanta, you are the Jane Hamsher (sanitized) of the mortgage world.
My uncle would have said, "sucking canal water up his ass".
As I look at the averages (S&P...), I do get the feeling that people are reluctant to be long over the weekend. Such a crazy world. There is even news on Saturdays.
Tanta,
The risk of the original bond has been dispersed, but then some hedge fund is writing CDS based on it. In some cases, the CDSs are written naked, to a factor of ten...
I just don't believe anyone has a handle on how who is holding how much risk.
Yeah, Bob, but that original article you quoted said CDOs, not CDSs. I got the impression that Today's New Story is that the institutional investors never got the memo on what assets were backing those CDOs. Great, they own securities they don't understand.
Bob, I like the exact opposite. If I have a good hunch, I go pretty far out of the money (yours are deep in the money). Once the shares get in the money they basically move along with the price. Contracts are much more reasonable and the gain is phenominal, however they usually expire worthless. The premium that I stand to lose is what I consider gambling money. I am no expert.
Do I understand it right when I say, put very simply, an ecomonic trap closing? The US is boxed into a corner. In order to help all the people getting into problems with their debts and mortgages the Fed needs to lower interest rates. Yet at the same time they need to do the opposite and raise them, to maintain capital inflows to finance the huge deficit and maintain spending. Is the choice between mass bancruptcy or a currency crisis? Was that also the situation in the 30's? Do we have a depression coming again?
barely, the principal advantage of Bob's strategy is that the deep in-the-money LEAPS have minimal premium and offer the advantages have limited downside (the cost of the premium) and no borrowing costs (such as dividend payouts).
In hindsight, I would have made better use of these than vertical or calendar spreads -- which always need to match a particular forecast (e.g., I had a vertical put spread on NEW that only yeilded the maximum return on my spread - which was ok, but it suffered me to miss out on about 80% of the rest of the decline and substantially higher profits).
Will the sub-prime meltdown allow the REIC to lure in more sheep?
It appears that the bottom is about to drop out of the market- This means a lot fewer sales. But it also means the sales that do go through will be for more expensive houses, possibly pushing the median existing home prices of those that sell UP. Does the NAR count foreclosure auctions in its statistics? If not, it could show rising prices even as the downturn really gets going!
umber2, If you look at Bob's trade and suppose he would have bot out-of-the-money PUTs, say $40/$35 when it was trading @ $46, probably ~$2 or less, and rode it down to $5 the gains would have been a jackpot.
The truth is, I do both, and sometimes on the same shares. I believe DSL & FED both look juicy. NDE is another one. I am hoping for a run for another shot. I love the leverage without the risk of shorts when I have a solid hunch. The RE market is in big trouble IMO, especially in CA where all of those lenders have a footprint. Now with the regulators weighing in heavily it seems like a no-brainer...
Robert Cote
I have been following the subprime market since 11,2004 and I knew it would end badly, but even I am unnerved by what is unfolding. Right now I am guessing that if we escape from the housing crater it will be with 2 broken legs and a crushed pelvis. But what do I know, I only got 2 hours sleep last night.
if anyone get new on "Tontine Partners " - please post. tnx.
Ah, Broker's Outpost: The Mos Eisley of the internet.
"You will not find a more wretched hive of scum and villainy." - Obi Wan Kenobi
Thanks for the comments Tanta. Your past posts have really helped me understand the DLS financials and this RE stuff in general.
I get your point about the accruing interest - which is normally fine if it's collectable. But...., given:
a) most originations are made by a third party, and
b) the % of borrowers dipping into the neg-am facility is starting to take off, and
c) the 110% cap was based on a potentially inflated, no longer current appraisal, and
d) 90% of the portfolio is underwritten on stated or no docs, and
e) Management has recently made an effort to obsfuscate the make-up of the investment portfolio,
I wonder just how good the assets are?
Perhaps in a previous world where you could get a mortgage on a fridigaire box (empty no less), maybe they could work through the problem loans or at least sell the REOs and come out ok.
But we now have this 'perfect storm' set of events from the Fremmont revised FDIC guidelines (goodbye stated income), and the secondary window bolted and nailed shut, and a Tsunami wave of foreclosures with dropping prices, and maybe vefified income will only qualify at 2001 prices anyway so with no savings who do we sell to?, and the workout scenario gets a little fuzzy.
Those neg-am appreciating assets might start lookig more like your prverbial black bananas. A bunch of em.
sorry for the rant
How very appropos, Brooklynite. On the thread above linked, I particularly savored the "Drunk AE" measure of a business's chance of escaping BK: if the AEs are "happy drunks," it means Wall Street is riding in to the rescue. If they're "morose drunks," it means everyone had better find another lender.
Do I recall correctly that the bounty-hunter who is shot by Hans Solo in the bar in Mos Eisley was called "Greedo"?
barely,
I'm not quite confident enough to go your way yet, but that's clearly the way people make big money from options. I would say though that FED JAN 08 $50 might be relatively riskless.
I do own some DSL AUG puts, but I'd feel better if the were Jan 08 LEAPs.
It was a no-brainer to short Amazon at $200, til it went to $400.
thanks Bob for the LEAPS insight.
Rant away, Haps, I don't disagree with you in the slightest. I just think that the question the DSLs and FEDs of the world should be forced to answer is not why they book neg am as noncash income; it's why they think that income is really truly collectable. I still don't hear their managements answering the question of why, if those loan assets are so unimpaired, these borrowers have to keep negatively amortizing this fast. They got away with saying "don't worry" when the RE values were going up faster than the loan balance was negatively amortizing. Now that that's in question, they need to fish or cut bait.
Bob, I hear you on the no-brainer remark. The famous quote, "the market can remain irrational longer than you can remain solvent" burns me every time. Timing, given the institutional and HF traders' advantages, is tough. Long term options help get around those obstacles.
However, you'll have to admit that the insanity of the past couple of years is now going the other way in a hurry. Really picking up steam over the past 2 months. Can't be long now. AUG gives you 2 quarterly reports. I own some of those myself...
That is correct!
Keen-eyed viewers will spot a young Greedo as a playmate of young Anakin "I can fly a a pod with my eyes closed but can't act to save my life" Skywalker in the lamentable prequel Episode I.
The ignorance, avarice and narcissism in that place is just appalling. I have to hand it to "Nico" and the other (few) reasonable folks over there though, I'd go postal in that place.
as in the AMAZON eg above, remember folks buying a stock has a limit to what you could lose (the entire share value)... now, when you sell short, the possible liability is theoretically limitless (the stock could keep on rising and rising and rising...)
Hey Bob. You have be on to something with FED.
PETER BRIMELOW
If it weren't for bad omens ...
CORRECT: It it weren't for bad omens ... Peter Brimelow - MarketWatch
So Bob, or others to re-cap your thinking on FED. If I were to take a short, the cheapest way to get leverage is.........
Anthony,
All I know is that Bernanke is inhibited from lowering interest rates by his concerns about the dollar...well, maybe not his concerns, maybe the concerns of our creditors.
To me, this is all very reminiscent of Argentina. Yes, I know all the differences. But our currency is very, very weak right now.
Question about classification of lenders. Most of the lenders who are now imploding are doing so because of EPDs from warehouse LOCs for wholesale of broker-generated mortgages, with the ultimate destination of securitization. A simpler description of these people has been "subprime lenders". The exception is FMT, which is a depository.
Now FED, DSL and BKUNA are depositories who are heavily into NegAm. It appears that the subprimers were not doing NegAm.
Question 1: is it a coincidence that only depositories are doing neg am or does this imply that neg am cannot be easily securitized and therefore you need deposits to fund them? Does this also not imply that depositories were not big on subprime, for the reason that the secondary market was so hungry and therefore depositories were pushed out (due to the amount of risk in subprime?). If this is wrong, what is behind this division, assuming i have it right?
Question 2: why do people only talk about FED, DSL and BKUNA? Is everyone else in the country who does NegAm essentially much smaller? Also, who are the biggest non-publicly-traded depositories?
thanks
Tanta, That sounds like witchcraft.
I just read Mish's most recent post, in which he interviews a mortgage broker who claims never to have had a single repurchase or foreclosure in the last ten years.
My response is not printable on a family blog.
Look, if you originate 1000 prime-credit, full-doc, 80% LTV loans on first-rate collateral with a solid-gold appraisal, you will have at least 1 foreclosure in the following 10 years. This is a statistical certainty.
Maybe some broker doing 100 squeaky-clean anal-compulsive loans a year can get by with no foreclosures. And if you're not doing more than 100 loans a year, you probably have the time to make sure that each one is exactly perfect, so you'll never have to repurchase because you screwed something up. But forgive me for not being interested, in that case, in your opinions about how large financial institutions work.
(Full disclosure: Tanta has had to buy back loans in her day. The best one was the one that someone, ahem, sold to Freddie Mac. Freddie required repurchase almost immediately. I wasn't actually surprised by that, because I had, actually, just repurchased the loan from Fannie Mae a few days before I accidentally sold it to Freddie. I honest to Peat meant the loan to go into the bank's portfolio, but somehow I typed in the wrong code and it got allocated into a held for sale pool. Fortunately for me, that was one out of the just under a billion dollars worth of loans we sold to Freddie that year, and so I got forgiven both by my own boss and by Freddie Mac.)
Any way, my view of a mortgage lender who has never had a foreclosure is like my view of a trader who has never had a losing position. What were you long in, US Savings Bonds?
probert, neg am is not impossible to securitize, but it's hard to securitize. Nonetheless, there are plenty of securities out there with neg am ARMs in them. Lenders who are holding them in portfolio are choosing to do so.
Also, even the subprimers generally have been willing to recognize that combining negative amortization with subprime credit is insane. It's bad enough that they do interest only.
What freaks most of us out about the lenders you mentioned is that they're thrifts whose portfolios are 80-90-100% neg am, which is terrible risk concentration, and that they are also completely geographically concentrated in bubble markets (CA). That's just turbo-charging your risk.
BY SALLY DUROS Real Estate and Homelife Editor
More than 54,000 homeowners in the Chicago area were 60 days behind on their mortgage payments and in serious danger of going into default as of Dec. 31, 2006. That's 14.5 percent of an estimated 374,000 subprime loans in the greater Chicago standard metropolitan area, said Bob Visini, vice president-marketing, for LoanPerformance, a California-based subsidiary of First American Real Estate Solutions.
In Chicago the numbers of these early warning defaults increased 56 percent between year-end 2005 and year-end 2006, a higher percentage increase than posted nationwide, Visini said.
I've been skimming the comments today due to alot of other things going on. One comment on DSL (I didn't see this, but didn't read carefully either), the company recently signed change of control agreements (golden parachutes) with senior execs which some are taking as a sign that a sale of the company is near. Keefe was out with a report Monday to that effect. Wouldn't be at the top of my list of targets, but then again, I'm still trying to figure out why MS bought Saxon last fall and MER bought FF, so you can't completely discount a dumb-ass take out bid. Might argue for buying puts rather than going short.
Sounds like alarm bells are starting to ring in Washington:
"Bies Says Subprime Defaults Are `Beginning of Wave' (Update2)
March 9 (Bloomberg) -- U.S. Federal Reserve Governor Susan
Bies said banks' losses from risky home loans made at a low
introductory rates are just beginning.
Bies, who has been Fed's top banking policy official in her
tenure at the U.S. central bank, said today banks are likely to
see more missed payments and foreclosures as consumers with weak
credit histories begin to face higher monthly mortgage payments.
What's happening is the front end of this wave of teaser-
rate loans that are coming into full pricing,'' Bies said today
at a risk-management forum in Charlotte, North Carolina.So
what we're seeing in this narrow segment is the beginning of the
wave -- this is not the end, this is the beginning.'
"This means a lot fewer sales. But it also means the sales that do go through will be for more expensive houses, possibly pushing the median existing home prices of those that sell UP."
yal, good observation. This is already starting to happen in Sacramento. Sales volume is very sluggish but median price is actually increasing while volume on low-end housing is especially bad. Yet another reason why the median price indicator is so unreliable in terms of gauging what the actual market is doing.
thanks Tanta,
So then a follow-up: why have depositories not done more sizable amounts of subprime? (i.e. why are there not more FMT's out there?)
Is it because their cost of doing this is below that of the NFI's and NEW's of the world, who had access to a leverage machine? And if so, was that a consequence of FDIC regulations?
What I'm trying to get at is whether FED,BKUNA & DSL are essentially anomalies that the FDIC should be very worried about. Is their chance of imploding truly smaller than that of FMT? Furthermore, was the probability of FMT's subprime segment imploding equal to that of NEW imploding? (i.e. did FMT live on the edge as much as NEW of NFI, leveraged to the hilt and focused on ROIC?)
``So
what we're seeing in this narrow segment is the beginning of the
wave -- this is not the end, this is the beginning.''
She is now lifting headlines from bloggers:
Bakersfield Bubble: Subprime Blowup Wave #2?
Subprime Blowup Wave #2?
probert, my reading of the C&D against FMT remains this: they've got some sucky loans, and the regulators don't like that. But they wouldn't have been shoved up against the wall like that had they not also had incompetent management, non-existent operating controls, etc.
Most regulated institutions don't do majority subprime in their book of business precisely because the regulators know how risky it is and the standards for reserves, capital, operational controls, etc. are just too high. Besides, traditionally there was what we call "reputational risk" in doing subprime--your average depository didn't want to get a reputation in the marketplace of being a bottom-feeder. (That may be coming back, as we're getting over the last several years of attempts to glamorize no-holds-barred subprime lending.)
So anyway, I would be willing to bet that the FDIC and OTS are watching those OA thrifts quite carefully. I suspect, actually, that at least one of them has already been told to lay off the OA--I've noticed that portfolio concentrations in OA are coming down slightly, and I think it's possible that that's regulator-driven. The reason we might not know that is that unless the lender is doing something truly egregious, the regulators may still be in "guidance" mode with them instead of "enforcement" mode.
We should also bear in mind that FDIC's (and every other regulators') budgets for long, in-depth on-site safety and soundess examinations are pretty thin. And you can thank the Bush administration, whose priorities have not extended to making sure there's enough oversight. One of the things that worries me is the extent to which the regulators are hiring young fresh-out-college greenhorns to examine these institutions. I have nothing against young people, but they can get outfoxed by thrift managers who know how to manipulate them. Part of me wonders whether FMT just happened to get the last "Patrick Fitzgerald" left on FDIC's examination team.
Honest to god, I would never have picked Memphis as ground zero in the foreclosure debacle:
The Foreclosure Report: Memphis Sales Almost Equal To Defaults
1 foreclosure for every 1.06 sold...mindblowing.
Personally, I was blown away by the news of NEW's acquisition this morning.
Wait, what do you mean that didn't happen?
This is weird.
With so many weaker players going down, I'd expect stronger ones to GROW. But it looks like all subprime is shutting down. No plankton?
GE's WMC Mortgage unit lays off 460
GE's WMC Mortgage unit lays off 460: spokeswoman
| Reuters
I read Mish's blog.
And sometimes I wonder if the folks he claims are real, are really real or not.
The best comment I read there was the comment that it attracted folks that viewed markets as sorta of a religion. And like any religion, the true believers that worship at its altars, cannot be losers or risk the appearance that the gods are against them.
The next best quote from there was the poster that noted that when markets are going up, folks want the government to stay out. But when the markets are going down want protection.
Check how out-of-the-money puts are
priced with an option calculator that allows comparison of historical volatility with implied volatility derived from the option price. More liquid stocks have tradable options for Jan 2009, but these are cheap only deeply below the strike price.
FED has been in the WSJ for over a year, even then half it's pre-tax profits were from neg am.
Personally. I think th e ntire financial sector is going to take a hit. I'm not one of those people who think Citi is going under, but a lot of people were making a lot of money selling mortgages, packaging them into bonds, buying the bonds, insuring the bomds... The investment banks are already down substantially. It doesn't matter that they aren't exposed to much in loses, they're losing the fat transaction fees.
The best, last move of the dot-com era was buy the guy who sold about.com to Primmedia. This was well after the bubble burst. They paid in there own stock, but the price was fixed, if the value of their shares fell (which it did, partly because of the moronic deal they just made) the seller got proportionately more shares.
For this buble, I noominate the people who sold Golden West to Wachovia. Talk about timing!
One big question I've felt has been unanswered, are all these layers of derivatives spreading risk, or amplyfying it?
Both, in manner of speaking. Spreading the risk around gives the appearance of mitigation, thereby emboldening participants to take on even more risk. Throw in all the leverage, and you get considerable amplification, i.e., systemic risk.
Is the choice between mass bancruptcy or a currency crisis? Was that also the situation in the 30's? Do we have a depression coming again?
Yes, no, and yes. We hadn't yet ceded control of our currency to foreigners -- that's a recent development, and one of the reasons why this'll be a "Greater Depression".
I realize that many of the residential subprime and stated income loans have been problematic. However, there is a commercial lending benefit to keeping this loan type alive. Financial institutions like Ocean Capital in Rhode Island maintain an up close and personal policy with the commercial lending that they do to folks trying to start a business and who may not have a portfolio substantial enough to make them attractive borrowers to the big box lenders. Sometimes, you have to purchase the gas station, auto repair shop or motel to generate revenue. Subprime commercial lending is oftentimes the only opportunity for certain new business developoment and should be retained.