FDIC Giving Distressed Real Estate Away and Other Distressing News

The FDIC conducted the second bulk sale of its sizable commercial real estate portfolio, which it inherited from all of the bankrupt banks deemed too small to survive. As a taxpayer, you'll be happy to hear it went off without the hitch and we get to keep much of the upside to boot! Wouldn't want to miss out on any of the upside, considering all the downside that's been shoveled down our throats in the past few years. Colony Capital and a minority owned investment firm named Cogsville LLC are proud owners of $1.85 billion (notional) in distressed assets. The investors paid 59 cents on the dollar, or $445 million for a 40% equity stake, with the FDIC retaining 60%, and (this is my favorite part) they get a seven-year, zero-interest loan, to reduce the upfront cash to $218 million. Let me repeat my favorite part: seven-year, zero-interest financing. I know I've been grousing for awhile now how all that zero interest financing is only benefitting the banks and they aren't passing the savings on to consumers and small businesses. Turns out I was wrong. All that zero percent money is helping large private equity funds goose their returns too!

Let's see, how else are we boosting the economy? Oh, according to the latest Fed lending survey, hedge funds, in addition to private equity funds, are getting better terms from their lenders. Consumers? Not so much. Dealers reported that funding markets for key consumer loans remained under stress, with a quarter of dealers reporting that liquidity and functioning of the consumer loan market had deteriorated in recent months. So what to do if you are a small business or consumer that needs a loan and you can't get one because your bank is too busy offering good deals to hedge funds? Quit complaining and start your own fund! Better yet, find the nearest woman or minority, call them CEO, and give the FDIC to call. You'll get all sorts of zero-percent financing, provided you take a few Las Vegas condos off their hands.

Banks On Edge Not Happy With FDIC Auctions

Bloomberg is out this morning with an uplifting story about the current state of our regional banking system. Apparently, banks that are on the brink are not happy with the FDIC's upcoming auctions of assets seized from failed banks because they may trigger writedowns of their assets and weaken them further. According to Bloomberg, of the $50.4 billion in loans seized from failed banks currently held by the FDIC, 63% involve participations by other lenders. Consequently, if the seized loan is auctioned at a discount, the lenders who participated on the loan will be forced to write down the loan on their own books.

The funny, and therefore highly mockable, portion of the story is the great quotes Bloomberg has managed to extract from the various mouthpieces of the banking industry. Take this gem from the lawyer who is representing 25 lenders that took part in financing the W Hotel (which will be auctioned next month by the FDIC): " These banks can't believe that the regulator they pay to protect them is going to sell these loans to someone who can flip them and cause them serious losses." For clarification purposes, the FDIC's role is not to protect banks; they are required to pay premiums in order to get deposit insurance. The FDIC is tasked with protecting depositors FROM banks, in the event that banks decide to piss away depositors' cash on ridiculous investments such as financing the construction of a W Hotel in Atlanta in the middle of a property glut and a credit bubble. Mr. Lawyer for the Bankers goes on to say "Our banks just cannot believe they are being treated in a way that ultimately hurts the FDIC's insurance fund because some of them are right on the edge." How dare the FDIC treat banks this way after they've done such a fabulous job winding up on the brink of insolvency!

"We have a number of banks teetering on the edge, and we don't need this problem" quoth the president of Community Bankers of Washington. Yeah, so can we just get back to burying our heads in the sand and forgetting about the fact that we're insolvent? That 140 banks failed last year, another 26 this year, and 702 are on the "problem" list? If it weren't for those pesky FDIC auctions, the banking system would be virtually sound. Right? In any event, those interested in purchasing a swank hotel in Atlanta, as well as a myriad of other half-built and partially vacant properties across the US, for a song are in luck.

FDIC Investigates Failed Integrity Bank

The FDIC has been busy for the past couple of years cleaning up the mess left behind in the wake of the credit bubble. Only the big banks were politically powerful enough to get the bailouts, while the smaller banks are getting shuttered on a weekly basis. The WSJ takes a peek inside what went wrong at Integrity Bank, a Georgia bank that opened in 2000 and was closed by the FDIC in August 2008.

What is interesting about Integrity Bank is that it went belly up because it lent out all of its capital to one borrower, a real estate developer that owned a hotel in Sausalito, California. The hotel went bankrupt and was auctioned off by the FDIC last month. Why on earth would a bank lend all of its capital to one borrower? Don't worry, the FDIC plans to find out. Now. After it has already cost the deposit insurance fund $295 million. Nevertheless, the regulator that was tasked with keeping and eye on banks and making sure they don't do things like lend all their capital to one guy in Sausalito, has launched an investigation. The FBI and Federal prosecutors are also hot on Integrity's tail postmortem.

Everybody's looking for the flight recorder because investigators want to know why the plane crashed so that we can keep it from ever happening again. But do we really need an FDIC investigation to conclude that it was a dumb idea for the bank to give 14 loans totaling $83 million, or 127% of the bank's capital, to one guy? Or that it wasn't a great idea for said loans to have interest reserves so that said guy wouldn't have to pay interest on the loans? I mean, don't banks already know that they should expect their borrowers to pay them interest? Or that dipping into a credit line to pay interest on a borrower's other loans doesn't actually lower the risk associated with the borrower? Really, are we going to have any big epiphanies here? Federal prosecutors just need to put a few people in jail. The FDIC needs to focus its resources on the rest of the regionals that are going to fail.

Fallout From Financial Crisis Widespread

This morning's WSJ is a veritable cornucopia of articles detailing the lingering effects of the financial crisis. First, the reader is hit in the face with the headline story "Lending Falls at Epic Pace" and the accompanying graph that depicts, well, lending falling at an epic pace. Aside from the top-tier banks, most of which are making money from trading rather than lending, the rest of the banking industry is suffering, according to the FDIC's quarterly report. Banks registered their biggest full-year decline in total loans outstanding in 67 years. Also, the FDIC's problem bank (those at risk of failing) list grew to 702. Furthermore, more than 5% of all loans were at least three months past due, the highest level recorded in the 26 years the data have been collected.

Moving right along to some dismal local news for those of us in California, there is the story entitled "Lehman's Ghost Haunts California," which tells the sad tale of the aftermath of San Mateo County's failed investment in Lehman Brothers. That $155 million the county punted on Lehman bonds (commercial paper? whatever it was, the risk premium was definitely not justified) is looking pretty foolish now that the public schools are laying off teachers, community colleges are scrapping new facilities and the commuter rail is trimming service.

Speaking of California and really bad investment decisions, you can read all about Calpers latest woes in "Backlash Hits Calpers Property Deals." The story details the controversy surrounding some of Calpers' real estate deals which, in addition to losing buckets of money for California retirees, also had the socially conscious benefit of evicting low income residents from their housing units. Calpers response? "These historical investments were made under previous investment leaders" and outside managers who handle Calpers real-estate investments. Translation? If you're looking for someone to nail to the stake, you might want to go after, um, the other guys who were here. Back in early 2008 when most of Calpers' senior investment managers left for "personal reasons," it turns out those reasons weren't so personal after all. Who could've guessed? Oh yeah, me.

Moving right along, there is the article on yesterday's unexpected plunge in consumer confidence entitled "Jittery Shoppers Dim Stores' Hopes." It turns out that unemployed people don't shop so much. Shocking.

Even Casket Makers are hitting tough times, according to the cleverly titled "Casket Makers Dig In as Sales Take Hit." In addition to discussing how the economic slump is hurting the casket making industry, the article also sports the Pulitzer-worthy opening line of: "As their sales slow, some casket makers worry their business is hitting a dead end."

Looking for some good news amid the gloom? Look no further than "Bon Appetit: Toxic Bonus Yields 72% at Credit Suisse," which tells the tale of the 2000 investment bankers forced to take some of their bonuses in 2009 in the form of toxic assets. The assets have since rallied 72%, although employees can't withdraw from the plan until 2014. According to the story, the bankers groused about the plan when it was first introduced and they are probably still grousing that they only get to collect interest payments until the plan's expiration in four years.

You can read all about Wall Street bonuses rebounding in 2009 in "Wall Street Bonuses Get 17% Bounce." Then again, unless you work on Wall Street, maybe you'd better not.

Capmark Files For Chapter 11

Capmark Financial, one of the nation's largest property lenders with $20 billion in assets, has filed for Chapter 11 bankruptcy protection. Capmark used to be the commercial lending unit of GMAC, the residential mortgage lending arm of GM that has since received excessive amounts of government aid. Seems like everything that GMAC ever touched was bound to be a lousy investment. At least GMAC had a bit of foresight in spinning off Capmark in 2006 to KKR, Goldman Sachs Capital Partners and Five Mile Capital Partners, who paid $1.5 billion in cash to acquire the doomed commercial lender. I'll let you guess what that investment is worth today.

Capmark has a bank in Utah with $10 billion in assets that is not part of the bankruptcy filing. However, the bank has been warned by the FDIC that it needs to boost its capital levels. The bank makes and holds commercial mortgages making it a likely candidate for seizure by our friends at the FDIC. Speaking of the FDIC, it closed seven banks on Friday bringing the YTD total to 106. Now if that isn't bullish news for the stock market, I don't know what is. Otherwise, I have no explanation for this morning's rally.

FDIC's Bair Gives "Secured" a New Definition

Bloomberg has an article this morning claiming that FDIC Chairman Shela Bair believes that regulators should consider making secured creditors carry more of the cost of bank failures. "This could involve potentially limiting their claims to no more than, say, 80% of their secured credits," Ms. Bair said yesterday while giving a speech in Istanbul, where hopefully nobody was listening. "This would ensure that market participants always have some skin in the game, and it would be very strong medicine indeed." I'll say. In fact, the medicine would be so strong that it might kill a few banks along the way. The whole point of secured financing is that secured investors can rely on being first in line to collect 100 cents on the dollar before anyone else gets a penny in a bankruptcy filing. If you are no longer assured of that outcome, you are no longer a secured investor. You are now "slightly secured and charging a much higher rate" or maybe "mostly secured and asking for WAY more collateral" or possibly "just not doing secured lending anymore." So, I'm thinking that cutting off secured funding on struggling banks is not going to help those banks stay alive, which is not going to help the FDIC's insurance fund, which doesn't really help Ms. Bair do her job of paying for bank failures.

Some Data and More Musings From FDIC and SEC

• In happy economic headlines, S&P's Case Shiller index on housing prices posted a small uptick from the prior month. Only Las Vegas and Seattle showed declines. Year-over-year, prices are still down across the board, with the worst performer, Las Vegas, posting a drop of 31.4%, and the best performer, Cleveland, posting a 1.3% decline.
• Meanwhile, the index of consumer confidence dipped to 53.1 from 54.5 putting an end to the stock market's rally this morning. I suppose economists who predicted a continued rise in consumer confidence were shocked that consumers somehow care about silly things like a 10% unemployment rate, rising credit card fees, and negative home equity.
• Desperate to raise money without having to tap the Treasury, the FDIC is now expected to propose that the bulk of the banking industry prepay three years' worth of fees to replenish the dwindling deposit insurance fund. The FDIC anticipates collecting between $36 billion and $54 billion through this new money-making scheme. I suspect this fee will be met with more than a wee bit of resistance from the banking industry. Certainly all banks have been underpaying for the past several years since it only took us a year or so to blow through the insurance fund, but still, it's never fun paying for the clean-up.
• The SEC is weighing new regulations for that mysterious and "opaque market" called securities lending. I know we need to regulate everything to look like we're actually doing something after last year's clustersuck, but still, this is getting ridiculous. There is nothing opaque or complex about securities lending that needs regulating. The securities lenders lost buckets of money last year out of sheer stupidity not because the industry needs more regulation. They took a very simple business model of lending out securities to shorts and reinvesting into liquid assets earnings higher rates and screwed it up by investing in highly illiquid toxic securities that lost money. Besides, if the SEC finally does succeed in making short-selling so difficult that nobody wants to do it anymore, securities lending won't be necessary.

Failed Banks Weigh on FDIC Insurance Fund

So the count of failed banking institutions hit 77 on Friday, with the FDIC seizing its biggest fish to date: Colonial. Fortunately, the FDIC found a buyer for the bank with $22 billion in assets, but not without providing the purchaser, BB&T, with one of its famed loss-sharing agreements. You know, the kind of deal you'd like to get on your trading account? I'll take 100% of the upside, and let the government eat the losses on my crappier trades. The loss-sharing agreements with the FDIC lessen the ultimate cost to the insurance fund, which is rapidly shriveling, and probably shivers with fright every Friday afternoon awaiting the news of the latest subtraction from what remains of its meager pool.

As I've noted several times before in my posts about bank failures, it is surprising how costly the recent bank failures have been as a percentage of assets. Lo and behold, the WSJ reports today that the recent period of bank failures are even more costly when measured as a percentage of assets than those during the S & L Crisis. The largest hit so far is coming from Community Bank of Nevada where the cost to the FDIC's insurance fund is estimated to be roughly 51.4% of the bank's $1.52 billion in assets. For the 102 banks that have collapsed in the past two years, the FDIC's estimated cost averaged 25% of assets. This is up from the 19% rate between 1989 and 1995 when 747 financial institutions were closed by regulators. What accounts for the increase in cost? First of all, many regional banks that were shut out of the mortgage boom chose to delve into risky construction lending that is now coming back to bite them. Is it any wonder that the most expensive bank failure to date as a percentage of assets is based in Nevada where the construction boom was particularly pronounced? Also, clearly regulators did a horrible job of supervising these banks, allowing them to grow at unsustainable rates through high-risk lending. For example, Integrity Bank of Alpharetta, Ga was permitted to continue accepting deposits while promising unusually high interest rates for more than two years after examiners noted deficiencies in its loan underwriting. The funny thing about lax regulatory supervision is that we wind up paying for it twice. First we pay the salaries for a bunch of bank examiners to sit around and do nothing while the largest real estate bubble we've ever witnessed percolates around them. Then we pay to clean up the mess when all of the institutions fail. Sure the FDIC's deposit fund is financed by premiums collected from banks. But the fund is down to $13 billion and there are 300 banks on the problem bank list. Does anyone really think the FDIC isn't going to have to draw down on that $100 billion line of credit with the Treasury?

Rally Peters Out Over Sobering Earnings Data

We're had quite the rally in the past few weeks. I know this because both the front page of the Wall Street Journal and Financial Times trumpet the Dow's return to 9,000. So it was only fitting that three fairly significant companies had to report weak earnings right after the close and spoil the party. Microsoft posted a jarring 17% revenue decline and 29% drop in profits, citing falling global demand for PCs and servers. Furthermore, this fiscal year (the company just reported its fourth quarter) marked the first time that Microsoft faced a revenue decline for the full year. Better earnings released earlier from Apple, IBM, and Intel had sparked hopes for better results from Microsoft and the rest of the tech sector. While Amazon had a 14% increase in sales, its profit fell 10% to $142 million. Since the online retailer has always believed in "providing customers low prices, vast selection, and fast delivery," (a direct quote from Mr. Bezos) the company's shareholders have the stock priced at an earnings multiple of 60, hence the 8% shellacking in the stock price. AmEx's net profits fell 48% on an increase in charge-offs. The company said that consumer spending declined by 16% in the second quarter and charge-offs increased to 10% from 8.5% in the previous quarter. One bright spot was the fact that only 4.4% of customers were one month behind on their payments, which was an improvement from the prior quarter's 5.1%. Perhaps delinquencies have peaked? Maybe, but if the job market gets worse that seems unlikely.

Nevertheless, stocks are only off modestly compared to the recent powerful rally. Maybe we can finish the day with the Dow still above 9,000 and investors can have a nice, restful weekend? That's assuming that the FDIC takes the weekend off and decides not to seize Guaranty Financial or Corus Bank this Friday. But then again, what's another two bank failures, albeit fairly large and expensive ones, when you're already expecting 500?

PPIP and the Ever-Steepening Yield Curve

Not two months after it was announced with much fanfare, the “Legacy Loan” portion of the PPIP looks DOA, due to lack of interest. The funny thing is that yesterday, an article appeared in the WSJ claiming that banks were jockeying to buy their own toxic assets to move them into off-balance sheet partnerships, complete with government supplied leverage. Sheila Bair wisely put the kibosh on that idea. For one thing, mysterious off-balance sheet partnerships were a big part of the problem (SIV’s anyone?) For another, merely shuffling assets around from one subsidiary to another was never the intention of the PPIP. The PPIP was supposed to provide transparency in pricing. It was supposed to tell us what all of this crap was really worth. How’s that going to happen if banks are buying the assets from themselves with the government just providing leverage to banks that have already received capital injections? In any event, after much furor in the blogosphere, Ms. Bair put her foot down with a resounding “That’s not gonna happen! Now if you’ll excuse me, I have some more loss-guarantees I must work out with some private equity funds.” Ms. Bair hinted that not enough interest, other than that from banks wanting to buy their own assets at inflated prices, was evident to go ahead with the legacy loan plan, which makes me fairly happy because I hated the idea to begin with.

Speaking of government plans gone awry, anyone notice the complete and utter bludgeoning of mortgages and treasuries yesterday? Poor Bernanke, this quantitative easing business is not quite as easy as he thought it would be. The problem with the idea of the Fed buying treasuries to drive down mortgage rates is one simply of supply versus demand. While it may seem like the Fed is buying a lot of treasuries, it is nothing compared to amount of treasuries that the Treasury has to issue to finance our ballooning deficits. So rates go higher. I mentioned earlier in the year that one of the big issues tugging at the market would be the question of deflation vs inflation. Is all of the fiscal and monetary stimulus being heaved at the economy going to cause run away inflation, or is the continuing deleveraging of the financial sector going to cause a deflationary spiral? My answer is that we get deflation first, and then inflation later, which is perhaps what bond investors are betting on right now, as the yield curve is very steep. Declining home prices, fabulous sales on consumer goods, and auctions of downsizer’s valuables are clear signs of deflation. But once the economy turns, which admittedly might not be for awhile, who knows if the Fed will be able to pull back the spigot fast enough to avoid an inflationary spiral?

BankUnited Seized By FDIC, Private Equity Consortium Gets Sweet Deal

BankUnited, the largest independent bank in Florida that specialized in that low-risk business of lending money to foreigners so they could buy properties in Florida during the housing bubble, was finally laid to rest by the FDIC. The FDIC has been looking for a buyer for the beleaguered bank for months, and conducted its auction yesterday. Although the FDIC was hoping to find a legitimate buyer, no bidders emerged that were willing to acquire the failing financial institution without massive loss guarantees. The winning bidder of the carcass of BankUnited was a consortium of private equity investors including Blackstone, Carlyle, Centerbridge and WLRoss yesterday. With assets of nearly $13 billion, BankUnited is the 34th and largest bank failure of the year, and is second only in size to IndyMac’s colossal failure last year.

On the surface, it should seem like a huge relief that the FDIC found a buyer for this large banking dud. That would certainly seem to be the case if the private equity buyers weren’t getting a ridiculously sweet loss guarantee from the US government. The government will take 80% of the first $4 billion in losses and 95% of any remaining losses. The next time I make any investment decision I’m calling the FDIC to see if I can arrange some sort of guarantee where the federal government eats around 90% of my losses, leaving my only risk to be that I break-even instead of make a mint. Oh sure, the FDIC will receive warrants giving it a share of any future upside, but the details on how much it will receive are scant, and it can’t possibly make up for the fact that the government is taking nearly ALL of the downside. Yes, the private equity firms are putting $900 million of equity into the bank and relieving the FDIC from the burden of having to wind down another large bank, but really, is all of that worth $10.7 billion in potential losses?? Seriously, why is the FDIC giving massive loss guarantees to private equity firms? Somehow this arrangement is still billed as a private sector deal with the FDIC claiming that the deal “is projected to maximize returns on covered assets by keeping them in the private sector.” But the truth is that, once again, only the profits go to the private sector, our rapidly dwindling deposit insurance fund gets to eat the losses. It’s “heads I win, tails you lose” all over again. Sadly, this is what our private sector is evolving into, only if you are a well-funded, politically connected finance firm, of course. The FDIC never called me to ask if I wanted to bid and I definitely would’ve tossed my hat into the ring with terms like these. At least the FDIC was approved on Wednesday to borrow $100 billion from the Treasury if it has a shortfall in its insurance fund. That piece of legislation couldn’t have been signed into law soon enough.

Should the FDIC Guarantee Anything Other Than Bank Deposits?

I've ruminated a bit more about the toxic asset plan unveiled by the Treasury Department this morning and read many interesting comments on other blogs.  I have finally honed in on the one point that irritates me the most about the plan: the FDIC's promise to guarantee debt issued by the entities that are purchasing loans under the legacy loans program.  The FDIC is already guaranteeing debt issued by many of our banking institutions.  However, the FDIC's primary purpose is to guarantee bank deposits.  This is what I want my FDIC to do for me.  This is ALL I want my FDIC to do for me.  The FDIC is very good at seizing failed banking institutions, disposing of any salable assets, and making certain that insured depositors are made whole.  The FDIC eats any ensuing losses through its insurance fund.  I like this system as it keeps depositors from panicking and withdrawing their funds from our nation's banks.  Given all of the stress in the financial system, the fundamental belief in the FDIC's ability to guarantee bank deposits has alleviated this type of panic for the most part (IndyMac and Wa Mu to a certain extent excepted.)

As a depositor, I'm a little pissed off that my claim on the FDIC's insurance fund is being diluted and shared with bond investors who are free-riding off of the FDIC's guarantee of bank debt, and now the FDIC's guarantee of the Legacy Loans program debt.  If there ever is a massive run on the US banking system, am I going to be standing in line with PIMCO's Bill Gross, waiting to withdraw my funds from the FDIC?  I fully understand that the FDIC can borrow from the Fed and the Fed can borrow from the Treasury and we can just keep printing an unlimited supply of money.  At some point, however, shouldn't the US government come up with its own capital structure, given how much every government organization is borrowing and is up to its eyeballs in private sector guarantees?  Is FDIC debt senior to the Fed's?  What about Fannie and Freddie's?  How about Treasuries?  When does it all get to be too much?  How can I be certain that I'm holding the senior debt of the US government?   

FDIC Blows Through $16 Billion of the Insurance Fund in Fourth Quarter

The FDIC released its eagerly anticipated quarterly report detailing the sad state of affairs that our banks find themselves in.  At this point, investors are immune to shockingly bad news, so from that perspective, the report was well received as the Dow only sold off around 88 points.  A few highlights for those not interested in reading the press release:

• Commercial and savings institutions insured by the FDIC reported a net loss of $26.2 billion in the fourth quarter of 2008.
• More than two-thirds of all institutions were profitable in the fourth quarter, but their earnings were outweighed by poor performance from a few large banks.  Ahem, you know who you are.
• Total deposits increased by $307.9 billion or 3.5%, the largest percentage increase in 10 years.  This is actually somewhat positive.  It seems that despite all the bad news, we haven't lost confidence in our banks.  It does indicate cash hoarding and risk aversion, but is still better than massive withdrawals and purchases of gold and guns.
• Twelve institutions failed during the fourth quarter and one received assistance.  During the year, a total of 25 insured institutions failed.  The problem list grew from 171 to 252, with total assets increasing from $115.6 billion to $159 billion.
• The Temporary Liquidity Guarantee Program raked in $3.4 billion in fees since its October inception.  Of course we can easily blow through this if any of the $225 billion in outstanding FDIC-guaranteed debt defaults or any of the banks that purchased guarantees on the $680 billion in additional deposits fails.
• Most troubling, in my opinion, is that the FDIC blew through $16 billion of its insurance fund and only has $19 billion available.  $22 billion has been set aside for estimated losses on failures anticipated in 2009.  Call me crazy, but this doesn't seem like nearly enough to cover the potential failures.    There are 252 banks on the list with assets of $159 billion and we're just getting warmed up.  We're not even out of February and already 14 banks have failed this year compared to twelve institutions in the fourth quarter which cost the FDIC $16 billion.  The rate of bank failures is just beginning to pick up steam as the economy has hit a brick wall and default rates will continue to ratchet higher.  Next year will be far more expensive than this year so how is $22 billion supposed to cover the rest of the year?  That number seems completely unrealistic to me.  Although the FDIC board is meeting tomorrow to set deposit insurance rates and to consider adopting enhancements to the risk-based premium system (uh, ya think?), something tells me that they are completely mispricing the cost of the insurance.  Mark my words, before the end of the year, the FDIC will be hitting up the Treasury for cash.  

Update on Operation Hope For Homeonwners and Other Mortgage Modification News

JP Morgan announced a sweeping plan to modify nearly $70 billion in troubled mortgages on Saturday.  According to the Wall Street Journal article, the plan will cover as many as 400,000 borrowers that will benefit from lower interest rates, smaller principal amounts or other more-affordable terms.  The plan is aimed at modifying the terms of option arms, a boatload of which JP Morgan acquired in its takeover of Washington Mutual.  In a shrewd PR move, JP Morgan unveiled the plan days after it received $25 billion from the US Treasury.  

Banks are facing increasing political pressure to use the bailout money to help beleaguered homeowners trapped in upside-down mortgages they either can't afford, or won't be able to afford once their mortgages recast.  The FDIC's Sheila Bair is pushing for widespread mortgage modifications to stop the continuing spiral of increasing foreclosures, plunging home values, leading to more foreclosures.  The government is planning an even larger effort, affecting up to 3 million borrowers, and estimated to cost between $40 billion and $50 billion.  The question remains: Will these modifications prevent foreclosures?  Or were the majority of option arm borrowers only interested in making a quick buck in a hot real estate market and not as keen on homeownership in a flat to declining market where they can rent for less than even their modified mortgage payment?  Perhaps the answers lie somewhere in between.  

A few clues indicating the potential effectiveness of these mass mortgage modifications can be found in the initial results of the programs initiated by Ms. Bair with Indymac borrowers following the FDIC's seizure of the California bank, and Operation Hope For Homeowners.  Operation Hope For Homeowners was passed through congress in July and went into effect on October 1st.  Housing Wire has an update on the progression of this plan, aimed at aiding 400,000 homeowners to refinance into kinder FHA-backed mortgages.  According to Housing Wire, 42 mortgage applications were filed during the first two weeks of the period.  When the plan was originally announced, I suspected that borrowers would not be interested in participating as they had no interest in sharing future equity appreciation with the US government.  According to the story, however, it is the investors that are unwilling to allow modifications, as it requires that they write down the principal to 90% of current LTV (not original LTV) plus pay an upfront premium.  Apparently, investors believe they can achieve higher returns by allowing the homes to go into foreclosure.

And then there's Indymac.  How are Ms. Bair's efforts progressing at Indymac?  The Wall Street Journal had a fantastic story on Saturday about the FDIC's efforts to aid troubled IndyMac borrowers.  IndyMac services 653,000 mortgage loans, about 65,100 of which are seriously delinquent, or at least 60 days late.  Of these, 47,000 might meet its requirement for a new loan.  The FDIC has already completed loan modifications for 3,500 borrowers.  Several thousand more have accepted the FDIC's offer, and are awaiting processing.  However, the FDIC has had difficulty in getting responses from some borrowers.  According to the article, the FDIC mailed out 7,500 letters to delinquent borrowers for whom the FDIC had recent financial information and received responses from three quarters of them.  In the past three weeks, the FDIC mailed offers to another 7,500 borrowers for whom it also has financial information.  Unfortunately, the FDIC has sent letters to another 19,000 borrowers for whom it had no recent financial information.  So far, only 10% have responded.  Uh oh.  If anything, the FDIC's experiment will reveal how many of these delinquent borrowers just flat-out lied on their mortgage applications about their incomes and are willing to walk away.  The statistics are not looking too good.  The Wall Street Journal's story is worth a read for anyone hoping to understand the root of the current mortgage crisis.  It is filled with anecdotal stories, that would be hilarious if they weren't so sad, about house cleaners and tree trimmers who make $35,000 a year that are having problems making the payments on their $700,000 mortgage, while their house is currently assessed at half the value.  Although they claim to want a mortgage modification, their best financial option is just to walk away and rent.  It seems unlikely that any government bailout plan can prevent the inevitability of people taking their best financial option.  After all, it was inevitable that people who were offered ridiculous terms on mortgages that they didn't understand would take those terms to buy a house they otherwise couldn't afford.            

          

Citi Cries Foul, Citing Exlusivity Agreement With Wachovia

The Wall Street Journal is reporting that Citi is claiming that Wachovia is in breach of the Exclusivity Agreement it signed with Citi earlier in the week. Citi states that "Wells Fargo's conduct constitutes tortious interference with the Exclusivity Agreement." Apparently, it's about to get ugly as Citi is using nasty legal terms like "tortious interference." The FDIC has put out a statement that it stands behind the Citigroup deal. Might we see a bidding war over Wachovia, who many had given up for dead at the beginning of the week? I find it hard to believe that the FDIC wouldn't welcome this opportunity to get out of the loss guarantee it granted to Citi and allow a much stronger institution to take over all of Wachovia. Not only is the Wells Fargo deal better for the FDIC, it is better for shareholders of Wachovia, for debtholders of Wachovia and for confidence in the market. Naturally, Citi is pissed because it thought it was getting a sweet deal and had catapulted itself into favored status with the government. But if it wants Wachovia, it better be prepared to pay more.

FDIC's Sheila Blair Vows to Keep Delinquent Borrowers in Their Homes

Yesterday, the FDIC unveiled a plan to keep thousands of currently delinquent IndyMac borrowers from losing their homes to foreclosure.  IndyMac, a formerly top ten mortgage lender that specialized in Alt-A loans during the boom, was seized by the FDIC on July 11th in one of the largest bank failures in US history.  The plan involves modifying thousands of loans through a combination of interest-rate reductions, longer repayment periods and principal forbearance.  The modifications will result in the reduction of homeowners' debt to no more than 38% of income.  Borrowers will need to provide documents verifying their incomes to have their loans modified.  Borrowers will be eligible for the program if they have a first mortgage serviced by IndyMac and are "seriously delinquent" or in default.  

According to Ms. Blair "Our goal is to get the greatest recovery possible on loans in default or in danger of default, while helping troubled borrowers remain in their homes."  I am thoroughly in agreement with Ms. Blair about getting the greatest recovery possible on the loans to keep the costs of this messy bailout at a minimum.  However, I don't think that helping delinquent Alt-A borrowers keep their homes should be a priority for the US taxpayer.  In most cases, Alt-A loans were granted to borrowers with good credit scores who stated their own incomes without providing documentation.  What happens if the loan modification documents are returned by the delinquent borrower to the FDIC with proof of income that shows that the borrower clearly overstated his income in order to obtain a loan to buy a house that he otherwise couldn't afford?  Is the FDIC still going to modify that mortgage, grant that person forbearance, so that he gets to keep his house?  What about the guy who lives next door to the delinquent borrower, who pays his mortgage every month on time and never lied about his income to purchase his house?  If the FDIC is so concerned about keeping liars in their houses, they should foreclose on the property, sell it to an investor, and allow the delinquent borrower first dibs on renting the house from the investor.

Construction Loans At Small Banks Concern Regulators

According to the Wall Street Journal Property Report, regulators have grown concerned over the $280 billion in outstanding construction loans to condo developers and home builders sitting on small banks' balance sheets.  Of particular concern is the practice of putting interest that will be paid into an "interest reserve" and then paying themselves out of the reserve until the loan becomes due or the property generates cash flow, thus masking potential problems with the loans until they blow up.  The FDIC is on alert for banks that are not coming clean about problem loans.  A potential hint that a bank has been using interest reserves to hide delinquencies is a large jump in the percent of nonaccruing loans from one quarter to the next without any prior buildup in the percent of delinquent loans.  The banks draw from the interest reserve until the reserve runs out and then they must reclassify the loan as nonacrruing, without ever noting that it was delinquent.  For example, ANB Financial, the failed Bentonville, Ark bank had 2.8% of loans delinquent in the fourth quarter of 2007 followed by 39.6% of nonaccruing loans in the first quarter of 2008.  The ironically titled Integrity Bank had 13.5% delinquent loans in the fourth quarter of 2007 followed by 35.1% nonaccruing loans in the first quarter of 2008.  Integrity Bank has stopped using interest reserves on loans used only for purchasing land without immediate plans for construction and loans on projects that have been delayed or abandoned.  Well, that's a relief.

It is very interesting that banking practices that have more than likely been business as usual for years can be used to mask potential problems during a major downturn.  I'm certainly not a bank accounting expert but I can see how using interest reserves was viewed as a perfectly reasonable practice when delinquency rates and default rates were low.  Unfortunately, when lax lending standards finally caught up with the industry, it became yet another loophole that banks could utilize to delay reporting the inevitable.  It is practices like these that have investors terrified and lead to suspicion about what other surprises are lurking on bank balance sheets.