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Reggie Middleton

Reggie Middleton

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…

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

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
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
Default rate Recovery
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.


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