Interest Rate Roundup

Thursday, August 28, 2008

Banks that didn't screw up

I've spent quite a bit of time and digital ink talking about banks, brokers, and other financial firms that really got this credit market wrong. So it's refreshing to come across stories on companies that actually got things right. In other words, they avoided the high-risk crud and stuck to their knitting. That's how Bloomberg describes People's United Financial of Bridgeport, Conn. in a story today:

"People's United Financial Corp., the largest New England-based lender, is seeking acquisitions after steering clear of the subprime-mortgage market, and can "cherry-pick'' borrowers abandoned by cash-strapped banks.

"The bank, which raised $3.44 billion in April 2007 before credit markets tightened, has money to purchase companies, Chief Executive Officer Philip Sherringham said. If no acquisitions catch his eye, the bank may buy back stock with the capital, "returning it to shareholders one way or the other,'' he said.

"Our greatest challenge?'' Sherringham said in an interview on Aug. 25. "Capital deployment, absolutely.''

"As banks and securities firms reeled from more than $500 billion in writedowns and credit losses tied to subprime, People's United consistently reported quarterly profits. The Bridgeport, Connecticut-based company's stock declined less than 1 percent in the past 12 months, holding steady as nine U.S. banks failed this year and finance companies were forced to raise more than $352 billion in capital.

"People's United has "a very clean balance sheet right now,'' said KBW Inc. analyst Damon Del Monte in an interview yesterday. "The last thing they want to do is acquire a bank that has some unknown loan issues on their books.'' He has a "market perform'' rating on the shares."

This brings up another point. So much time, effort, and money is being spent trying to keep even crummy firms liquid, on life support, or whatever you want to call it. Everyone seems to want a bailout. But how about the thought that maybe -- just maybe -- letting the weak die off would make it easier for the strong to thrive? Isn't that what capitalism is all about?

GDP up 3.3%, jobless claims elevated

I've been extremely busy, so haven't had time to post much here. I also have to travel soon. So I'll keep this short and sweet: Heading into he holiday weekend, we've gotten some better news on the economic growth front. Revisions show GDP rose at 3.3% annual rate in the second quarter, versus a prior estimate of 1.9%. Exports were the big driver of growth, adding 3.1 percentage points to GDP. That was the most going all the way back to 1980.

Meanwhile, initial jobless claims filings dipped to 425,000 from 435,000 in the previous week. But continuing claims rose to 3.423 million from 3.359 million. That's the highest since November 2003, and more evidence that the labor market remains weak here in the U.S.

The market reaction? Stocks are up notably, while the long bond futures are off about a half point. The dollar index has been all over the map -- up, then down, and now back up a couple of basis points.

Tuesday, August 26, 2008

FDIC QBP: Earnings down, "problem" institutions up, charge-off rate at 17-year high and more

The FDIC just released its latest Quarterly Banking Profile (PDF link), or QBP report. This is a comprehensive report that provides a wealth of data about the health of the banking industry. Some highlights (or lowlights, as the case may be; emphasis added by m):

* Insured commercial banks and savings institutions reported net income of $5.0 billion for the second quarter of 2008. This is the second-lowest quarterly total since 1991 and is $31.8 billion (86.5 percent) less than the industry earned in the second quarter of 2007. Higher loan-loss provisions were the most significant factor in the earnings decline.

* Loss provisions totaled $50.2 billion, more than four times the $11.4 billion quarterly total of a year ago. Second-quarter provisions absorbed almost one-third (31.9 percent) of the industry’s net operating revenue (net interest income plus total noninterest income), the highest proportion since the third quarter of 1989.

* Loan losses registered a sizable jump in the second quarter, as loss rates on real estate loans increased sharply at many large lenders. Net charge-offs of loans and leases totaled $26.4 billion in the second quarter, almost triple the $8.9 billion that was charged off in the second quarter of 2007. The annualized net charge-off rate in the second quarter was 1.32 percent, compared to 0.49 percent a year earlier. This is the highest quarterly charge-off rate for the industry since the fourth quarter of 1991.

* Net chargeoffs increased year-over-year for all major loan categories in the second quarter. Charge-offs of 1-4 family residential mortgage loans increased by $5.8 billion (821.9 percent), while charge-offs of real estate construction and land development loans rose by $3.2 billion (1,226.6 percent). Net charge-offs of home equity loans were $2.8 billion (632.7 percent) higher than a year earlier, charge-offs of loans to commercial and industrial (C&I) borrowers were up by $1.8 billion (127.5 percent), credit card charge-offs increased by $1.7 billion (47.4 percent), and charge-offs of other loans to individuals grew by $1.4 billion (70.3 percent).

* The amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) rose for a ninth consecutive quarter, increasing by $26.7 billion (19.6 percent). This is the second-largest quarterly increase in noncurrent loans during the nine-quarter streak, after the $27.0-billion increase in the fourth quarter of 2007 when quarterly net charge-offs were $10 billion lower.

* All major loan categories registered increased levels of noncurrent loans in the second quarter. The amount of 1-4 family residential real estate loans that were noncurrent increased by $11.7 billion (21.2 percent) during the quarter, while noncurrent real estate construction and land development loans rose by $8.2 billion (27.2 percent). Large increases were also reported in loans secured by nonfarm nonresidential real estate properties (up $2.0 billion, or 19.6 percent), C&I loans (up $1.8 billion, or 15.0 percent), and home equity loans (up $1.7 billion, or 25.5 percent). At the end of June, the percentage of the industry’s total loans and leases that were noncurrent stood at 2.04 percent, the highest level since the third quarter of 1993.

* For the third consecutive quarter, insured institutions added almost twice as much in loan-loss provisions to their reserves for losses as they charged-off for bad loans. Provisions exceeded charge-offs by $23.8 billion in the second quarter, and industry reserves rose by $23.1 billion (19.1 percent). The industry’s ratio of reserves to total loans and leases increased from 1.52 percent to 1.80 percent, its highest level since the middle of 1996. However, for the ninth consecutive quarter, increases in noncurrent loans surpassed growth in reserves, and the industry’s “coverage ratio” fell very slightly, from 88.9 cents in reserves for every $1.00 in noncurrent loans, to 88.5 cents, a 15-year low for the ratio.

* A majority of institutions (60.0 percent) reported declines in their total risk-based capital ratios during the quarter. More than half (50.9 percent) of the 4,056 institutions that paid dividends in the second quarter of 2007 reported smaller dividend payments in the second quarter of 2008, including 673 institutions that paid no quarterly dividend. Dividend payments in the second quarter totaled $17.7 billion, less than half the $40.9 billion insured institutions paid a year earlier. Even with reduced dividend payments, fewer than half of all institutions (45.5 percent) reported higher levels of retained earnings compared to a year ago.

* Two insured institutions failed during the quarter, bringing the total for the first six months of 2008 to four failures. Three mutually owned savings banks, with combined assets of $1.1 billion, converted to stock ownership in the second quarter. The number of institutions on the FDIC’s “Problem List” increased from 90 to 117 during the quarter. Assets of “problem” institutions increased from $26.3 billion to $78.3 billion.

* The Deposit Insurance Fund (DIF) decreased by 11.7 percent ($7.6 billion) during the second quarter to $45,217 million (unaudited). Accrued assessment income added $640 million to the DIF during the second quarter. The fund received $1.6 billion from unrealized gains on available for sale securities and took in $395 million from interest on securities and other revenue, net of operating expenses. The reduction in DIF came primarily from $10.2 billion in additional provisions for insurance losses. These included provisions for failures that have occurred so far in the third quarter.

The DIF’s reserve ratio equaled 1.01 percent on June 30, 2008, 18 basis points lower than the previous quarter and 20 basis points lower than June 30 of last year. This was the lowest reserve ratio since March 31, 1995, when the reserve ratio for a combined BIF and SAIF stood at 0.98 percent.

New home sales rise 2.4% in July ... thanks to downward revisions

New home sales figures for July have been released by Census. Here's a breakdown of the numbers ...

* Sales rose 2.4% to a seasonally adjusted annual rate of 515,000 in July. That was "better" than the average forecast, which called for a 0.9% decline in sales. But the only reason sales rose on a percentage basis was because last month's reading was revised lower -- to 503,000 units from a previously reported 530,000. May's reading of 533,000 sales was also lowered to 514,000. Don't you just love economics?

* Regionally, sales surged 38.9% in the Northeast and 9.9% in the West. Sales fell 2.5% in the South and 8.2% in the Midwest.

* The supply of homes for sale continues to decline, by 5.2% to 416,000 units in July from 439,000 in June (previously reported as 426,000). Inventories were down from 539,000 a year earlier. On a months supply at current sales pace basis, inventory fell to 10.1 months from 10.7 months in June (previously reported as 10). That was also up from 8.3 months in July 2007.

* Median home prices were essentially unchanged at $230,700 in July vs. $230,100 in June. They were off 6.3% from $246,200 a year earlier.

So what's the story on new home sales in July? They rose more than 2%, but only because June's figure was revised sharply lower. May's reading was cut as well. Stepping back and looking at the bigger trend, we're essentially churning around the 500,000 to 550,000 unit area when it comes to the sales rate and should remain in that ballpark for some time.

Home prices continue to fall from year ago levels, down a bit more than 6% in July. The bright spot in the new home market remains the inventory picture. Builders have done a much better job of bringing down the supply of homes for sale than their counterpart sellers in the existing home market. Supply is down to 416,000 units, compared with a peak of 572,000 in July 2006. That said, we still have almost 100,000 more houses on the market than normal. So we should expect to see construction activity remain weak into 2009, and prices remain under pressure.

June Case-Shiller figures show prices down 15.9% YOY

We just got the latest S&P/Case-Shiller figures (PDF link), this time for June. Here is what the numbers showed:

* Prices fell 0.5% from May in 20 major U.S. metropolitan areas. That was another improvement on the month (May was -0.9%, April was -1.3%, March was -2.2%, and February was -2.6%). However, the year-over-year decline in prices came to 15.9%, worse than the 15.8% drop in May. That's also the largest decline so far for the monthly index, which was first published in 2001.

* The 10-city index has a longer history. It declined 17% YOY in June, compared with 16.9% in May. That's the worst reading since S&P started tracking in the late 1980s.

* We are still seeing prices down on a year-ago basis in every one of the 20 metropolitan areas the group tracks. The biggest declines were found in Las Vegas (-28.6%), Miami (-28.3%), Phoenix (-27.9%) and multiple markets in California (-25.3% in L.A., -24.2% in San Diego, and -23.7% in San Francisco). Charlotte, N.C. (-1%) and Dallas (-3.2%) were the best performing markets on a relative basis.

The story remains the same with the latest Case-Shiller figures: The month-over-month rate at which home prices are falling is moderating. Some markets have even seen a minor spring rebound. But the year-over-year rate of change is still abysmal. Moreover, some of the markets that were strong are joining the "loser's list." Indeed, prices were down from year-ago levels in all 20 major metropolitan areas in the index.

The bottom line: In some markets where distressed sales rule the roost and prices are down sharply, we are seeing transaction volumes climb. But all that distressed sales volume makes life very difficult for average sellers. In other markets that didn't experience huge price booms, the weakening broader economy and tighter credit standards are starting to make life tougher. They're starting to experience a more "traditional" type of housing market downturn -- one brought on by slower growth and rising unemployment, rather than the bursting of a speculative bubble.

Monday, August 25, 2008

Captive auto finance firms facing fattening spreads

Here is yet another interesting story on the spreading impact of wider spreads -- this time focused on the spread between yields on vehicle-loan Asset Backed Securities over Treasuries. From Bloomberg:

"Wider spreads on auto-loan securities may make it harder for the financing arms of Ford Motor Co., General Motors Corp. and Chrysler LLC to compete with banks for new business.

"Yields over benchmark rates on auto-loan debt from the automakers' lending units has soared to record highs, with the spread on AAA rated bonds maturing in three years climbing 35 basis points last week to 240 basis points more than the swap rate, according to Lehman Brothers Holdings Inc. The swap rate, a borrowing benchmark, is set at 3.7 percent. A basis point is 0.01 percentage point.

"Historically, tight spreads in the ABS market have allowed the auto manufacturers to offer attractive financing to both boost auto sales and compete with bank lending at a relatively low cost,"' Lehman analysts Brian Zola and Sandipan Deb in New York wrote in an Aug. 22 report. "That is no longer the case.

"The higher cost to sell debt in the asset-backed market makes it more expensive for lenders to fund new loans, squeezing auto companies already struggling with slower sales as consumers battered by record gasoline prices abandon the fuel-thirsty trucks that provided most of U.S. companies' profit. U.S. auto sales tumbled 13 percent in July, pushing the industry toward its worst year since 1993.

"Captive auto finance companies, needing to make up for the higher spreads the companies have to pay to raise money, may end up issuing loans to riskier borrowers who would pay higher interest rates, the Lehman analysts wrote."

FNM, FRE preferred pain spreads

I mentioned in a recent post that many banks and financial instiutions hold preferred shares issued by Fannie Mae and Freddie Mac. There are a lot of questions about how preferreds would be treated in any bailout. But what is not in question is that the value of the GSEs' preferred shares has fallen sharply. Today, another institution quantified the impact that's having. From an 8-K filing JPMorgan just released:

"JPMorgan Chase & Co. disclosed today that it held approximately $1.2 billion par value of Fannie Mae and Freddie Mac perpetual preferred stock. Such securities are held in the Firm's investment portfolio and are marked to market through the Firm's earnings. The Firm estimates that such preferred stocks have declined in value by approximately an aggregate $600 million in the third quarter to date, based on current market values. The precise amount of losses that may be incurred on these securities for the third quarter is difficult to determine, given the significant volatility being experienced in the market values of these securities."

July existing home sales pop 3.1%, but inventory rises

Data on July existing home sales were recently released by the National Association of Realtors. Here's what the numbers showed ...

* Sales rose 3.1% to a seasonally adjusted annual rate of 5 million in July from 4.85 million in June (previously reported as 4.86 million). That was better than the average forecast of 4.91 million home sales. Sales were down 13.2% from the year-earlier reading of 5.76 million.

* Regionally, sales rose 5.9% in the Northeast from a month earlier. They also climbed 9.7% in the West and 0.9% in the Midwest. Sales were down 0.5% in the South. By property type, single-family sales were up 3.1% and condo sales were up 3.4%.

* The supply of homes for sale rose 3.9% to a record 4.669 million units in July from 4.495 million in June. Inventories were up from 4.561 million a year earlier. On a months supply at current sales pace basis, inventory climbed to 11.2 months from 11.1 months in June. That was also up from 9.5 months in July 2007 and ties April's cycle high.

* Median home prices fell 1.3% to $212,400 in July from $215,100 in June. They dropped 7.1% from $228,600 a year earlier.

There's a bit of good news/bad news in today's existing home sales report. On the one hand, the sales rate climbed 3.1%, a larger gain than was expected. We saw strength in both single-family and condo sales, with a noticeable increase out West. In fact, sales in the West region have risen five months in a row.

So what's the fly in the ointment? Inventories. The supply of homes on the market rose even faster than sales -- up 3.9% on the month to a record 4.67 million units. While investors and traditional buyers are starting to step up and buy in certain locations when lenders get aggressive enough on price, it's not enough. So many new foreclosed properties, short sales, and traditional homes for sale are hitting the market that it's overwhelming the decline in old inventory. As long as the economy and credit markets remain challenged, the housing market should continue to struggle and pricing should remain under pressure.

Sunday, August 24, 2008

Bonfire of the leveraged loans

It's the weekend, so I'm not going to spend too much time delving into the financial headlines. But I couldn't help bringing the following Wall Street Journal story to your attention. It talks about how leveraged loans are the latest financial product to be thrown on the credit market bonfire. Color me completely unsurprised. As long-time readers may recall, I warned that the LBO/PE bubble was getting out of control and would likely burst a long time ago.

Anyway, back to the Journal (I especially like the quote that's bolded below):

"There's nothing like a bad bust to make investors regret a good boom.

"The feeling is particularly acute in the leveraged-loan market, where during the bull years of 2006 and early 2007, investors felt emboldened to take on excessive risk.

"As a result, the rate of defaults -- instances where a company is unable to make its interest payments or meet the obligations in its debt agreements -- is higher in the loan market than it is in the junk-bond market, which has traditionally been perceived as the riskier of the two markets. To make matters worse, investors stand to recover less in leveraged-loan defaults than what was historically normal because of the riskier composition of the market.

"What that tells you about is the tremendous amount of poor quality financing in the easy money period of 2004 to 2007 and now, when the economy slows down, these companies have way too much debt and they're hitting the wall," Margie Patel, portfolio manager at Evergreen Investments, said. "It also tells you why loans have been trading, in general, at a substantial discount to face value."

"The average price in the loan market is around 88 cents on the dollar these days, according to Standard & Poor's Leveraged Commentary & Data unit, down from above 100 cents before the credit crisis."

Saturday, August 23, 2008

And then there were nine ...

We got news of our ninth bank failure of the year late Friday evening. Columbian Bank and Trust Co. of Topeka, Kansas, with $752 million in assets as of June 30, went under. The FDIC arranged a purchase and assumption agreement with Citizens Bank and Trust of Chillicothe, Missouri to take over Columbian's insured deposits. The FDIC estimates there were $46 million in uninsured deposits. The total cost to the FDIC's Deposit Insurance Fund will be an estimated $60 million. More details can be found here.

Friday, August 22, 2008

Auto industry looking for a bailout, too

Some interesting news worth mentioning: It looks like the AUTOMAKERS are now joining the list of companies shopping for bailout money in Washington -- perhaps $25 billion in subsidized, low-interest federal loans. From a Reuters story this afternoon:

"The Big 3 Detroit-based automakers are seeking about $25 billion in federal loans as they struggle to ride out a steep downturn in U.S. auto sales, The Wall Street Journal reported on Friday.

"Lobbyists for the U.S. automakers -- General Motors Corp, Ford Motor Co and Chrysler LLC -- briefed White House officials, as well as U.S. Rep. John Dingell and other Michigan Democrats, on a possible bailout and plan to unveil the proposal after Labor Day, according to the report.

"The plan is for the government to lend some $25 billion to the automakers in the first year at an interest rate of 4.5 percent, or about one-third what the companies are currently paying to borrow, the report said.

"Under the proposal, the government would have the option of deferring any payment at all for up to five years, the article said."

A separate Bloomberg story says GM, Ford, and Chrysler want even more - $50 billion -- with 25 up front and 25 in subsequent years.

This is the problem with bailouts. You do it for someone, you have to do it for everyone.

Think back to when the Fed started its whole TAF and TSLF programs. Originally, they were largely designed to support the residential mortgage market. But then the financial industry whined and complained about how commercial mortgage backed securities markets had tightened up. So CMBS were added to the Fed's mix of eligible TSLF securities. Then, the student loan lenders joined in the chorus, asking the Fed to accept asset-backed securities packed with student loans. The Fed obliged.

Of course, the Fed had to follow up with the PDCF once it became clear that non-bank primary dealers might at some point need to tap into the Fed's largesse. And all of these facilities show no sign of being cut off any time soon, a point made clear today when Bernanke said the following:

"Briefly, these programs are intended to mitigate what have been, at times, very severe strains in short-term funding markets and, by providing an additional source of financing, to allow banks and other financial institutions to deleverage in a more orderly manner. We have recently extended our special programs for primary dealers beyond the end of the year, based on our assessment that financial conditions remain unusual and exigent. We will continue to review all of our liquidity facilities to determine if they are having their intended effects or require modification."

Of course, you don't need me to tell you the mother of all bailouts could also be in the works for Fannie Mae and Freddie Mac. This all begs the question: When is enough, enough?

Fannie, Freddie preferreds an issue for some banks

One of the interesting dynamics in this whole Fannie Mae, Freddie Mac situation is the GSEs' preferred shares. Many institutions hold positions in Fannie and Freddie preferred paper, and there is a general expectation that any government bailout will prove detrimental to those securities. If the Treasury were to inject money into the GSEs, it might do so by purchasing a new class of preferreds that is senior to the existing securities, for instance. That, in turn, would hurt the value of the existing preferred shares, which are on the books of bank all over the country.

Sovereign Bancorp, for instance, bought into Fannie and Freddie paper for about $900 million, according to a recent Bloomberg report quoting CFO Kirk Walters. The value of those stakes had declined to $623 million as of the end of June. A separate Bloomberg story today talks about other institutions that own Fannie and Freddie preferreds. Here's an excerpt:

"Midwest Bank Holdings Inc. Chief Investment Officer Don Wiest is wagering U.S. Treasury Secretary Henry Paulson will rescue him from a failing $67 million stake in Fannie Mae and Freddie Mac.

"Melrose Park, Illinois-based Midwest and banks from Philadelphia-based Sovereign Bancorp to Frontier Financial Corp. in Everett, Washington, own preferred shares in the beleaguered mortgage-finance companies that have lost more than half their $35 billion value since June 30. Concern that Paulson may step in with a rescue plan that would wipe them out along with common stock investors has sent the securities tumbling.

"I guess we are betting on Paulson,'' Wiest, 54, said. ``We have to believe that his plan carries the day somehow.''

"Midwest, an owner of banks in Illinois, has $67.5 million, or as much as 23 percent of its risk-weighted assets tied up in Washington-based Fannie and Freddie of McLean, Virginia.

"Small, regional banks may have the most to lose from the stumbles in Fannie and Freddie, and Paulson may risk bank failures unless he protects preferred stockholders, said Ira Jersey, an interest-rate strategist at Credit Suisse Group AG in New York. The impact on the preferred holders "may be an important driver'' in Paulson's decisions, Jersey said.

"Any wipeout of the preferreds could have implications for the capital of the greater financial system and these regional banks that might have reasonably precarious capital situations,''Jersey said. "You don't want to make that worse if you're the government.''

Speaking of this issue, Moody's just came out with a note this morning slashing its ratings on Fannie and Freddie preferreds by five steps to Baa3 from A1. That is the lowest possible investment grade. Moody's had this to say about its move:

"The downgrade and continued review for further downgrade of the preferred stock ratings reflects a greater risk of dividend omission on the preferred stock. This greater risk stems from two issues. First, both Fannie Mae's and Freddie Mac's mortgage portfolio performance is worse and more volatile than Moody's expected. This could lead to the firms breaching their capital requirements that govern their ability to pay a preferred dividend. Second, there is uncertainty with regard to how these preferred securities would be treated should the US Treasury provide Fannie Mae or Freddie Mac with support. Should a capital injection result in the subordination of the existing preferred stock, or should it result in any missed preferred dividends, then the preferred stock rating would be lowered further."

Bernanke focuses on strengthening the financial system's inner workings in comments today

Fed Chairman Ben Bernanke's comments at the Kansas City Fed's Annual Economic Symposium in Jackson Hole, Wyoming were recently released. The comments recap recent Fed actions, explaining why they have been taken. Not much of that part is forward looking, as near as I can tell. More of the comments are focused on strengthening the financial system's "hardware" and "software." An excerpt:

"An effective means of increasing the resilience of the financial system is to strengthen its infrastructure. For my purposes today, I want to construe "financial infrastructure" very broadly, to include not only the "hardware" components of that infrastructure -- the physical systems on which market participants rely for the quick and accurate execution, clearing, and settlement of transactions -- but also the associated "software," including the statutory, regulatory, and contractual frameworks and the business practices that govern the actions and obligations of market participants on both sides of each transaction. Of course, a robust financial infrastructure has many benefits even in normal times, including lower transactions costs and greater market liquidity. In periods of extreme stress, however, the quality of the financial infrastructure may prove critical."

Regarding some early conclusions of the Fed's research into stablity, Bernanke talks about some of the problems in the derivatives and repo markets:

'More generally, although customized derivatives contracts between sophisticated counterparties will continue to be appropriate in many situations, on the margin it appears that a migration of derivatives trading toward more-standardized instruments and the increased use of well-managed central counterparties, either linked to or independent of exchanges, could have a systemic benefit.

"The Federal Reserve and other authorities also are focusing on enhancing the resilience of the markets for triparty repurchase agreements (repos). In the triparty repo market, primary dealers and other large banks and broker-dealers obtain very large amounts of secured financing from money funds and other short-term, risk-averse investors. We are encouraging firms to improve their management of liquidity risk and to reduce over time their reliance on triparty repos for overnight financing of less-liquid forms of collateral."

Meanwhile, in the markets, we're seeing a reversal of recent trends -- swap spreads are coming in, Treasury prices are down, stocks are up, commodities are down, and the dollar is rallying. That all signals some lessening in risk aversion. All I can say is that if you're not seasick by now, you're not paying attention!

The New York Times tackles CRE

Yesterday, I put up a post focused on the problems starting to emerge in commercial mortgage backed securities (CMBS) and the commercial real estate (CRE) market. The New York Times picked up the mantle this morning. Some more details from their piece:

"At the end of the second quarter, Deutsche Bank held $25.1 billion worth of commercial loans. Morgan Stanley held $22.1 billion and Citigroup had $19.1 billion.

"Lehman Brothers, which has the largest exposure to this type of security, is shopping about $40 billion worth of commercial real estate assets, as well as its entire commercial real estate business. A large part of its portfolio is a high-risk loan known as bridge equity made with Archstone, a metropolitan apartment developer, and most of the rest are floating-rate loans, which are riskier, according to a person who reviewed the offering.

"Banks are scrambling to dispose of these loans, typically made to hotels, office developers and retail strips, before problems arrive.

"Broader real estate indexes are already showing signs of trouble. Moody’s/REAL Commercial Property Price Index has dropped nearly 12 percent since its peak last October. A more conservative index by the National Council of Real Estate Investment Fiduciaries shows growth slowing to one-half of a percent in the second quarter, from upward of 4 percent a quarter.

"Loans made for commercial real estate are typically among the safest, because a building can be used as collateral and big property developers generate income from the investment, raising the likelihood they will repay their loans.

"But cracks began to emerge late last year, when Morgan Stanley reported write-downs of $400 million in commercial mortgage losses. In the first quarter, Wachovia, which had transformed itself into a leading lender in the nation’s commercial real estate market, said it would take write-downs of more than $1 billion for commercial loans for the second half of 2007. Investors had already begun balking at buying securities backed by these bonds, so banks like Wachovia were stuck with loans of diminished value."

Thursday, August 21, 2008

Some interesting news on the CMBS market

For the past several months, this is what you've heard from the financial industry about the scope of the credit crisis:

"It's just subprime mortgages."

Then ...

"No, it's just Alt-A and subprime."

Then ...

"Okay, you're right. Prime doesn't look so hot anymore either. But clearly, it's just residential mortgages.

Then ...

"Those auto loans? Alright. You caught me there too. But that's it. I swear."

But time and again, I have made the point that this credit crunch was never the result of just reckless subprime residential mortgage originations. It's the result of stupid LBO lending ... stupid commercial mortgage lending ... high-risk Alt-A and prime mortgage lending ... risky auto lending ... and so on. While the residential mortgage lenders were the worst offenders, banks and nonbank lenders went overboard extending other forms of credit. Now they're paying the price.

In fact, it's no surprise whatsoever that I'm now reading stories like this one from Bloomberg. It talks about how spreads on commercial mortgage backed securities, or CMBS, are blowing out due to deterioration in the underlying commercial real estate market. An excerpt (with a key quote highlighted by me):

"Yields on commercial real estate securities relative to benchmarks rose to near record highs on concern that Riverton Apartments, a high-rise complex in Manhattan's Harlem neighborhood, will default on a loan.

"AAA rated commercial mortgage-backed bonds widened about 37 basis points to 305.57 basis points more than 10-year swap rates during the week ended yesterday according to data from Bank of America Corp. A basis point is 0.01 percentage point.

"The gap, or spread, jumped after a trustee report showed payments wouldn't be made by Rockpoint Group LLC and Stellar Management in September on a $225 million loan on the 1,230-unit Riverton. The property was refinanced in December 2006 using optimistic assumptions for anticipated income, a practice that became common as prices reached their peak, said Alan Todd, head of commercial-mortgage backed securities research at JPMorgan Chase & Co.

"It is indicative of the type of loans that were allowed to get securitized during this time,'' Todd, who is based in New York, said yesterday in a telephone interview."

Wednesday, August 20, 2008

Follow the bouncing spread ball

The bailout debate for Fannie and Freddie continues to rage. But it's noteworthy that after big widening in the past few days against Treasuries, Fannie and Freddie debt yields are NARROWING against Treasuries today. Ten-year Freddie paper is tightening by almost 12 basis points to 74 basis points, for instance.

Slumping mortgage activity ... questions about credit ... and thoughts on a SWF bailout that went awry

Good Wednesday morning to one and all. A few things I'm perusing at this hour:

* The Mortgage Bankers Association's weekly application index dropped 1.5% to 419.3. That is the lowest level for this gauge of home loan activity since December 2000. Purchases fell 0.4%, while refinancings dropped 3.7%. The MBA chart above really puts into perspective the rise and fall of the great refinance and home purchase bubble.

* U.S. Treasuries are on the move again this morning, with the long bond futures up about 11/32 as I write. Swap spreads are also a bit wider, as are mortgage spreads. We're right around some crucial levels here, closing in on what we saw at the time of the Bear Stearns-related panic. It'll be interesting to see if we can surpass those levels or if this area will hold.

* The Wall Street Journal does a good job of dissecting the capital concerns and market issues at Fannie Mae and Freddie Mac. Here's an excerpt:

"Both Treasury and the companies are in somewhat of a bind. The government is reluctant to intervene and had hoped to reassure markets by asking Congress for temporary authority to take an equity stake in the firms or loan them money.

"Meanwhile, Freddie's ability to raise capital, and therefore avoid a bailout, is constrained by the uncertainty created by the government's deliberations, according to people familiar with the matter. Investors are unlikely to buy new Freddie shares if they fear the government might mount a rescue that would hurt the value of those shares. Freddie executives are due to meet with Treasury officials Wednesday to discuss the situation and the two sides may explore whether the Treasury could clarify its intentions in a way that would reassure investors.

"Mr. Paulson asked for the authority as a means to reassure the markets that the government wouldn't allow the companies to fail. But the companies' share prices have continued to fall as investors fear that the two won't be able to avoid a government bailout. Fannie and Freddie own or guarantee more than $5 trillion of home mortgages or nearly half the total outstanding.

"The companies' increasing financing costs tend to push up mortgage rates paid by consumers. Mortgage applications are at their lowest levels since December 2000. For the week of Aug. 8, applications were down about 37% from a year ago, with purchase applications off 32% and refinance applications down 44%, according to the Mortgage Bankers Association.

"Two weeks ago, Treasury hired investment banking giant Morgan Stanley to help it "analyze and understand these authorities, should circumstances ever warrant their use." Morgan Stanley bankers are working with Treasury staff to come up with a series of options it could use to shore up Fannie and Freddie depending on various market conditions.

"Among the issues being debated is whether to force out management as part of any investment or loan. There is also debate about what to do about the companies in the long term. If Treasury were to take an equity stake at a high price, it would benefit shareholders. Coming in at a low price would essentially wipe out the shareholders, making the government the de facto owner of the firms. It's not clear whether Treasury would treat both companies equally or devise a rescue for one and not the other.

"Some market observers say an investment or a loan from the government will perpetuate a model that no longer works. Fannie and Freddie are government-sponsored enterprises -- meaning they were chartered by Congress -- and yet also public companies. "The better step would have been to have legislation that would have permitted them to be taken over immediately," said Peter Wallison, a former Treasury general counsel and critic of the companies.

"As home prices continue to fall in much of the country, the collateral backing loans guaranteed by Fannie and Freddie is dwindling in value., a provider of real-estate data, released an estimate Tuesday that 14% of U.S. homeowners -- about one in seven -- owe more in mortgage debt than the current market value of their home.

"One option for both companies is to reduce their purchases of home loans and related securities to conserve capital. But that would reduce the flow of money into the market and push interest rates up for consumers, perhaps prolonging and deepening the housing slump."

* Sovereign Wealth Funds have been the suckers ... I mean, the investors ... that have provided huge amounts of capital to leading U.S. financial firms over the past year. Our banks and brokers have been passing the hat around in China, in Singapore, and all over Asia, as well as the Middle East.

The idea the early investors had: "This is a great time to buy blue chip financial firms on the cheap. Our money will help them absorb write downs and charge-offs. And then it will be off to the races again for the stocks." Unfortunately, every "kitchen sink" quarter of losses and every capital raise has been followed by even more kitchen sink quarters and even more capital raisings. So the early investors have lost their shirts.

Now, it appears that they may be getting cold feet. From the New York Post this morning on Lehman Brothers:

"Lehman Brothers' embattled Chief Executive Dick Fuld nearly struck a deal to raise almost $5 billion from South Korean wealth funds and institutions but the pact disintegrated, according to sources familiar with the matter.

"It's unclear why the deal fell apart earlier this month, although one source speculated that Lehman was aiming to raise more capital than the Korean investor was willing shell out at the time.

"The precise terms of the deal could not be learned.

"Fuld and his newly appointed lieutenant, COO and President Bart McDade, have been in numerous discussions with prospective investors about raising additional capital internationally.

Lehman needs the extra cash as protection against expected losses as it looks to unload tens of billions of dollars in commercial mortgage securities and other real-estate assets.

"A JPMorgan Chase analyst wrote on Monday that Lehman may writedown about $4 billion when it reports fiscal third-quarter earnings next month."

The Lehman CEO has been working to forge a deal with Korean entities since earlier in June, when he sought to raise an estimated $6 billion.

"However, those negotiations never culminated in a deal, sources said."

Tuesday, August 19, 2008

Freddie debt sale bombs

Yet another sign of turmoil in the credit markets: Freddie Mac's sale of $3 billion in 5-year notes did not go well. The Government Sponsored Enterprise was forced to pay 113 bps over Treasuries to borrow money, up from 69 bps at its last 5-year note sale in May. Asian investors – big buyers of FRE and FNM paper in recent years – bought less of the auction as well: 31% vs. 41% in May. Bloomberg reports the spread is the highest going back at least a decade.

Wet, wild, and wooly day -- and I'm not even talking about the tropical storm!

Ah, hurricane season in South Florida. Nothing like it. Having the power go out at 3:30 in the morning. The dog barking at the thunder. The rain falling sideways. The tornado watches and warnings. In other words, it's been a wet, wild and wooly day thanks to Tropical Storm Fay. It isn't shaping up to be a very good day for the markets, either. Credit concerns continue to percolate, and the latest news on the inflation and housing fronts didn't help either.

Take the Producer Price Index. The PPI surged 1.2% in July, twice as much as economists polled by Bloomberg were expecting. The "core" rate, which excludes food and energy, shot up 0.7%. The headline PPI climbed 9.8% from a year earlier, the largest rise in 27 years. The core PPI is up 3.5% YOY, a rate of increase we haven't seen since 1991.

As for housing starts, they dropped 11% on the month to an annual rate of 965,000. That's the lowest since March 1991, but slightly higher than the consensus forecast for a reading of 960,000. Single family only starts fell 2.9%. Building permits dropped more than expected -- down 17.7% to an annual rate of 937,000. Economists were expecting a number of around 959,000. Single-family only permit issuance was down 5.2%.

Monday, August 18, 2008

NAHB index holds at record low in August

The National Association of Home Builders just released its housing market index for August. Bottom line: The summer doldrums continue. Here are the details ...

* The group's overall index held at 16 for a second month. This is a record low for the index, which dates back to 1985.

* The sub-index measuring present home sales ticked up to 16 from 15. The sub-index measuring expectations about future sales rose to 25 from 23. Meanwhile, the sub-index measuring prospective buyer traffic was unchanged at 12.

* Regionally, the index rose to 16 from 14 in the Northeast and climbed to 14 from 10 in the Midwest. It held steady at 20 in the South and fell to 11 from 14 in the West.

Congress has passed a major housing stimulus bill. The Treasury Department has made its implicit support of Fannie Mae and Freddie Mac explicit. And the sudden, sharp decline in things like gasoline prices has given consumers a welcome break. That may be helping confidence stabilize a bit in the housing sector.

But credit market headwinds remain significant. More lenders than ever before are tightening standards on home mortgages. The spread between mortgage rates and Treasury yields is ballooning, keeping loan costs elevated. Plus, the broad economy remains mired in weakness, with seven straight months of job losses. All of this suggests that any recovery in the housing market and construction activity should be less vigorous and more drawn out than in the past.

Fannie and Freddie at the center of a credit storm ... again

Another day, another credit crisis. That's how things seem to be going lately. Today, it is Freddie Mac and Fannie Mae at the center of the maelstrom (though I'm kind of in the center of my own storm, given that T.S. Fay is barreling toward me here in South FL!). What is going on with Fannie and Freddie?

Well, Barron's published a nasty story on the GSEs this weekend. Entitled "The Endgame Nears for Fannie and Freddie," it started out as follows:

"IT MAY BE CURTAINS SOON FOR THE MANAGEMENTS and shareholders of beleaguered housing giants Fannie Mae and Freddie Mac. It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer's dime, availing itself of powers granted it under the new housing bill signed into law last month. Such a move almost certainly would wipe out existing holders of the agencies' common stock, with preferred shareholders and even holders of the two entities' $19 billion of subordinated debt also suffering losses. Barron's first raised the possibility of a government takeover of Fannie and Freddie in a March 10 cover story, "Is Fannie Mae Toast?"

"Heaven knows, the two government-sponsored enterprises, or GSEs, both need resuscitation. Soaring mortgage delinquencies and foreclosures have led the companies to gush red ink for the past four quarters, and their managements concede the outlook is even grimmer well into next year. Shares of Fannie Mae (ticker: FNM) and Freddie Mac (FRE) have lost around 90% of their value in the past year, with Fannie now trading at $7.91, and Freddie at $5.88.

"Similarly, the balance sheets of both companies have been destroyed. On a fair-value basis, in which the value of assets and liabilities is marked to immediate-liquidation value, Freddie would have had a negative net worth of $5.6 billion as of June 30, while Fannie's equity eroded to $12.5 billion from a fair value of $36 billion at the end of last year. That $12.5 billion isn't much of a cushion for a $2.8 trillion book of owned or guaranteed mortgage assets.

"What's more, the fair-value figures reported by the companies may overstate the value of their assets significantly."

That is rekindling fears in the bond market. The pricing on Credit Default Swap contracts tied to the $19.2 billion in subordinated debt that Fannie and Freddie have outstanding is going up, indicating greater concern about how that debt will perform.

Moreover, Freddie Mac's latest sale of short-term bills didn't go so well. The bid-to-cover ratio came in at just 2.19 on the 3-month bill portion of the auction, compared to 2.73 a week earlier. The bid-to-cover ratio on the 6-month sale fell to 2.42 from 2.92.

Fannie Mae 10-year debt is now yielding about 86.5 basis points more than comparable Treasuries. That's up 5.5 basis points on the day ... well above the low of 48.8 bps back in early May ... and closing in on the peak of 104 bps during the Bear Stearns panic this March.

And those swap spreads I mentioned late last week? They're wider again too.

Friday, August 15, 2008

Tension palpable in the credit markets

Sorry for the lack of posts over the last day and a half. Took a vacation day yesterday and been busy with other things today. I did want to pop in for a minute though and note that the tension in the credit markets is palpable these days. One indicator of something lurking beneath the surface? Swap spreads. They are widening noticeably today and getting close to their March highs. You'll find a chart of the 2-year swap spread from Bloomberg above.

What the heck is a swap spread? Why does it matter? I could try to write up a completely new explanation. But how about I just refer you to a 2002 Federal Reserve paper on swaps and swap spreads (PDF link) instead? It's entitled "Counterparty Credit Risk in Interest Rate Swaps during Times of Market Stress" and was authored by Antulio N. Bomfim. Suffice it to say that widening swap spreads are yet another indicator that credit stress and fear is running high in today's market.

Wednesday, August 13, 2008

Regulators getting more active in the banking sector

One thing worth noting amid all the chaos in the banking sector: Regulators are getting much more hands-on in terms of restricting certain banking activities. United Community Financial Corp. is just the latest firm to announce a crackdown. From Bloomberg:

"United Community Financial Corp., the Youngstown, Ohio-based savings and loan, said U.S. regulators ordered it to restrict lending and raise capital.

"A cease-and-desist order was issued by the Federal Deposit Insurance Corp., the Ohio Department of Financial Institutions and the U.S. Office of Thrift Supervision, the lender said in a statement today. United Community must create a plan to reduce debt, improve risk management and find more capital.

"There will be a short-term negative impact on earnings due to higher compliance costs associated with the order,'' United Community said in the statement. The company said it was profitable in the first two quarters of 2008.

"United Community, which runs more than 60 branches of Home Savings and Loan and Butler Wick in Ohio, Pennsylvania and western New York, has declined 12 percent in the past year in Nasdaq Stock Market trading."

UCFC is the holding company for Home Savings and Loan Company and Butler Wick. The company operates in Ohio, New York, and Pennsylvania. Total assets were $2.7 billion at June 30.

Vineyard National Bancorp, with $2.4 billion in assets, is another example of this trend toward tighter oversight. So is Downey Financial, a $12.6 billion institution that was a major option ARM lender during the housing bubble. From the firm's latest 10-Q:

"After the end of the second quarter, the Bank experienced elevated levels of deposit withdrawals. More recently, in response to steps taken by management to address the situation, the Bank has experienced net deposit inflows. If the Bank’s deposit levels continue to stabilize with withdrawals at historical levels, Downey believes its current sources of funds would enable Downey to meet its obligations while maintaining liquidity at appropriate levels. However, if elevated levels of net deposit outflows resume, the Bank’s usual sources of liquidity could become depleted, and the Bank would be required to raise additional capital or enter into new financing arrangements to satisfy its liquidity needs. In the current economic environment, there are no assurances that we would be able to raise additional capital or enter into additional financing arrangements.

"The OTS restrictions on the Bank’s and the Holding Company’s ability to pay dividends, and on the Holding Company’s ability to issue new debt or renew its existing debt, may adversely affect our ability to pay dividends and ultimately to service our Holding Company debt.

"Our ability to pay regular quarterly dividends to our stockholders and to pay interest on our debt at the Holding Company level depends to a large extent upon the dividends we receive from the Bank. The OTS, the Bank’s principal regulator, has prohibited the Bank from paying dividends to the Holding Company without the OTS’s prior approval. In addition, the OTS has prohibited the Holding Company from paying dividends (after the quarterly dividend payable in August 2008) without the OTS’s prior non-objection."

Retail sales in-line; Import prices hot

Lots going on this morning, so I'm going to be brief. Retail sales in July came in roughly in line with expectations. Sales were down 0.1%, right in line with forecasts. Motor vehicles and parts were the biggest drag on retail sales, down 2.4% on the month. That left them down 8% from the same month a year earlier. Retail sales less autos were slightly weaker -- up 0.4% vs. forecasts for a 0.5% gain.

Import prices, for their part, rose 1.7% in July. That was hotter than the 1% gain that was forecast. Import prices are up a whopping 21.6% year-over-year, compared with a rise of 21.1% in June. It's not just energy, either. Ex-petroleum import prices were up 0.9%, and ex-all-fuels prices were up 0.7%. The cost of imports from China -- which I've talked about before -- continues to go up. Chinese imports rose 0.9% on the month, vs. 0.6% in June.

Bonds had a knee-jerk sell off after the numbers came out, but it didn't last. Long bond futures are now up 13/32 to their morning highs. The dollar index has given back early gains, while stock futures have weakened further.

Tuesday, August 12, 2008

Dallas Fed's Fisher says current crunch worse than S&L crisis

There's an interesting report out this afternoon from the Dallas Morning News. The paper interviewed Richard Fisher, president of the Dallas Fed. In the article, Fisher characterized the current credit collapse as worse than the Savings & Loan Crisis. That's a bold statement (so I put it in bold -- clever, huh?). More from the story below:

"The U.S. economy faces “a sustained period of anemia,” said Richard W. Fisher, president and chief executive of the Federal Reserve Bank of Dallas, in comments Tuesday to The Dallas Morning News.

“I expect that in the second half of this year we will broach zero growth,” he said. “The word recession means nothing to me. The important thing is we’re not doing as well as we could.”

"Despite the sluggish outlook for the U.S. economy as a whole, Texas remains a bastion of relative economic strength, Mr. Fisher said. The state’s economy has slowed somewhat compared to last year, but it continues to add jobs while the national economy is losing them.

“The benefit of being in Texas is we will have positive employment growth, somewhere in between 1.5 percent and 2 percent,” he said. “We’re the one shining star in the United States.”

"Nationally, however, one source of continued economic weakness is the credit crunch that began last year, as lenders have become much more cautious after a credit binge earlier this decade.

“This is bigger than the S&L [crisis]. It’s broader. It’s deeper,” Mr. Fisher said. “We go through these periods of correction. It’s not unhealthy. It’s the way capitalism works.”

What's $1.5 billion among friends?

I don't know about you, but I've become so inured to gazillion-dollar write-downs and credit losses, that I hesitate to even lift an eyebrow at $1.5 billion. But that's the amount of additional write downs on mortgage-backed assets that JPMorgan Chase said it's facing. The problem? Since the June quarter closed, market conditions "have substantially deteriorated" according to a JPMorgan regulatory filing. A few other details from a Reuters report on the filing:

"In the August 11 filing, JPMorgan said that it expects continued deterioration in credit trends for its consumer portfolios, and that this will likely require additions to the consumer loan loss allowance during the rest of 2008.

"Quarterly net charge-offs in the home equity portfolio could continue to increase for the rest of 2008, the company said.

"Prime and subprime mortgage net charge-offs were likely to continue to rise "significantly" in the second half of 2008, with deterioration expected to continue into 2009, JPMorgan said."

Monday, August 11, 2008

Federal Reserve survey shows lending standards tightening across the board

The Federal Reserve just released its latest figures on credit standards and credit demand. The "Senior Loan Officer Opinion Survey on Bank Lending Practices," in the words of the Fed, is designed to shed some light on "changes in the standards and terms of the banks' lending and the state of business and household demand for loans."

The Q3 2008 survey (PDF link) was conducted in July; 52 domestic banks and 21 foreign banks with operations here in the U.S. responded. The results are reported in terms of "net tightening/loosening." Specifically, the Fed adds up the percentage of banks that either "tightened considerably" or "tightened somewhat" in a given loan category and nets that out against the percentage of banks that "eased somewhat" or "eased considerably."On this page, which has historical data, a positive percentage figure means more banks tightened than loosened; a negative percentage figure means more banks loosened than tightened. So what did the latest survey show?

* Residential mortgage credit was tougher to get all around. The Fed began breaking out tigthening/loosening figures for three sub-categories of mortgage -- prime, nontraditional, and subprime -- in Q2 2007. Some 74% of those surveyed this time around said they are tightening standards on prime mortgages, up from 62.3% in Q2 2008. A net 84.4% of those surveyed said they were cracking down on nontraditional financing, up from 75.6%, and a net 85.7% said they were tightening on subprime loans, up from 77.7% a quarter earlier.

The subprime and prime figures are records. The nontraditional number is just shy of the high (84.6% in Q1 2008). The previous record for the all-mortgage category was 32.7% in Q1 1991.

* The tightening trend is spilling over into commercial real estate. A net 80.7% of respondents said they were tightening standards on CRE loans. That was up from 78.6% a quarter earlier and the highest on record (Fed data goes back to 1990).

* Consumer credit figures tell a similar story. Some 66.6% of lenders said they were tightening standards on credit card borrowers, up from 32.4% a quarter earlier and the highest on record (The data in this category goes back to 1996). Fed figures show that 67.4% are also tightening standards on other consumer loans, up from 44.4% (another record).

* C&I customers can't catch a break either. Lastly, banks are tightening standards and raising the cost of the loans they do make for commercial and industrial customers. A net 57.6% of banks are tightening standards for large and medium sized borrowers, up from 55.4% a quarter earlier and the highest since Q1 2001. 80.8% said they were raising the spread over their cost of funds that they charge large and medium sized borrowers for access to money. That was up from 71% a quarter earlier and the most ever.

These days, you practically need the Jaws of Life to pry open a banker's wallet. That's the message from the latest Fed survey on bank lending standards. It showed that record-high percentages of lenders are tightening standards on residential mortgages, commercial mortgages, credit cards, and consumer loans. Businesses are also finding it tougher and costlier to borrow.

It's easy to see why banks are so stingy. They went overboard during the housing bubble, leaving them vulnerable to large losses on previously issued home mortgages. Unfolding downturns in other sectors, like autos and commercial real estate, are starting to drive up delinquencies in other parts of their loan portfolios, too. Overall, the longer the crunch lingers, the longer the economic slump could drag on.

Credit unions take their mortgage lumps; Another mortgage insurer reports big losses

This mortgage crisis is an equal opportunity one. It doesn't matter if you're a non-bank lender, an S&L, or a commercial bank ... chances are, you're taking hits due to the unravelling of the housing and mortgage markets. Heck, the Wall Street Journal is reporting that even credit unions are joining in the "fun." From a story this morning ...

"Five of the nation's largest credit unions are reporting big paper losses on mortgage-related securities, a sign that housing-market distress is spreading even to the most risk-averse financial sectors.

"The federal regulator overseeing credit unions says the losses are likely to be reversed when mortgage markets stabilize, and that the institutions are sound and adequately capitalized. But some outside observers are concerned that the credit unions are underestimating the depth of their mortgage-market problems.

"This is a serious situation," says Gerald Hanweck, a finance professor at George Mason University, who studies the banking industry and is a visiting scholar at the Federal Deposit Insurance Corp. Mr. Hanweck believes the five firms have sufficient access to funding to handle a deeper downturn, but he worries that perceptions of added risk could lead to a run on one or more of them.

"Credit unions are not-for-profit, member-owned cooperatives that take deposits and lend money like banks. The mortgage problems are focused on so-called corporate credit unions, which are key players in the industry. They don't deal directly with consumers, but provide investment services and financing to regular credit unions, which do.

"The five corporates showing big mortgage-related losses, according to federal regulatory filings, are U.S. Central Federal Credit Union; Western Corporate Federal Credit Union; Members United Corporate Federal Credit Union; Southwest Corporate Federal Credit Union; and Constitution Corporate Federal Credit Union. Together, they reported about $5.7 billion in "unrealized" losses as of the end of May, the filings indicate. Unrealized losses happen when the market value of a security falls, even if it hasn't been sold."

Meanwhile, another mortgage insurer -- Radian Group -- reported a large quarterly loss. All of these guys, who help cover the losses that lenders suffer when high LTV borrowers default, have seen claims surge. Both the frequency of defaults and the severity of associated losses have been climbing. Here's more from Bloomberg:

"Radian Group Inc., the third-largest U.S. mortgage insurer, lost $392.5 million as it increased its expectations for future claims. The company said it will fold its bond insurance unit into its mortgage guarantor to increase capital in its primary business.

"The second-quarter net loss was $4.91 a share, compared with profit of $21.1 million, or 26 cents, a year earlier, the Philadelphia-based insurer said today in a statement.

"Mortgage insurers help lenders make up for losses when borrowers default. The companies have borne record claims and ratings cuts as home prices fall at a 16 percent annual rate. One in every 171 households faced some kind of foreclosure action in the second quarter, more than double the rate a year earlier, according to RealtyTrac Inc., a seller of default data.

"Adding the bond unit's assets to the mortgage business "benefits our shareholders and allows Radian to continue to take advantage of market opportunities,'' Chief Executive Officer S.A. Ibrahim said in the statement.

"Radian declined 8 cents to $2.66 at 9:43 a.m. in New York Stock Exchange composite trading. A year ago, the stock sold for $19.60 a share.

"The company boosted its claims predictions and set aside an additional $421.8 million to pay for them. Including this "premium deficiency reserve,'' and $458.9 million added to regular reserves in the quarter, Radian has allocated $1.43 billion this year for policy losses. That's a fourfold increase over the same period last year."

Friday, August 08, 2008

BankUnited takes a beating

In some late-breaking news this Friday afternoon, BankUnited Financial announced that it's taking a bath on bad mortgages. The Coral Gables, Fla.-based institution, with $14.2 billion in assets as of June 30, was a major option ARM lender. Its exposure to the weak Florida real estate market is coming back to bite it. Some details from the company's report ...

-- BankUnited Financial Corporation, parent company of BankUnited FSB, today reported a loss of $117.7 million, or a loss of $3.35 per diluted share for the quarter ended June 30, 2008, compared to earnings of $23.2 million, or $0.62 per diluted share, for the quarter ended June 30, 2007. The loss was primarily attributable to a $130 million provision for loan losses.

-- BankUnited Financial Corporation contributed $80 million in capital to BankUnited FSB. At June 30, 2008, BankUnited’s Tier 1 leverage capital ratio was 7.6% and total-risk based capital ratio was 13.8%. Furthermore, we have made considerable progress in our pursuit to raise additional capital.

-- The ratio of non-performing assets as a percentage of total assets increased to 7.73% at June 30, 2008, from 4.75% at March 31, 2008, and 0.86% at June 30, 2007.

-- For the quarter ended June 30, 2008, the provision for loan losses totaled $130 million, compared to $98 million for the quarter ended March 31, 2008, and $4.4 million for the quarter ended June 30, 2007.

-- Net charge-offs for the quarter ended June 30, 2008, were $22.7 million, or an annualized rate of 0.73% of average total loans. This compares to $13.3 million, or an annualized rate of 0.42% of average total loans, for the quarter ended March 31, 2008, and $1.1 million, or an annualized rate of 0.04% of average total loans, for the quarter ended June 30, 2007.

-- Of the $7.1 billion in option-ARM balances, $6.5 billion had negative amortization of $376 million, or 5.3% of the option-ARM portfolio.

-- Chairman and chief executive officer Alfred R. Camner, members of his family and other members of the board of directors have agreed to waive their receipt of preferred stock dividends. It is expected that these dividends will be waived until the bank returns to profitability.

Thoughts on the dollar and commodities

I'd be remiss if I didn't point out the REAL action in the markets right now (and frankly, for the past few weeks) is in currencies and commodities. The "sell dollars/buy gold/buy oil" trade has dramatically morphed into a "buy dollars/sell gold/sell oil" trade. In fact, the Dollar Index has risen the past six days in a row, with a massive (for the currency markets, anyway) 1.5% rise today. The euro dropped more than three full cents at one point, or 2.08%. That was the biggest one-day percentage move since September 6, 2000, according to Bloomberg. Oil futures prices are down to around $116 from a high of $147 and change, a decline of almost 21%.

Now, here's the $100,000 question -- is this "good" or "bad" news? On one hand, the falling dollar and falling commodities prices should bring down inflation (especially headline CPI) and give U.S. consumers a break at the gas pump. That's "good." It could also help stem the bleeding in industries that are on the ropes, like airlines and autos. Another "good" thing.

But plunging commodities prices could also put a real kibosh on some of the emerging market economies that have been diving growth the past few years. If, let's say for the sake of argument, Middle East oil wealth dries up, we're going to see fewer new islands showing up in the waters off Dubai -- and fewer record-setting skyscrapers going up on land, aren't we? Result: Multinational firms will get fewer orders for things like tractors and mega-cranes. That's "bad," isn't it?

Speaking of multinationals, many of them have been reporting strong profits because the euros, pounds, and other currencies they earn overseas translate into more dollars at earnings time. So they could actually get hit by a rising dollar. That's "bad" too, right?

Here's something else to chew on: One reason commodities prices are starting to plunge is that demand is tanking, right? Isn't that an indicator that we're headed toward a possible global recession, with the U.S. leading the way and economies in the Eurozone, the U.K., and elsewhere following suit? So how does that factor in? Could that mean that falling oil prices are, on net, a "bearish" signal on the global economy?

Those are the questions I'm pondering. How about you?

Fannie Mae joins Freddie Mac in reporting ugly numbers

Quarterly results from the two GSEs have been pretty awful. On Wednesday, Freddie Mac reported an $821-million quarterly loss, more than three times what Wall Street analysts were looking for. It's now sitting on 22,000 foreclosed homes, the highest in the company's 38-year history. And it was forced to set aside $2.5 billion in the second quarter to cover loan losses, more than double what it reserved just three months prior.

Those losses are helping shrink Freddie's capital cushion. It fell to $37.1 billion in the quarter, only $2.7 billion above what its regulator requires. The company is responding in a couple of ways to preserve capital:

First, it's cutting its stock dividend. Shareholders will now get just $0.05 per share, down from $0.25 per share previously.

Second, it's looking to sell new common or preferred shares — more than $5 billion worth (analysts are openly questioning whether Freddie can do so in this market environment, however).

Third, — and this is most important — Freddie will likely SLOW the growth of its portfolio of mortgages and mortgage securities. Specifically, take note of this excerpt from a Dow Jones story:

"Freddie, along with Fannie, is a dominant provider of funding to the U.S. housing market. Together they own or guarantee about $5 trillion of mortgages or nearly half of all U.S. home-mortgage debt outstanding.

"One of the two ways Freddie and Fannie make money is by holding on to a heap of mortgages and securities made up of bundles of home loans that they buy from lenders.

"In addition, they earn money from guaranty fees charged to insure mortgage payments. Bundles of these guaranteed loans are then packaged into securities to be sold to investors in the asset-backed market.

"The mortgage-related investments that Freddie stores on its books fall in its so-called retained portfolio. And the company earns income from the interest and principal payments from the underlying loans held.

"But Buddy Piszel, Freddie’s chief financial officer, said Wednesday that the company intends to slow the growth in its $791.8 billion retained portfolio of mortgage-related securities, in an effort to shore up capital."


"More than half of this portfolio - or $413.9 billion - is made up of securities of mortgage loans guaranteed by Freddie. By buying securities whose loans it guarantees, the company provides support in the marketplace for these investments, encouraging others to buy them. In addition, this also kept borrowing costs for homeowners low as there was steady buying support for mortgages.

"Piszel said the company will pause growing its portfolio but will continue to buy mortgage securities from capital freed up from the possible sale of securities from within this portfolio and the repayment of principal on the underlying home loans."

What does this reduced activity mean for consumers? It will likely drive mortgage rates up, or at least keep them higher than they would otherwise be, by causing the spread between Treasury yields and yields on MBS to widen out. In fact, that's already happening. The difference between yields on Freddie Mac's actively traded, 30-year mortgage-backed securities and yields on 10-year Treasury Notes has ballooned to about 218 basis points. That's far above the 136-point average of this decade and just shy of the record high of 242 set during the credit market panic in March.

Result: Rates on 30-year fixed-rate mortgages are now averaging 6.52%, according to Freddie Mac. That's up notably from the recent low of 5.48% in late January and closing in on a six-year high.

Fannie Mae's results probably won't help spreads -- or market confidence -- either. Per Bloomberg:

"Fannie Mae, the largest U.S. mortgage- finance company, sliced its dividend after posting its fourth straight quarterly loss and cut its dividend as record delinquencies pushed up credit costs.

"The second-quarter net loss was $2.3 billion, or $2.54 a share. Before a one-time gain, the loss was $2.51 a share, compared with the 72-cent average estimate of 10 analysts in a Bloomberg survey. The common-stock dividend will be cut to 5 cents from 25 cents a share, Washington-based Fannie said today in a regulatory filing."

Thursday, August 07, 2008

Blockbuster long bond auction

Wow, did buyers ever step up to the plate at today's auction of 30-year Treasury Bonds! The government sold $10 billion of long bonds at a yield of 4.609%. That was far below pre-auction talk of 4.662%. Indirect bidders (a category that includes foreign central banks) swallowed 42.9% of the paper, the most going back to February 2006.

The only weak spot was the bid-to-cover ratio, which came in at 2.4 (down from 2.69 in the last auction). That means $2.40 worth of bids were submitted for every $1 of debt being sold. But all in all, it was a strong auction. Long bond futures are surging on these results -- up 1 13/32 at last count. Yields on the benchmark 10-year Treasury Note were recently down 12 basis points to 3.94%.

What accounts for the strong demand? Perhaps the fall in commodity prices, which may be easing some of the market's inflation concerns. Also, big institutional and official accounts may be stepping back a bit from things like agency bonds and moving into Treasuries instead.

Jobless claims surge; Filings at highest since March 2002

In the other major piece of economic data out today, initial jobless claims filings surged to 455,000 in the week ended August 2 from 448,000 in the prior week. That was well above the 425,000 forecast of economists polled by Bloomberg ... the highest in any week since March 2002 ... and one of the highest readings going back a couple of decades (as you can see in the chart above).

This is yet another indicator that the economy is either already in recession or on the verge of one, in my view. The weakening labor market is also a potential threat to the housing and credit markets. After all, when you lose your job, you have less money available to service debt and you become less willing to commit to the purchase of big-ticket items, including homes and cars.

June pending home sales jump 5.3%

Now THAT was a surprise -- June pending home sales figures jumped, according to the National Association of Realtors. Specifically ...

* Pendings climbed 5.3% in June. That was well ahead of forecasts for a 1% drop. May's reading was revised to -4.9% from -4.7%.

* Regionally, June was the polar opposite of May. Pending sales dropped in all four regions in May; They rose in all four regions in June. June pendings were up 1.3% in the Midwest, 3.4% in the Northeast, 4.6% in the West, and 9.3% in the South.

* The index level was 89 in June, down 12.2% from the year-earlier reading of 101.4 but up from the cycle low of 83, set in March.

Pending sales put in a strong showing in June, with gains in all four regions of the country. That's encouraging on its face. But there are some caveats to consider here.

For one thing, distressed inventory is accounting for a larger percentage of sales in many markets. Lenders are getting more aggressive when it comes to unloading foreclosed property, and that's attracting some bargain hunters. That's good if you want to start reducing the amount of inventory on the market. But it's bad news if you're a regular home seller because you're competing against institutions that are willing to undercut you -- in some cases, by a large margin.

For another, this data covers PENDING rather than CLOSED sales. Tighter mortgage standards and rising home loan rates will likely prevent more of today's hopeful buyers from actually closing deals.

To whit: 30-year fixed mortgage rates -- at 6.52% -- are close to a six-year high. And the Federal Reserve's survey on bank lending standards from earlier this year showed tightening across the board. Some 77.7% of banks are tightening standards on subprime mortgage loans ... 75.6% are making it tougher to get mid-grade Alt-A and “nontraditional” mortgages ... and 62.3% are tightening standards on prime loans, the most since the Fed started its quarterly survey 18 years ago.

Wednesday, August 06, 2008

Fed does nothing ... Market throws a party anyway ... Losses mount at Freddie Mac ... Morgan freezes HELOCs

I had some things to take care of yesterday afternoon, so I missed the hoopla coming immediately after the Fed meeting. The Fed did nothing with rates and said only the following. But apparently that was enough for the stock market to have a raucous good time, adding more than 331 points on the Dow. Go figure ...

"Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

"Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

"Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability."

In other news, the losses are really mounting at GSE Freddie Mac. The company lost more than three times what analysts were expecting, while credit losses increased significantly. Here's a bit more from Bloomberg:

"Freddie Mac, the U.S. mortgage-finance company hobbled by record foreclosures, will slash its dividend at least 80 percent after posting a quarterly loss that was three times wider than analysts' estimates.

"The second-quarter net loss of $821 million, or $1.63 a share, compares with the 54-cent a share average estimate of nine analysts in a Bloomberg survey. The common-share dividend will be reduced to 5 cents or less from 25 cents, McLean, Virginia-based Freddie said today in a statement.

"Freddie had credit-related expenses of $2.8 billion, double the first quarter, and wrote down the value of subprime and low- quality mortgage securities by $1 billion as the biggest housing slump since the Great Depression increased delinquencies. Freddie Chief Executive Officer Richard Syron said he still plans to raise capital after U.S. Treasury Secretary Henry Paulson was forced to step in with a rescue plan to restore confidence in Freddie and the larger Fannie Mae.

"This correction is more severe than what we've seen in the recent past,'' said Christopher Whalen, co-founder of independent research firm Institutional Risk Analytics in Torrance, California. "Both Fannie and Freddie are going to be profoundly insolvent by the time we're done with this.''

"Freddie has plunged 76 percent this year on the New York Stock Exchange on concern the company may not have enough capital to overcome loan delinquencies on the $2.2 trillion of mortgages it owns and guarantees. Syron, 64, agreed to raise $5.5 billion in equity though failed to complete the sale as the stock slumped."

One other thing that caught my eye: Mother Morgan (Stanley, that is) is cutting access to HELOCs for thousands of borrowers whose properties have declined in value. Morgan is just the latest in a long list of lenders that have cut the size of borrower lines, frozen borrower drawing privileges, and otherwise made it tougher for people to use their homes like ATMs. Many banks are also exiting the wholesale lending business entirely to focus on in-house, retail loan originations instead.

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