Safehaven | Beware of Bank Earnings Propaganda - They are Still in BIG Trouble!

July 07, 2009

Beware of Bank Earnings Propaganda - They are Still in BIG Trouble!
by Reggie Middleton

If one were to parse the bullshit that the government has allowed the banks to proffer in the name of earngings, one would find the banks will probably be flailing this quarter from bad loans and mortgages. Beware of the FASB authorized accounting games and peer beneath the hood. I have included a portion of the professional level Wells Fargo analysis (click this link to subscribe) to help drive my point home, but before you peruse it as a non-subscriber, be sure to remember how this research subject twisted and manipulted their numbers to produce a bank profit out of a bank loss - Tricky Dick Bank Reporting Schemes - What record earnings are you referring to? then take a look at the hard data released by the FDIC and the NY Fed: Revised SCAP Assumptions Public Open Source Version 1.1 2009-05-18 15:15:47 1.21 Mb) as well as an explanation as to how I tabuluated it.

Wells Fargo

Wells Fargo acquired home equity loans from Wachovia, which carries the highest default risk as its portfolio largely comprises second lien mortgages. The value of the home equity portfolio is US$128.9 billion.

Home equity portfolio	US$ mn
Core portfolio
California	31,784
Florida	12,067
New Jersey	8,086
Virginia	5,653
Pennsylvania	5,129
Other	56,342
Total core portfolio	119,061
Liquidating Portfolio
California	3,835
Florida	492
Arizona	233
Texas	179
Minnesota	122
Other	5,001
Total liquidating portfolio	9,862
Total core and liquidating portfolios	128,923

The value of Wells Fargo's pick-a-pay portfolio (home loans) is US$93.2 billion of which US$39.7 billion or 42.6% is impaired loans. The principal balance of the impaired loans is US$61.6 billion. This loan has the highest probability of risk and could result in complete writedown. Currently, the LTV in majority of the states is above 100%, with California and Arizona having the highest - 161% and 152%, respectively. Despite writing down US$21.9 billion, the carrying value at these two states hovered around 100%, implying high risk.

Pick-a-pay-portfolio		Impaired loans
	Unpaid principal balance	Current LTV %	Carrying value	Carrying value to current value
California	42,216	152.0%	26,907	98.0%
Florida	6,260	129.0%	3,779	79.0%
New Jersey	1,750	101.0%	1,271	74.0%
Texas	475	76.0%	336	54.0%
Arizona	1,642	161.0%	987	99.0%
Other states	9,306	110.0%	6,397	77.0%
Total	61,649		39,677

Methodology to compute loan loss rate: Real estate 1−4 family junior lien mortgage

Real estate 1−4 family junior lien mortgage comprises home equity line of credit (HELOC) and second/junior lien mortgage. Home equity carries a very high risk of default due to high LTV and being second lien mortgage. We segregated the loans into owner occupied and non-owner occupied based on the state-wise proportion published by FDIC. Thereafter, applying the respective default rate of each category we arrived at the weighted average default rate.

To determine net charge-offs, we have considered the recovery rate based on historical recovery rates applied in conjunction with the current LTV. The table below gives the recovery rates used to determine net charge-offs.

	Current LTV	Recovery rate	Basis
Greater than	120%	12.0%	(recovery rates during 1990-1991, lowest since 1976)
Greater than	110%	16.7%
Greater than	100%	21.4%	(average recovery rate since 1976)
Greater than	90%	28.2%
Less than	<90%	35.0%	(highest recovery rate since 1976)

Source: FDIC and Boombustblog.com Analysis

We estimated the current LTV for home equity loans based on the housing price decline calculated using the Case-Shiller Index of each state and LTV at origination to determine the current LTV. Impaired loans have a two-year loss rate of 67.5%, while other loans have a loss rate of 56.4%. We have assumed impaired loans to have a 0% recovery rate in each of the states. The non-impaired home equity loans would have a loss rate of 56.4% for 2009 and 2010, while the Federal Reserve's estimated loss rate is 21-28% for the same period.

Real estate 1−4 family junior lien mortgage		High Risk Subprime ARM Loans (Low FICO and high LTV)
	Current LTV	Owner Occupied	Non-Owner Occupied	Default rate	Recovery Rate	Loss Rate
Impaired Loans		65.0%	95.0%
California	128%	93.7%	6.3%	66.9%	0%	66.9%
Florida	124%	88.7%	11.3%	68.4%	0%	68.4%
New Jersey	108%	91.5%	8.5%	67.6%	0%	67.6%
Arizona	146%	91.9%	8.1%	67.4%	0%	67.4%
Other	112%	91.0%	9.0%	67.7%	0%	67.7%
Total Impaired Loans						67.5%
All other loans:
California	128%	93.7%	6.3%	66.9%	12%	58.9%
Florida	124%	88.7%	11.3%	68.4%	12%	60.2%
New Jersey	108%	91.5%	8.5%	67.6%	21%	53.1%
Virginia	111%	91.1%	8.9%	67.7%	17%	56.4%
New York	90%	92.0%	8.0%	67.4%	28%	48.4%
Pennsylvania	111%	90.0%	10.0%	68.0%	17%	56.6%
North Carolina	86%	88.3%	11.7%	68.5%	35%	44.5%
Texas	89%	91.6%	8.4%	67.5%	35%	43.9%
Georgia	105%	88.5%	11.5%	68.5%	21%	53.8%
Arizona	146%	91.9%	8.1%	67.4%	12%	59.3%
Other	112%	91.0%	9.0%	67.7%	17%	56.4%
Home equity portfolio						56.4%

As a reminder...

The two tailed banking crisis and the raw data with the storie behind it;
America, You have been outright lied to! Bamboozled! Swindled! Hoodwinked! The Worst Case Scenario
Reggie Middleton Slashes Financial Jargon with Weapons of the TRUTH! Here are the Stress Tests
Warning: "What you don't report in your balance sheet can screw the average investor"!
Is the Fed following BoomBustBlog? Let's hope so!
Quick opinion on bank stress tests

For those who want the hard data that I used to come up wit; h the findings below, as well as to run their own calculations, I welcome you to the open source model: The Truth About the Banks Has Been Released: the open source spreadhseet edition as well as the Welcome to the Big Bank Bamboozle! and The banking backdrop for 2009.

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

Who am I?

Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I am definitively outside the box - not your typical or stereotypical Wall Street investor. I work out of my home, not a Manhattan office. I build my own technology and perform my own research - in lieu of buying it or following the crowd. I create and follow my own macro strategies and am by definition, a contrarian to the nth degree.

Since I use my research as a tool for my own investing to actually put food on my table, I can stand behind it as doing what it is supposed too - educate, illustrate and elucidate. I do not sell advice, I am not a reporter hence do not sell stories, and I do not sell research. I am an entrepreneur who exists just outside of mainstream corporate America and Wall Street. This allows me freedom to do things that many can not. For instance, I pride myself on developing some of the highest quality research available, regardless of price. No conflicts of interest, no corporate politics, no special favors. Just the hard truth as I have found it - and believe me, my team and I do find it! I welcome any and all to peruse my blog, use my custom hacked collaborative social tools, read the articles, download the files, and make a critical comparison of the opinion referencing the situation at hand and the time stamp on the blog post to the reality both at the time of the post and the present. Hopefully, you will be as impressed with the Boom Bust as I am and our constituency.

I pay for significant information and data, and am well aware of the value of quality research. I find most currently available research lacking, in both quality and quantity. The reason why I had to create my own research staff was due to my dissatisfaction with what was currently available - to both individuals and institutions.

So here I am, creating my own research for my own investment activity. What really sets my actions apart is that I offer much of what I produce to the public without charge - free to distribute and redistribute, as long as it is left unaltered and full attribution is given to the author and owner. Why would I do such a thing when others easily charge 5 and 6 digits annually for what some may consider a lesser product? It is akin to open source analysis! My ideas and implementations are actually improved and fine tuned when bounced off of the collective intellect of the many, in lieu of that of the few - no matter how smart those few may believe themselves to be.

Very recently, I have started charging for the forensics portion of my work, which has freed up the resources to develop the site to deliver even more research for free, particularly on the global macro and opinion front. This move has allowed me to serve an more diverse constituency, which now includes the institutional consumer (ie., investment turned consumer banks, hedge funds, pensions, etc,) as well as the newbie individual investor who is just getting started - basically the two polar opposites of the investing spectrum. I am proud to announce major banks as paying clients, and brand new investors who take my book recommendations and opinions on true wealth and success to heart.

So, this is how I use my background and knowledge in new media, distributed computing, risk management, insurance, financial engineering, real estate, corporate valuation and financial analysis to pursue, analyze and capitalize on global macroeconomic opportunities. I have included a more in depth bio at the bottom of the page for those who really, really need to know more about me.

Visit his blog Boom Bust Blog.