The Mortgage Dance? EZ: Just Follow the Bouncing Ball

And the beat goes on…  but sometimes it helps to have that little bouncing ball show us exactly what lyric we are singing this week.  All together now:

Today the Fed suprised no one by opening the discount window to ailing siblings: Fannie Mae and Freddie Mac.  Together they hold more than half of all mortgages in the US and the guarantee that they would not fail has been implied for some time.  The Fed also intimated there would be no other bail outs in the foreseeable future.  Who is walking the thin line?  WaMu, Wachovia, Downey, Indy Mac (oops, they were written out of the chorus last week).  Now it looks as if the Fed has reworked a few more lines and their song to the Wall Street firms goes a little something like this: if you can not fix your problem with the ability to borrow at 2.25%, your problem is not fixable.

This does not bode well for our short list.  Downey is more of a regional and will likely go down under its own weight of Losses and Lawsuits (the real ”L” words).  Previous posts have fixed WaMu as the consensus “next big one” to fall.  Wachovia, in my opinion, is more of a question mark.  Straight-laced, tea-loving bank goes to a frat party where “everyone who is anyone” is drinking and the peer pressure just becomes too much.  This is a hangover for which they are ill prepared.

What does this mean for real estate and the mortgages that drive its cycles?  Here’s one thought: if you are a specialist in homes that do not play the Fannie/Freddie tune, you may want to create some more income streams and fast.  Any regional that has not already eviscerated it’s “improvisational jazz” lending will find themselves looking at a Wall Street that no longer believes anyone is above failing.  If recent history has taught us anything it is this: the big firms currently involved in lending are either asleep at the wheel or lying outright.  We watched Counrywide lie about their financials right up until the end.  We watched WaMu take hits twice their predictions.  Even Wachovia, a stalwart bank, was “surprised” by losses more than double what they had predicted for Wall Street.  Not sure why anyone believes anything these firms say now.

I believe this all goes back to a problem that is not discussed in the media (whether for lack of a sound bite or just ignorance is anyone’s guess) and never given the light of day by these firms themselves: the accounting debacle tied to neg-ams.  Want to know who is going down next or where “surprise” losses will most likely come into play?  Look to the firms that made a killin’ putting clients into neg-ams.  (And before some of you start commenting on how neg-ams are just a tool and can be a good loan to boot – you know who you are – let me say “I know.”  Loaded guns are just a tool too.  Cars are just a tool.  I am in favor of both.  But if I stand at the door handing out keys and guns to everyone as they leave the party… let’s just say the onus of responsibility comes back to me.)

I guess it is not so difficult to follow the bouncing ball afterall.  I think I’ll go to bed tonight and dream about how attractive Fannie & Freddie have become lately.  They just may be the only two left on the dance floor.

Filed under: BUYERS, INVESTORS, LENDERS, POLITICAL & ECONOMIC FOLLY, REALTORS, SELLERS , Countrywide, Downey, Fannie/Freddie, Fed, IndyMac, Wachovia, WaMu

Countrywide, Wall Street and Animal House

There is a great scene toward the end of the movie Animal House.  The Deltas have decided to wreak havoc on the Faber College Homecoming parade.  The grandstand has been destroyed, floats are running amok, people are fleeing for their very lives and there is chaos in the streets.  One of the ROTC members who has been charged with maintaining public safety (played, I believe, by Kevin Bacon in his on-screen debut) stands still amidst the whirlwind of activity that envelops him and screams at the top of his lungs: “Remain Calm!  All is Well!!”  The absolute lunacy of his reality is made hilarious by his sheer conviction.  I am amazed every time I see it.  I feel that way lately as I watch Wall Street react to Countrywide, almost imperceptibly screaming “Remain Calm! All is Well!!”

I was more than a little confused by Wall Street’s reaction to Countrywide’s pronouncements last October regarding a profitable 4th quarter.  I wrote about it then and I guess I am writing again with a childish “told you so.”  Countrywide is underestimating their financial obligations in my humble opinion and it seems rather obvious to even the casual observer.  But as I have pointed out, main stream media is missing the real problem as well.  In a world of doom and gloom I am loathe to admit it, but these players are not doom and gloomy enough.  That is all well and good because their misjudgments serve them and it is easy for us to follow the ball when we follow the money.  More difficult to follow, however, is Wall Street’s desire to play along.

Today Countrywide announced that they were in fact unprofitable in the fourth quarter (which must have come as a bit of a shock to those that bid their stock up last quarter) .  This was in direct contradiction to their public estimates.  It now seems even more reasonable to conclude that Countrywide’s set asides are woefully inadequate, yet their stock today was… up.  “Remain Calm!  All is Well!!”

Filed under: LENDERS, POLITICAL & ECONOMIC FOLLY , Countrywide, Wall Street

Countrywide Set Asides

The following is an email sent 10/26/2007 to some of my Realtor clients. Their is no attachment to this post (not sure how to do that yet!) but I believe all the salient information is included.  Again, I am posting these now because I am fairly sure I will want to reference them at a later date. 

Attached is a rather interesting article regarding Countrywide.  I am including some thoughts here and I want to make it clear that I am not picking on any one lender and especially not on Countrywide.  I do believe Countrywide can be instructive, however, as to what is happening now and what is to come.  As Countrywide goes, so goes the industry.  I have also included an attachment from a previous email regarding loan resets. According to the article, “Countywide lost $1.2 billion in the third quarter… Countrywide’s first quarterly loss in 25 years.  Yet its shares soared Friday after the nation’s largest mortgage lender said it expects to be profitable this quarter and next year”.   Now I do not pretend to know as much as the asset managers that watch these stocks and I certainly do not know what the future holds.  I hope Countrywide is accurate in their predictions and that the soaring shares which greeted the news are warranted.  I am, however, painfully aware of the market’s relatively myopic view; rarely looking further than the party streamers amidst any cause for celebration.  I must say that I am a bit perplexed by Wall Street’s jubilation and Countrywide’s rosy assessment.  Let’s take a closer look at the numbers.

• According to the New York Times (Countrywide to Help Restructure Loans 10/24/2007) Countrywide services approximately $1.46 trillion in loans.
• In the Mortgage Reset Table attached we can see the total loans resetting (not just Countrywide)
  • $153 billion in loans reset in the 3^rd quarter
  • $165 billion in loans are resetting in the 4^th quarter
  • $278 billion in loans are resetting in the 1^st quarter of ‘08
  • $233 billion in loans are resetting in the 2^nd quarter of ‘08 

Now, even though the above numbers are for all lenders, let’s assume that most lenders will be looking at a similar ratio of reset increases. While we are on the subject, let’s assume that everything else will hold constant (including the assumption that Countrywide’s percentage of defaults going forward will remain similar to what it is now).  We will see later why holding everything else constant may give us a rosier picture of Countrywide’s health than merited, but let’s give the benefit of the doubt. In the attached article we see that “Countrywide reserved $934 million for bad loans in the third quarter… (and) moved about $12 billion in nonconforming loans to its held-for-investment portfolio after having to take a write-down on them”.  This was against the 3^rd quarter reset number of $153 billion.  Yet going forward we see “the company took a $690 million impairment charge for home-equity and subprime loan residuals in anticipation of future credit losses”.  This is against a fourth quarter where we expect to see an 8% increase in the number of resets.  Let’s give that one to Countrywide as a part of their aggressive reaction to the credit crunch and massive downsizing.  Going forward a little further, however, we are looking at first and second quarter ’08 reset increases of 82% and 52% respectively.  That is a three quarter total of $676 billion in resets against $350 billion for the first three quarters of ’07; a 190% increase, yet Countrywide is decreasing their set aside by 26%!   Now let’s take a closer look at our assumption that everything else will remain constant.  It is widely accepted that the loan resets for the first three quarters were primarily comprised of sub-prime loans.  The upcoming resets, however, are predominately ARMs and option arms which went to more main-stream credit risks.  We have documented previously where Countrywide Chairman and Chief Executive Angelo Mozilo has proclaimed the limited exposure Countrywide has to the sub prime market.  It would seem reasonable then, to assume that their exposure to the upcoming resets will be even greater than what has been seen thus far.  Leaving out the entire discussion of Countrywide’s exposure to the option arms that made up a majority of their portfolio and you can still see my utter consternation when it comes to Countrywide’s outlook and the stock market’s acceptance of that outlook.

I have said before that I hope I am wrong.  Others certainly believe so.  Bank of America essentially bet that Countrywide stock would be over $18/share two years from now when they “bought” a portion of the company.  Of course the stock was trading close to $18 at the time and is now down to around $15/share even after the exciting news about Countrywide’s vastly improved future.  I am not in any way going to suggest that in-house optimism is anything but genuine, or that some of Countrywide’s insiders found “dumping” stock at $13/share to be less enjoyable than when it was $18/share… but I am concerned about Countrywide’s future.  It bears repeating: as Countrywide goes, so goes the industry. 

Filed under: LENDERS, POLITICAL & ECONOMIC FOLLY , Countrywide, option arms

Option Arms: Iceberg Dead Ahead

The next couple of posts are a bit dated, but they reference events going on in the real estate mortgage market that I am sure I will point to later.

 

Adapted from a speech given August, 2007 

There has been a lot of discussion in the press lately regarding the mortgage industry and the increase in foreclosures.  I am here today with a good news/bad news type of report.  The good news is that the actual stats are not nearly as bad as the press would have you believe.  The bad news is that it is going to get much worse.  The sub-prime issue is only what we currently see; the real problem, Option Arms, lurks just below the surface – and it is the size of Countrywide and Washington Mutual plus many more.  The US Mortgage ship Titanic be warned: “Iceberg dead ahead!”

 Here is the concept in a nutshell: Virtually all lenders use accrual based accounting (as do virtually all corporations of any business type).  Standard practice in this type of accounting is to book accounts receivable even though you have not actually received the cash.  This is, as I said, standard practice.  But what do you think might happen when this accounting standard is practiced by a lender such as Countrywide or Washington Mutual; lenders with a tremendous amount of option arms on their books?  These lenders are booking the expected income (which is to say the interest income) from all of their loans.  Yet with option arms there is a percentage of customers (in some cases I suspect a very large percentage) that are paying only the minimum payment.  “OK”, says the lender, “we are not receiving the income right now, but we will eventually”.  Which is fine until you look at the mortgage reset tables and recognize the vast number of loans that will be going into foreclosure in the near future.  To the degree that these loans are option arms the lenders will have to go back and remove the interest income they booked but did not receive and will now never receive.  This often results in a process on Wall Street called “restating your earnings”.  If you are curious how Wall Street views companies that restate their earnings, ask the people over at New Century Mortgage… oh, that’s right; you can’t.  They had to declare bankruptcy about 48 hours after they restated theirs.

Filed under: LENDERS, POLITICAL & ECONOMIC FOLLY , Countrywide, option arms

Countrywide is Losing Its Car Keys

The market has been an interesting place lately. Not too long ago New Century, the second largest sub-prime lender in the land, declared bankruptcy. How did this happen and what does that have to do with Countrywide?

My good friend and co-worker Brian Brady came out of the securities field just as I did (he was a bond trader and I was an options trader). We both are fairly well versed in ‘corporate speak’, which is the business version of military double speak. (For instance, when the military says there was “collateral damage”, what they mean is innocent people were killed.) Corporations use ‘double speak’ to address bad news in the business world. About two weeks before New Century “shuffled off this mortal coil” (Shakespearean ‘double speak’ for died) they came out with an announcement that they had lost track of their underperforming assets. This rather innocuous statement sounds a lot like “I seem to have lost my car keys”. Of course, in the world of lender finance the key focus and the one and only thing you never lose track of is your underperforming assets: loans that are going bad and that you will most likely be buying back. So as a corporation you need to have a very good estimate of that number. When New Century said they “lost track” I took that as ‘corporate speak’ for “we are seeing the beginning of a real problem that we had not accounted for and we are delaying the release of our numbers until we can wrap our heads around what is coming”. Sure enough, after two weeks they “found their car keys” and announced some staggering losses. That, in and of itself, was not the problem. The problem was that they had to restate their earnings and Wall Street is VERY unforgiving when you go back and tell them “hey, remember when we told you we made this much money? Well we were wrong. We only made half as much.” Within 48 hours New Century was bankrupt.

Soon after this New Century debacle, Mr. Mozilo – the CEO of Countrywide – came out and announced that while they had no real sub-prime exposure, they expected to see some losses due to the sub-prime problems. To which Brian and I looked at each other quizzically and said “what?” You have no exposure to the problem, but you will incur losses due to the problem? A short time later Mr. Mozilo announced that while they had absolutely no problems with their current sources of funding, they were in fact looking for new funding. To which Brian and I looked at each other quizzically and said “what?” Your funding source is not a problem but you need a new funding source? Countrywide is the largest lender in the land and over 60% (by my last check) of their portfolio is made up of option arms. The option arm problem is still on the horizon but I have often said I cannot imagine being the V.P. in charge of risk management at Countrywide. How do you hedge the majority of your portfolio against a product that has never existed at this volume and for which the future value is so uncertain?

I think that Countrywide is in the process of misplacing their car keys…

Filed under: BUYERS, INVESTORS, LENDERS, POLITICAL & ECONOMIC FOLLY, REALTORS, SELLERS , Countrywide, option arms