I dedicate this article to those loyal readers who tell me that there are times that you can't rely on fundamentals. I respectfully disagree. Over time, 1+1 will always equal 2. As a matter of fact, when people tell me 1+1 = ANYTHING other than 2 is when I start looking for opportunity. That's what I do for a living. See more about my occupation here, "The Great Global Macro Experiment, Revisited". Now is the most appropriate time to make use of the fundamentals. You see, when you are able to master a high level of analysis, you can actually SEE PEOPLE LYING! Lies lay the seeds for significant financial profit, for somewhere behind the lie lays the truth.
The Supervisory Capital Assessment Program: Revisited
We have conducted analysis of Fed's assumption for loan losses for Supervisory Capital Assessment Program by taking into account current delinquencies, foreclosure and charge-off to determine severity of assumptions. Below is the summary findings of the potential "WORST CASE" losses over the next two years for all 19 of the bank holding companies that were subject to the government's stress test (taken from page 7 of the official stress test results).
Now, this is supposed to be Armageddon numbers for up to two years into the future. Let's compare this to the data we have gathered from credible sources, and potentially even some incredible sources. The primary source of default and delinquency data was actually the Fed itself, believe it or not, the same guys who gave the stress test in the first place and currently stating that banks are well capitalized!
The table below presents a comparison of the Fed's SCAP (stress test) assumption for cumulative 2 year loss rate and likely two year cumulative expected losses based current trends in charge-off's, foreclosure and delinquency taken in large part from the Fed's public website. When looking at this table, be sure to reference the actual results above, and the definition of Fraud.
The Supervisory Capital Assessment Program
|Fed 2 yr cumulative loss rate||Current trend|
|Base Case||Adverse Case||Net Charge-off rate¹||Fore- |
|Deliquency³||These scenarios trends have already breached the worst case scenario|
|First Lien Mortgages||5 - 6||7 - 8.5||8.86%||3.92%||<---------|
|Prime||1.5 - 2.5||3 - 4||4.89%||<---------|
|Alt-A||7.5 - 9.5||9.5 - 13||19.98%||5.00%||9.69%||<--------- |
moratriums have temporarily kicked foreclosure filings down the road
|Subprime||15 - 20||21 - 28||36.18%||13.7%||21.88%||<--------- |
(charge offs) moratriums have temporarily kicked foreclosure filings down the road
|9 - 12||12 - 16|
|Closed-end Junior Liens||18 - 20||22 - 25|
|HELOCs||6 - 8||8 - 11||4.00%||2.45%|
|C&I Loans||3 - 4||5 - 8||2.70%||2.58%|
|CRE||5 - 7.5||9 - 12||>12%||5.36%||<----- |
Trend is already higher than predicted, but current losses in range
|Construction||8 - 12||15 - 18||10.24%|
|Multifamily||3.5 - 6.5||10 - 11||1.30%|
|Nonfarm, Non-residential||4 - 5||7 - 9|
|Credit Cards||12 - 17||18 - 20||>20%||5.56%||<----- |
Trend is already higher than predicted, but current losses in range
|Other Consumer||4 - 6||8 - 12||5.38%||3.32%|
|Other Loans||2 - 4||4 - 10||2.15%||1.05%|
|1) Computed for Alt A First Lien Mortgage, Alt A ARM and Subprime based on Fed data for Foerclosure and past due loans adjusted for LTV and housing price change.|
|1) HELOC, C&I, Other consumer and Other loans are as of December 31, 2008 representing 2 yr cumulative loss rate and are sourced from FDIC and Federal Reserve. Credit Card charge-off as per Moody's estimate. CRE charge-off's as per Deutsche Bank estimates.|
|2) Foreclosure as of March 31, 2009 from Bloomberg except for Subprime foreclosures which is as of December 31, 2008 and is sourced from Mortgage Bankers Association.|
|3) Delinquency as of December 31, 2008 sourced from MBA, FIDC and Federal Reserve|
First Lien Mortgage
Mortgage foreclosure rate stood at 8.86% as of March 31, 2009 with US home foreclosure filings increasing 46% to 341,180 as of March 31, 2009 over last year. This number is significantly understated due to the fact that many, if not most, of the largest lenders were either under or just exiting a moratorium on foreclosures in the US. This moratorium, or more accurately, the lack thereof, will cause an extreme spike in foreclosure fillings in the upcoming months. As U.S housing prices continue to decline (with S&P Case Shiller Index declining 5% in 2009 in the first two months) mortgage forecloses and delinquencies are expected to reach additional historical peaks resulting in higher loan losses for banks on real estate loans. The Fed's 2 year cumulative loan loss rate for Alt A loans (7.5%-9.5%) appear overly optimistic and is even lower than current delinquency as of December 31, 2008 (9.69%). Based on the Fed's data (that's right, this data is sourced directly from the Fed itself, which explicitly contradicts the data that the Fed released for its stress tests) for Loan losses for Alt -A loans as of March, 2009 (for loans past due and current foreclosures) adjusted for recovery based on LTV taking into consideration price decline and original LTV, 2 yr cumulative losses for Alt A is expected to reach 19.98% which is significantly higher than Fed's adverse case of 9.5-13% - nearly twice as much! The Alt-A category is probably one of the most dangerous for the banks, for this is expected to literally explode over the next 24 months (and is in part masked by moratoriums), as is confirmed through our independent research and, ironically, through the Fed's data itself! I strongly suggest that those who are interested in this mosy on over to Mr. Mortgage's blog, for a peek at what is "really" happening in regards to foreclosures in California - see "4-23 March Final Loan Default Wrap-up". This is the man that sounded the trumpet along with myself regarding Lehman Brother's RE exposure.
Now, in case my bold font and italics are wasted on some of you, let me state this again. The Fed says X through the stress test assumptions, and now the results, yet if you simply surf over to the other side of the government's own web sites, they offer actual default and foreclosure rates (among other data), that are considerably more dire than they asked you (the tax payer and investor) to believe is credible and "not that bad". My previous post requested that BoomBustBlog readers consider the technical and legal definitions of Fraud - see "Preparations for Monday's and Tuesday's Articles". Keep this in mind as we move forward.
The delinquency rate is soaring to extremes in the subprime mortgage segments as the plummeting house prices and poor credit standing of the borrowers translate into rising defaults. As per the Bloomberg estimates, the delinquency in the subprime mortgage spiraled to nearly 21.9% in 4Q08, pushing up the foreclosures to 13.7%. While the Fed pegs the two year cumulative loss within the range of 21%-28% for the subprime mortgage loans under the adverse case, the estimate seems far too optimistic given the deteriorating housing market which is likely to trigger greater delinquencies in this highly vulnerable segment. Based on the Fed's OWN PUBLICHED DATA for Loan losses for subprime loans as of March, 2009 (for loans past due and current foreclosures) adjusted for recovery based on LTV taking into consideration price decline and original LTV, 2 yr cumulative losses for subprime is expected to reach 36.18% which is significantly higher than Fed's adverse case of 21-28%.
Commercial real estate sector
The commercial real estate sector is set to deteriorate sharply in the months ahead. Significant swaths of commercial real estate mortgages are coming due at a time when liquidity problems persist, coupled with rising vacancy rates and a severely restricted ability to securitize commercial real estate mortgages continue to aggravate the problem. According to Deutsche Bank, US commercial delinquency rate could touch as high as 6% in 2010. These estimates could still be conservative (and not aggressive) as economic turnaround is far from recovery in the next couple of years. I see this as being much worse then generally anticipated, and I have been correct on commercial real estate's downfall since 2007 - see:
Will the commercial real estate market fall? Of course it will,
Do you remember when I said Commercial Real Estate was sure to fall?
The Commercial Real Estate Crash Cometh, and I know who is leading the way!
and GGP and the type of investigative analysis you will not get from your brokerage house.
As per Federal Reserve, credit card annualized charge-offs for 4Q2008 was 6.25%. With consumers continuing to struggle amid a rapidly deteriorating employment situation and from declining housing prices, the rate is expected to surge to higher levels in the coming months. Fitch's prime charge-off index was at 6.8% in December, nearly one-third higher than year-earlier levels. It expects the figure to reach 8% in 2009 as unemployment continues to rise. As per Moody's, credit card charge-offs advanced to already 8.82% in February, nearly 300 basis points higher than a year ago. Moody's expect charge-off rates to touch double digits by end of this year. Based on these projections for charge-off rates, it is expected that the two year cumulative charge-offs rates on credit cards is going to be higher than 20%.
I will plug these new (Fed-generated) numbers into my SCAP templates to come up with realistic capital requirements for the banks covered as well as any adjustments to valuation, if any. One thing we can be fairly confident of, the banks need a lot more than the government's stated $599 billion.
Here are a few news clips from around the Web:
Ex-regulator comments on the government endorsed Wall Street Propaganda (Yahoo Finance):
"It's in the interest of the financial community to send this propaganda out," Black says. "It's remarkable not that they do it but that it still works." In other words, this isn't the first time we've been told "the crisis is over" and that "banks are well capitalized" - and probably won't be the last. The professor and former financial regulator foresees another wave of foreclosures and future bank losses of more than $2.5 trillion vs. the government's $599 billion estimate. Simply put, the stress tests weren't strong enough to be considered "wimpy," Black says. Furthermore, Fannie Mae, Freddie Mac, AIG and IndyMac were deemed to have "passed" much more stringent government stress tests before their respective failures, he notes, recalling the grim history:
Fannie and Freddie: In July 2008, Treasury Secretary Paulson testified that Fannie and Freddie were "adequately capitalized" under the test. In August 2008: "even in [Freddie's] most severe stress tests, [show] losses ... less than $5 billion." Actual losses: 20 to 40 times greater.
AIG: "It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those [CDS] transactions." AIG claimed in 2008 "Using a severe stress test ... losses could go as high as $900 million." Actual losses: 200 times greater.
IndyMac: Sold over $200 billion of "liar's loans." Actual losses: 160 times greater than its tests.
Rating Agencies: Their stress tests gave AAA ratings to toxic waste. Actual losses: more than an order of magnitude greater.
"The examinations and stress tests are shams -- always precise, always farblondget," Black claims.
Black, who was one of the regulators who oversaw the S&L resolution if I am not mistaken is 100% in stating that this is not the first time the government has told us all is well on the Western front. For those with fickle memories, please see "Is Paulson to be trusted, or is this Bush Administration Shock and Awe, 2.0?" [Wednesday, 24 September 2008]. This is roughly the third or fourth assurance that things have turned for the better from the Fed and the Treasury and at least twice last year the Treasury department has assured us about the strength of our banking system. Oh yeah, right before we were told the entire banking system would collapse if we didn't give Paulson $700 billion.
The Federal Reserve at the last minute significantly scaled back the size of the capital hole facing some of the nation's biggest banks, following days of intense bargaining over the stringency of the stress tests.
In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits.
When the Fed last month informed banks of its preliminary stress-test findings, executives at corporations including Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. were furious with what they viewed as the Fed's exaggerated capital holes. A senior executive at one bank fumed that the Fed's initial estimate was "mind-numbingly" large. Bank of America was "shocked" when it saw its initial figure, which was more than $50 billion, according to a person familiar with the negotiations.
At least half of the banks pushed back, according to people with direct knowledge of the process. Some argued the Fed was underestimating the banks' ability to cover anticipated losses with revenue growth and aggressive cost-cutting. Others urged regulators to give them more credit for pending transactions that would thicken their capital cushions.
At times, frustrations boiled over. Negotiations with Wells Fargo, where Chairman Richard Kovacevich had publicly derided the stress tests as "asinine," were particularly heated, according to people familiar with the matter. Government officials worried San Francisco-based Wells might file a lawsuit contesting the Fed's findings. As if I wouldn't sue if I found out about the Fed allowing banks to negotiate the terms of regulation. Hey, taxpayer, your well being and safety is now up for negotiation. Did you know that? Should you sue?
The Fed ultimately accepted some of the banks' pleas, but rejected others. Shortly before the test results were unveiled Thursday, the capital shortfalls at some banks shrank, in some cases dramatically, according to people familiar with the matter.
Bank of America's final gap was $33.9 billion, down from an earlier estimate of more than $50 billion, according to a person familiar with the negotiations.
Bank stocks soared Friday, including Wells Fargo and Morgan Stanley, which sold shares a discounts of more than 10% below Thursday's close.
The ability of banks to raise capital is certainly positive but the idea of shares rallying amid the capital raising and dilution is "counterintuitive," Bank of America CEO Ken Lewis said on CNBC this morning.
The PPIP is the "greatest boondoggle in the history of the world," says Black, a former bank regulator who was counsel to the Federal Home Loan Bank Board during the S&L crisis. As occurred during the S&L era, Black says the PPIP will allow banks to exchange "trash for cash" and turn "real losses into faulty gains."
If the goal of Tim Geithner and other regulators was "to rip off the American taxpayer for the benefit of the least-deserving wealthiest people you can imagine, well - mission accomplished," Black says.
Speaking of PPIP, I walked the world through how easily this system is gamed, and provided a downloadable model to actually game the system yourself: Reggie Middleton on PPIP, part 2
The Government Stress Tests, revised with the Government's own SEC reported loss numbers plugged in, ex. The TRUTH!
Notes from Fannie Mae's latest quarterly filing. Be aware that this information was in the possession of the federal government considerably before the results of the stress tests were released. After all, Fannie Mae IS a government owned entity. Keep that Wikipedia definition of Fraud and Securities Fraud in mind as you read on:
For example, our level of foreclosures and associated charge-offs were lower in the first quarter of 2009 than they otherwise would have been due to foreclosure delays resulting from our foreclosure suspension, our requirement that loan modification options be pursued with the borrower before proceeding to a foreclosure sale, and state-driven changes in foreclosure rules to slow and extend the foreclosure process. As a result, we determined that it was necessary to refine our loss reserve estimation process to reflect these newly observed delinquency patterns, as we describe in more detail below.
We historically have relied on internally developed default loss curves derived from observed default trends in our single-family guaranty book of business to determine our single-family loss reserve. These loss curves are shaped by the normal pattern of defaults, based on the age of the book, and informed by historical default trends and the performance of the loans in our book to date. We develop the loss curves by aggregating homogeneous loans into pools based on common underlying risk characteristics, such as origination year and seasoning, original LTV ratio and loan product type, to derive an overall estimate. We use these loss curve models to estimate, based on current events and conditions, the number of loans that will default ("default rate") and how much of a loan's balance will be lost in the event of default ("loss severity"). For the majority of our loan risk categories, our default rate estimates have traditionally been based on loss curves developed from available historical loan performance data dating back to 1980. However, we have recently used a shorter, more near-term default loss curve based on a one quarter "look-back" period to generate estimated default rates for loans originated in 2006 and 2007 and for Alt-A loans originated in 2005. More recently, we also have relied on a one-quarter look back period to develop loss severity estimates for all of our loan categories.
We experienced a substantial reduction in foreclosures and charge-offs during the periods November 26, 2008 through January 31, 2008 and February 17, 2009 through March 6, 2009 when our foreclosure suspension was in effect and a surge in foreclosures during the two-week period of February 1, 2009 through February 16, 2009. Since February 16, 2009, we have continued to observe a reduced level of foreclosures as our servicers, in keeping with our guidelines, evaluate borrowers for newly introduced workout options before proceeding to a foreclosure. Because of the distortion in defaults caused by these temporary events, we adjusted our loss curves to incorporate default estimates derived from an assessment of our most recently observed loan delinquencies and the related transition of loans through the various delinquency categories. We used this delinquency assessment and our most recent default information prior to the foreclosure suspension to estimate the number of defaults that we would have expected to occur during the first quarter of 2009 if the foreclosure moratorium had not been in effect. We then used these estimated defaults, rather than the actual number of defaults that occurred during the first quarter of 2009, to estimate our loss curves and derive the default rates used in determining our loss reserves. Consistent with our approach during the fourth quarter of 2008, we also made management adjustments to our model-generated results to capture incremental losses that may not be fully reflected in our models related to geographically concentrated areas that are experiencing severe stress as a result of significant home price declines and the sharp rise in unemployment rates.
We also made several enhancements to the models used in determining our multifamily loss reserves to reflect the impact of the deterioration in the credit performance of loans in our multifamily guaranty book of business resulting from current market conditions, including the severe economic downturn and lack of liquidity in the multifamily mortgage market. Our model enhancements involved weighting more heavily our recent loan performance experience to derive the key parameters used in calculating our expected default rates. We expect increased multifamily defaults and loss severities in 2009.
Our combined loss reserves increased by $17.0 billion during the first quarter of 2009 to $41.7 billion as of March 31, 2009, reflecting further deterioration in both our single-family and multifamily guaranty book of business, as evidenced by the significant increase in delinquent, seriously delinquent and nonperforming loans, as well as an increase in our average loss severities as a result of the continued decline in home prices during the first quarter of 2009. The incremental management adjustment to our loss reserves for geographic and unemployment stresses accounted for approximately $5.6 billion of our combined loss reserves of $41.7 billion as of March 31, 2009, compared with approximately $2.3 billion of our combined loss reserves of $24.8 billion as of December 31, 2008.
We provide additional information on our combined loss reserves and the impact of adjustments to our loss reserves on our condensed consolidated financial statements in "Consolidated Results of Operations-Credit-Related Expenses" and "Notes to Condensed Consolidated Financial Statements-Note 5, Allowance for Loan Losses and Reserve for Guaranty Losses."
Credit loss metrics taken from Table 14 of the FNMA report:
Credit Loss Performance Metrics
Management views our credit loss performance metrics, which include our historical credit losses and our credit loss ratio, as significant indicators of the effectiveness of our credit risk management strategies. Management uses these metrics together with other credit risk measures to assess the credit quality of our existing guaranty book of business, make determinations about our loss mitigation strategies, evaluate our historical credit loss performance and determine the level of our loss reserves. These metrics, however, are not defined terms within GAAP and may not be calculated in the same manner as similarly titled measures reported by other companies. Because management does not view changes in the fair value of our mortgage loans as credit losses, we exclude SOP 03-3 and HomeSaver Advance fair value losses from our credit loss performance metrics. However, we include in our credit loss performance metrics the impact of any credit losses we experience on loans subject to SOP 03-3 or first lien loans associated with HomeSaver Advance loans that ultimately result in foreclosure. (Does the management of Fannie actually expect the price of the housing collateral or the value of the loans backing it reflate back to the bubble level prices?)