The Truth! The Truth? Bankers Can't Handle the Truth!!!

I have finally updated my Alt-A and Subprime delinquency, charge-off
and loss data using FDIC, NY Fed, Corelogic, First American, and
Bloomberg (among others) as sources. If you thought things looked bad
last year or this spring, they are getting worse - with no reprieve for
the 3rd quarter despite the extreme amounts of liquidity and capital
thrown at the situation by central bankers and the US government. As
soon as I started writing this piece, CNBC comes out with "US to Push Mortgage Lenders To Modify More Home Loans: The
US Treasury announced plans to push lenders to modify more loans after
the administration's $75 billion housing rescue plan, called Making
Home Affordable, fell short and foreclosures continued rising."

Hmmm... $75 billion is a lot of money. Mayhap the problem is that the
banks know how useless pushing on a string is, or mayhap $75 billion is
not enough to stem $304 billion (and counting) in Alt A and subprime
losses that are still in the pipeline (see graphic below). 

It gets worse though. Let's glance at the non-conforming loan losses
that have already occurred in comparison to the SCAP projections that
justified the return of TARP in many cases. Recovery rates had the
illusion of increasing ever so slightly due to an increase in prices as
illustrated by the Case Shiller index. I have expressed my doubts about
this housing price recovery for several reasons, the least of which is
the construction flaws in the index itself which fail to capture the
nature of the transient price increases, namely the activity of short
term investors and flippers (see On the Latest Housing Numbers).
There are some areas that have witnessed some firming of pricing
though, but that firmness is the result of the Fed and Treasury trying
to blow another bubble within a bursting bubble and is more than
outdone by the rampant deterioration in credit quality of loans that
result in the dumping of foreclosures -> REOs -> short
investor turnaround sales/flips (via investors, which are not captured by Case Shiller, hence the illusion of a firming market in the lower end of housing prices) all over the place.

Subprime delinquency, charge-off and foreclosure rates are still flying
through the roof - with many other categories rushing to keep up. This
is as I described from the beginning (2007) through the Asset Securitization Crisis series
- there was an underwriting induced crisis and never a true "subprime
crisis". As such, there is a very strong chance that many other loan
categories may outstrip subprime loans in terms of aggregate losses. It
hasn't happened yet, but the Alt-A category is hot on subprime's heels
(see below). Construction and CRE will follow up the rear with
unsecured consumer (ex. credit cards) and commercial loans fighting to
get into the race.

Below, you see the loss trend as of October 2009. These are losses that
have most likely NOT been claimed by the banks, and they are
significant. In addition, the credit deterioration trend is climbing,
not falling. If I am correct in my assumption on the validity of the
Case Shiller index in capturing true inventory price depreciation
across investor related sales and bank "hold outs", then prices will
soon start dropping again, killing recovery rates and causing losses to
spike even further.

 

The mainstream financial media has led many to believe that the
"subprime crisis" has passed. FRB and FDIC data actually show that
subrpime credit deterioration is increasing in the face of lowered
interest rates through QE/dollar debasing and HAMP government efforts.
This is also despite certain bank policies that mask delinquencies,
such as lagging the time it takes to mark a loan delinquent. We found
Wells Fargo doing this last year with its HELOC portfolio. 

As you can see, every reprieve seen since the crisis started has
been followed by a spike in delinquencies. I expect the same to occur
for 2010.

As can be expected, ARMs sport more than twice the delinquency rate as
fixed rate loans. The drop in rates has caused a leveling of ARM
delinquencies, but it is clear that rates can't remain at zero forever,
and the bulk of these loans are close to if not passed the underwater
mark. Literally any move by interest rates in the direction of
equilibrium (read as the cessation or failure of the Fed's direct
intervention in the interest rate markets) will cause a flood of
delinquencies and foreclosures that are bound to overwhelm the banks.
This is an inevitable occurrence. It is not a matter of if, but a
matter of when. The interesting issue is that all of the categories are
at currently a level that scream solvency alert!

 

The Case Shiller index has shown price increases for the last two
quarters. Despite my reservations about its accuracy, the increases
have done nothing to stem the onslaught of credit deterioration. As a
matter of fact, actual losses are increasing despite the increase (and
its requisite rise in recovery values) due to the amount of charge-offs
and the rate in whch they are occurring. If you lool closely at the
chart, the credit quality deterioration actually picked up as Case
Shiller was showing price improvement.

Below are the loss rates by state. Be aware that these are "LOSS RATES",
not delinquencies or charge offs. This is what the actual losses will
end up being (sans admin and legal costs, which will driver the losses
higher). These loss rates are calculated as follows: Overall default
rate - Recovery rate (Case Shiller - LTV) = Loss Rate 

California, Florida and Nevada have been held up as loss "icons" by the
media, but there are pockets of significant loss throughout the
country. States such a Wisconson and Michigan are pushing 50% in
subprime losses, yet still pale to the near 60% in losses from states
such as Florida. I query, "How can a bank with 10% equity, and 90%
leverage wither 30% to 60% losses on its loans and still be considered
solvent?" For those not versed in these matters, imagine you sold 100
million dollars in stock to the public to start a bank, and borrowed
900 million dollars to write mortgages on $3 billion worth of houses.
You consequently take a 50% loss on those mortgages - to the tune of
$500 million. How much is that initial $100 million of stack worth,
even assuming you can make $30 million dollars a year trading risky
assets with inflated spreads? You are now totally insolvent and still
owe your investors $300 to $400 million in order for them to break
even. Now, imagine that your stock just shot up 300% in price
because.... Well, just because. .

There are many banks that literally specialize in underwriting these
(among others) high risk loans in the hardest hit of the areas below.
There is no way in hell they are carrying those loans anywhere near
their actual value.  

A good example of this is PNC Bank. They were running a 41% loss rate
in Wisconsin (according to our birds-eye view calculations using FRBNY
and FDIC data) in May, and now are exposed to a 45.8% loss rate.
Florida is even worse! Many states have seen a 5% INCREASE in LOSS
rates. Again, it is no wonder why they aren't returning their TARP
monies.

 

 

 

Realize that the losses graphed above are mostly losses that have not
been marked yet by the banks. They are quite significant. For a
birds-eye view of the situation, simply apply the state loss metric to
your favorite bank's portfolio, on a state by state basis. 

This is PNC's granular
break down using the government data from May of this year - before the
roughly 5% jump in economic losses that we have calculated for the most
recent quarter.

As
you can see, going through each major loan category in PNC's books
reveals a much LESS optimistic scenario than ANY portrayed in their
SCAP take home test results... If one were to factor in the more recent
information, the SCAP test and the return of TARP look more like fodder
for litigation than any true attempt at solving the banking problem.

 Sources: FirstAmerican CoreLogic, LoanPerformance Data, U.S. Census Bureau, and Federal Reserve Bank of New York

(a) Statistics calculated on first-lien and active (includes REO) loans.
(b) Statistics calculated on first-lien, owner-occupied, active (includes REO) loans.
(c) 'Prepayment penalty in force' denotes that the loan age is less than the prepayment penalty term.
(d) Statistics calculated on first-lien, owner-occupied, active (includes REO), variable rate loans.

Let's also revisit some data from "You've Been Bamboozled, Hoodwinked and Lied To! Here's the Proof. What Are You Going to Do About It?"
with which we can compare the assumptions that justified the bank's
return of TARP monies with the actual unfolding of events. 

In terms of unemployment, we are already breaching the worst case scenario projection of two years into the future.  

As you can see, the major driver of
future bank credit losses has been woefully underestimated, and thus
the capital requirements of said banks have been woefully
underestimated, among other things.

Below is subscriber content that reveals what the
banks REALLY needed in terms of capital and cushions to whether the
true rate of losses and unemployment to come. You may subscribe here to access this content.

 Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb

 Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb

 MS Simulated Government Stress Test 2009-05-05 11:36:25 2.49 Mb

 MS Stess Test Model Assumptions and Stress Test Valuation 2009-04-22 07:55:17 339.99 Kb

 PNC SCAP Results recast using FDIC and NY Fed data - Pro 2009-05-15 07:31:21 455.37 Kb

 PNC SCAP Results recast using FDIC and NY Fed data - Retail 2009-05-15 07:30:25 395.18 Kb

 PNC Stress Test Pro 2009-04-13 02:10:17 3.11 Mb

 PNC Stress Test update - Professional 2009-04-21 15:55:56 3.00 Mb

 PNC Stress Test Retail 2009-04-13 02:11:08 323.51 Kb

 PNC Stress Test update - Retail 2009-04-21 15:53:52 777.50 Kb

 PNC stress test write up - public lite 2009-07-27 02:37:11 995.30 Kb

 Sun Trust Banks Simulated Government Stress Test 2009-05-05 11:37:13 1016.17 Kb

 JPM Public Excerpt of Forensic Analysis Subscription 2009-09-22 14:33:53 1.51 Mb

Comments

[Herd Redirectio...]

Too big to fail?  Or too big to not fail?

I like the idea that NOT having hyperinflation or deflation is the black swan! LOL, good luck, because I am pretty sure other governments/empires have been in the US' shoes before, and it didn't turn out well, then.

But we are so much more clever than our ancestors, we keep telling ourselves!

[Anonymous]

Sheila Bair and the FDIC had better doing their job instead aiding and abetting securities fraud. They need to start taking the big banks one by one, otherwise the whole banking system is going to implode all at once.

[Anonymous]

The solution is fire. Remember back in the 70's when RE fell apart? Half of Atlanta was torched. Fire was the answer.

Push the problem off onto the insurance sector. They have huge piles of cash. Create jobs, revive the construction industry.

They don't call it jewish lightning for nothing. It's a well establish response to bad investments, or bad economies.

We don't need no water let the mother f***er burn.

[Anonymous]

Gravity is the number one killer. As you get older, it is harder to get up in the morning. Gravity pulling you down. You don't run as fast as you used to. Gravity. Six feet under? Gravity pulling you down. So the banks are broke? What else is new? We flew the same flight path as Japan did twenty years ago. We will land in the same place. Its gravity! Doing the same thing expecting a different result, I believe, is one definition of insanity.

[Anonymous]

It appears that the only ones making money are the ones drinking the Kool Aid.

People are turning Blue in the Face trying to explain why this Market should go down. But, the Magic Computers keep it up at all costs. I do wonder who is controling the Computers. Goldman Sachs or the Government.

Logic tells everyone that this Market does not belong where it is Trading. Or, is that the reason it is Trading up? Because the market seems to run opposite of logic?

[Green Sharts]

Below are the loss rates by state. Be aware that these are "LOSS RATES", not delinquencies or charge offs. This is what the actual losses will end up being (sans admin and legal costs, which will driver the losses higher). These loss rates are calculated as follows: Overall default rate - Recovery rate (Case Shiller - LTV) = Loss Rate

Uh, that's not how you calculate loss rates on mortgages.

[Green Sharts]

No explanation of that calculation Reggie?

[Anonymous]

Gloom and Doom depresses me. Even though I already have months of supply, ammo, guns, bunker, various scenarios to deal with nuclear fallout, war, famine, zombies etc etc etc.

Bleah.

The one scenario that really stumps me is ZERO CASH. No credit, tab, advance, deferment. Just ZERO CASH.

Zero Banks?

Zero Anything?

There is a old saying in my family. What goes up must eventually lose energy and fall. The gravity of the situation fails to escape all the Kings Men trying to put Humpty Dumpty back together again so that all can report back to the King that all is well.

You want to get the USA out of this mess?

Start by cutting a check of sufficient size to each and every adult US citizen over 18. This check will be a one time issue designed so the Citizen can wipe out debts, loans, leverage and other liabilities.

Once the People are free and clear, they can start spending again. But with one cravat; no credit card over 10% interest and no Government spending beyond what cash revenue is actually coming into the Nation for THAT MONTH.

Everything else will fall into place. But first, we need it to fall. What bounces and stays intact will be rubble strong enough to build on when this all drama is over and done with.

[Anonymous]

Great work by Reggie yet again.
Only question, when do we short with DRV, FAZ?

Timing is everything in life.

[AnonymousMonetarist]

'And you always think
Always speak cryptically
I should know
that you're no good for me'
-Katy Perry

'Oh what a tangled web we weave, When first we practice to deceive'
- Sir Walter Scott 

'Stand and deliver
your money or your life!
And even though
you fool your souls
Your conscience will be mine
all mine.'
-Adam and the Ants

The Oracle at Eccles stating that we can't handle the truth is the fiscal equivalent of Stockholm's Syndrome.

But you already knew that.

The strong dollar policy is facetiously olfactorius ; the chimera of currency debasement masquerading as America's wealth exporting machine that is regularly promulgated by our leaders as an exceptional example of America's resiliency.

But you already knew that. 

Employment, inflation, productivity, GDP, and other sundry stats are massaged into irrelevance and yet are perennially market-moving.

But you already knew that.

The markets are rigged.

But you already knew that.

As a corollary, spooks align with certain hedgies towards mischievous ends...

Did I get you on that one? Well, if so, tis only 'cause one of them confided in me. 

Please don't knock on my door Mr. Hand, I have no specifics. 

Fooled by randomness? Or tooled by randomness? 

From troubles to bubbles and back again?

Or has the Great Moderation morphed into the Great Modification?

If the intelligentsia of finance are squared off between deflation and hyperinflation, is the true Black Swan one of these two likely scenarios not occurring?

To paraphrase Winnie, it is a riddle, wrapped in a mystery, inside an enigma; but there is a key. That key is the Amerikantura's (copyright applied for) interest.

The new marketplace of ideas.

Down is up, up is down.

Punish the sober.

Exalt the drunk.

And we all know that the Oracle at Eccles

has junk in the trunk.

[mr brincq]

http://www.fd.nl/artikel/13715260/bos-laat-alt-a-hypotheken-ing-opnieuw-...

the dutch minister of finance investigates the alt-a mortgages of ING. the dutch state is liable for 80% of the risk and ING pays a fee....

thanks for your great work

[Anonymous]

http://www.fd.nl/artikel/13715260/bos-laat-alt-a-hypotheken-ing-opnieuw-...

Hello Reggy, the dutch finance minister is investigating the ING Alt-A mortgages. The dutch state has taken 80% of the risk of the alt-a....and ING pays a fee for the risk that the state takes...