JP Morgan To Purchase WaMu Deposits

The WSJ is reporting that JP Morgan will purchase the bulk of Washington Mutual's operations. This is being billed as a "government brokered deal," although it is not expected to affect the FDIC.  Perhaps the Fed is granting yet another one of its generous Bear Stearns-like loans?  The Fed seems to like arranging these types of deals for JP Morgan.  Details of who exactly will be swallowing the losses from WaMu's $60 billion option arm portfolio will be revealed on the conference call at 9:15 pm Eastern.    

Update: JP Morgan is acquiring Washington Mutuals assets and deposits from the FDIC for $1.9 billion.  Reuters reports that the FDIC felt it had to seize the bank before Friday to quell customer anxiety fueled by media leaks.  WaMu had suffered an exodus of $16.7 billion in deposits since September 15th, leaving it with insufficient liquidity.  Shareholders and senior bondholders will be wiped out in the deal.  

Why do we need a $700 billion bailout when JP Morgan can just buy every ailing bank?  Seriously, this is a fine example of why we shouldn't allow the government to pay "hold-to-maturity" prices for assets.  In this situation, a bank failed, and a healthier bank was willing to purchase the assets and deposits.  Shareholders and bondholders were wiped out, depositors were saved, and JP Morgan assumed the remaining risk in WaMu's portfolio because it purchased the assets at what it determined was a good price.  This proves that investors are willing to make opportunistic acquisitions at the right price.  Paulson and Bernanke's idea of buying assets from banks at prices above fair value would be a money-losing proposition.

Lehman Bankrupt, Bank of America Buying Merrill

Both Barclays and Bank of America opted out of purchasing Lehman.  No surprise.  I wouldn't have bought Lehman without a $60 billion guarantee from the Fed either.  My sources are telling me that a bankruptcy filing by Lehman is imminent.

Meanwhile, Bank of America has moved on to considering a purchase of Merrill Lynch.  Interestingly, a sale of Merrill wasn't even in the cards until this week when it became apparent that investors were losing confidence in any leveraged institution's ability to survive through the credit crunch.  No word on Washington Mutual or AIG's fate.  I guess we'll resolve those issues next weekend.     

Foreclosures, Retail Sales, and Financial Company Deathwatch

US home foreclosures rose again in August.  According to Realty Trac, one in every 416 households received a foreclosure filing in August affecting 303,879 properties nationwide, an increase of 12% from July and 27% from August 2007.  Realty Trac indicated these were the highest numbers they've seen since they started tracking foreclosures.  Nevada was once again ranked as the state with the highest foreclosure rate, followed by California and Arizona.  The rate of increases in default notices moderated in parts of the country due to measures taken by states to give troubled borrowers more time before foreclosure proceedings are initiated.  Whether extra time will actually keep borrowers from ultimately defaulting remains to be seen, but this can be viewed as a small positive in otherwise bleak news.

Meanwhile, retail sales were down .3% with ex-autos down .7%.  Excluding gasoline, however, purchases were unchanged last month.  I think this indicates that consumers are dodging those foreclosure notices from the bank by walking to the mall and shopping all day.  

A few updates on Financial Firms on Life Support in a pleasing bullet point format:

• WaMu anticipates loan loss provisions of $4.5 billion, Fitch downgrades to junk
• Lehman still working on a deal, market praying for a resolution
• AIG puking in pre-market trading, CDS spreads continue to widen on continued fears it will be downgraded and forced to raise more capital
• Other brokers also down in pre-market trading after ridiculous rally into the close yesterday

   

Market Tumbles on Pervasive Fears of Financial Failures

Lehman is trading at $4 in the pre-market.  To answer myself from Tuesday's "Will Lehman Go To Zero? Today?" post: Yes, but apparently not until tomorrow.  Equity investors have given the firm up for dead as it has finally dawned on them that the investment bank cannot recover from this crisis of confidence.  Frankly, this is terrible news for the other investment banks as the business model is seriously being questioned.  One investment bank's failure can be viewed as a "one-off" capitulation event.  Another bank clinging to survival a mere six months later begs the question of whether investors want to bet on a model that relies on borrowing huge sums of money on a short term basis.

The market is also betting that Washington Mutual is toast, as the stock has fallen below $2.  Although this is not a surprise to anyone who knew of WaMu's option ARM portfolio (i.e. anyone reading Mock The Market for the past six months) and default rates hitting option ARMs, realization has finally dawned on the market like a ton of bricks in the past week.  What is a surprise to me, is that Wachovia is yet to hit the single digits, as its option ARM portfolio is over $120 billion.

Finally, AIG has been pummeled for the past few days on widening spreads in the CDS market.  As I mentioned in my last post about AIG's toxicity after its earnings announcement, "I don't care how good the insurance business is, until AIG figures out a way to mitigate the risk in its derivatives portfolio, the company will continue to post losses until the credit markets return to normal."  $441 billion in notional CDS?  $57.8 billion tied to subprime?  AIG is short volatility in the volatility perfect storm.  Furthermore, there is a story in the Financial Times addressing the losses that insurers are likely to suffer from the default on Fannie and Freddie CDS.  Apparently the recovery value is currently expected to be around 95 cents on the dollar on an estimated $200-$500 billion of outstanding contracts.  This translates into potential losses of $10-$25 billion for the insurance industry that offered credit insurance.  The International Swaps and Derivatives Association is expected to announce today which of the bond issues from Fannie and Freddie will be eligible to be used to settle the CDS.

Where do we go from here?  Who's next to fail?  How many more bailouts can the US grant? These are all the questions floating around in the market, which makes me think that we can only go lower from here.  

Management Shake-Ups at Lehman and WaMu Can't Change Stinky Investments

If ever there was a time to slip some management changes in below the radar, this weekend was it.  While every investor worth his salt was furiously calculating a new price target on Fannie and Freddie's common and preferred, it was easy to overlook the ousting of a few key executives.  Washington Mutual gave its CEO Kerry Killinger the boot.  According to the Bloomberg report he was ousted "after he failed to halt losses tied to home mortgages."  The newly appointed CEO Alan Fishman, formerly of Meridian Capital, will take a shot next to see if he can halt the losses.  The stock initially ripped on the announcement, before investors realized that a new CEO can't change the fact that the company's balance sheet reeks like a pile of stinking dung.  Speaking of balance sheets that reek, Lehman has shuffled its management yet again.  The company is replacing the current head of fixed income (who spent all of seven months at the post) with two other guys I've never heard of (feel free to click on the link if you actually care about names.)  Dick Fuld remains in charge, and will continue attempting to concoct some sort of spin-off, recap, asset-sale, financing, write-down, half-caff with a twist, but with new yes men by his side.  In my last post about Lehman, I went out on a limb and offered to eat my crox if a deal with KDB actually materialized.  I have yet to put my bib on, so it's looking good for me.  The only good news I can find in the headlines for Lehman and WaMu investors is that Hank Paulson is finished with his Fannie and Freddie plan.  That means he can move on to the next bailout package.  

Option Arms Chart Signals Looming Disaster

The Wall Street Journal had a fascinating story yesterday about FirstFed Financial,  a small bank based in California that focused its lending efforts on option arms to credit-worthy borrowers.  Although the bank had been heralded for its pristine underwriting standards in the past, FirstFed had lowered those standards during the housing boom to avoid losing business to competitors.  FirstFed is now facing a spike in delinquencies that is rivaling levels seen in subprime.  Forty percent of FirstFed's borrowers became at least 30 days delinquent after the payments on their adjustable-rate mortgages were recast.

For those who aren't familiar with option arms, these loans have an initial teaser rate that is significantly below the market rate.  The borrower has several options when he gets the bill every month.  The variety of choices reflect either payments towards principal, the market interest rate or merely the teaser interest rate.  The lowest payment allowed by the loan typically does not cover principal and often does not even cover the interest due, the balance of which is added to the principal amount, leading to negative amortization.  At some point, the borrower is forced to make full payments of principal and interest, either when the loan resets after a preset period (typically five years) or when the principal balance on the loan hits a preset amount (typically 110% to 125%).  When these loans reset, monthly mortgage payments can increase by 60% or more, causing credit-worthy borrowers to begin defaulting at subprime rates.

I have written about option arms ad nauseam here, particularly when I am discussing Washington Mutual and Wachovia, banks which have enormous exposure to these toxic loans.  But sometimes a really good chart is better than words.  What I found most disturbing about the chart is that we haven't even begun to see the bulk of these loans recast.  The second half of 2009 is when it starts to get really ugly, with roughly $30 billion in loans per quarter resetting to higher rates.  How many of those borrowers can really afford spikes of 40-60% in their monthly mortgage payments?  I'll let you mull that one over...    

Wa Mu: What's Another $3.3 Billion?

Washington Mutual proved yet again that it could extract more value from its operations by firing everyone except a few beefy guys to shovel deposits into an incinerator.  Can a handful of former bankers work fast enough to incinerate $3.3 billion in a quarter?  It seems unlikely.  However, the bank had no problem burning through another $3.3 billion on its lousy portfolio of assets.  The Seattle thrift reported a net loss of $6.58 a share, which included a charge related to the $7 billion capital raise the company announced in April.  Excluding the charge, WaMu reported a loss of $3.34 a share.  Apparently, analysts, if you still care what they think, were expecting a loss of $1.05 a share on this basis.  Naturally, the stock immediately ripped higher after the earnings report.  Why?  I haven't a clue.  I suppose the same reason that Wachovia rallied nearly 30% after reporting an $8.9 billion loss before the open.  If anyone out there knows the reason, feel free to enlighten the rest of us.  In the meantime, I'll be scratching my chin until I come up with an explanation.        

WaMu, Wachovia Resort To Desperation

Once the bread and butter of Washington Mutual's core business, negative amortization loans are going the way of the dodo bird, the company announced last week.  In a brilliant PR move, the announcement to discontinue negative amortization and "flexible payment" loans was buried in the ninth paragraph of a press release WaMu issued on June 18th touting an additional $1 billion assistance fund for troubled mortgage borrowers.  The press release did not indicate what the company planned to offer as assistance to its credit card account holders.  Through its ill-timed purchase of Providian Financial, WaMu entered the business of credit card lending to questionable borrowers in 2005 at the peak of the bubble, and has aggressively increased its credit card accounts since.  No surprise that WaMu has the highest proportion of overdue loans among the top 15 providers.  Given how lousy WaMu's timing has been, I suppose it is also not surprising that it took WaMu a year into the credit crisis to figure out that maybe, just maybe, it should stop offering negative amortization mortgages.

Meanwhile, Wachovia has apparently given up trying to solve its own "pick-a-payment" mortgage problem and has hired Goldman Sachs as an adviser.  I imagine that Goldman may take one look at Wachovia's loan portfolio and immediately short the stock.  Wachovia's hiring of Goldman has started the rumor mill once again that some white knight will come along and rescue Wachovia.  JPMorgan is always considered a likely contender, but I'd bet against it.  Wachovia, after all, is still a $17 stock.  When it gets to $2 and comes with a $50 billion loan guarantee from the Fed, maybe Jamie Dimon will start negotiating.  

Goldman was more than likely tapped by Wachovia not only because it has managed to avoid damage suffered by its competitors, but possibly also for arranging the restructuring of Cheyne Finance, the $7 billion SIV that collapsed last year.  If any bank knows what to do with a bunch of underperforming assets, it should be Goldman Sachs.  More than likely, Goldman's solution for Wachovia will mirror what they just pulled off with Cheyne.  Just spin it all off into another investment vehicle and make sure that Goldman gets paid a portfolio management fee after marking the assets down significantly.  Nice gig if you can get it.

Wachovia and Wa Mu Give Leaders the Boot

Wachovia ousted its CEO Kennedy Thompson, as the board opted to blame him for losses that cost the lender more than half its market value...so far. Meanwhile, in other juicy scapegoating news, Washington Mutual's Chairman Kerry Killinger stepped down, after shareholders voted to oust him in April. The board indicated it was responding to feedback from its shareholders. The board may also wish to canvas shareholders for some good ideas on how to stop losing buckets of money. Anyone with feedback in that department is welcome to put it on the shareholder's ballot for a vote. But you'd better hurry because we may not make it to the next shareholder's ballot...

"Liar Loans" Live Up To Expectations

Investors who purchased soured mortgages securities are forcing lenders to repurchase the original loans based on a provision that required lenders to take back loans that defaulted unusually fast if mistakes were made or fraud was committed during the underwriting process. The Wall Street Journal reported yesterday that Countrywide estimated that its liability for such claims rose to nearly $1 billion as of March 31, 2008. Countrywide took a first-quarter charge of $133 million for claims that have already been paid. The loan disputes allege bogus appraisals, inflated borrower incomes, and other misrepresentations made at the time the loans were originated. Demands from loan buyers include Fannie Mae, who claimed in a recent conference call that it was attempting to review every loan that defaults and force lenders to buy back loans that failed to meet promised standards. The bond insurers including Ambac and MBIA which guaranteed investment-grade securities backed by home-equity loans and lines of credit are also getting in the game of scrutinizing the quality of loans in the original pools and taking action where necessary. Even GE, through its subprime mortgage subsidiary WMC Mortgage, is being sued by PMI Group who alleges that WMC misrepresented the quality of loans it included in a pool of subprime loans that were insured by PMI.
Offering further proof that the incidence of misrepresentation was not merely a subprime problem, S&P cut or downgraded its ratings on $34 Billion of Alt-A securities yesterday. Ratings on 1,326 classes of bonds created in the first half of 2007 were reduced. Another 567 similar bonds with AAA ratings were placed on review. A total of 14% of the bond issuance from the period was either cut or placed under review. Late payments of at least 90 days and defaults among Alt-A loans underlying the bonds issued last year rose to 6.64% as of April 2008, up 65% since January of 2008. Clearly the situation is getting worse rather quickly. Alt-A loans were made to borrowers who provided little-to-no documentation of income or assets but had respectable credit scores. Among skeptics they were deemed "liar loans", as it gave borrowers ample opportunity to fabricate their income and assets in order to receive loans to purchase houses they otherwise could not afford. Investors in the securities must've assumed that either borrowers were telling the truth or home prices would never decline. Loans were offloaded by the originators to investors who were more than willing to purchase diversified pools of these loans as they were given AAA ratings by the ratings firms.
Investors are now facing the double whammy of misrepresentations of the borrower's financial condition coupled with declining home prices across the nation. As a consequence, default rates on the loans are surging beyond original estimates when the securities were structured, leaving investors with losses. The ratings agencies are, of course, late to the downgrade party as the securities are already being pummeled in the market. Pissed off investors are now attempting to recoup losses by forcing the originators to repurchase the loans because the quality of the loans was misrepresented. The top four Alt-A lenders in early 2007 were Indymac, Countrywide, GMAC, and Washington Mutual. Clearly these once celebrated lenders have suffered a considerable drubbing. Yet, bottom-fishers have emerged, betting that their fortunes will turn. Given the continuing parade of lousy housing news, I remain a skeptic. Furthermore, I'm disappointed that I never took advantage of the opportunity to purchase a $25 million home using my imaginary bars of gold as a stated asset.

Pending Home Sales Hit Record Low, Again

Pending home sales hit a record low for the second consecutive month in March. March's reading was down 20.1% year-over-year and 35% from the index's peak in April 2005. With the recent resilience in homebuilder stocks, powered by those who must believe that the housing market is bottoming, these numbers should be a disappointment. In my universe of understanding, a bottom should be followed by some sort of uptick, not continuing declines. The nagging persistence of weakness in the housing market is perplexing to those who subscribe to the theory that loose monetary policy always juices the market. The Fed has done its part, now where are all the buyers? Or was a large portion of demand in the housing market merely the result of lenders handing money to anyone with a pulse who claimed to have assets and income?
A close look at Fannie Mae's earnings yesterday reveals that the company has a problem with its Alt-A portfolio. Apparently, $946 million of the $2.2 billion in losses incurred during the first quarter involved Alt-A loans. The company went on to state that it had $344.6 billion in Alt-A exposure and a limited strategy for stemming future losses. For those unfamiliar with Alt-A mortgages, they are backed by loans to borrowers with higher credit ratings than subprime but have little to no documentation of a borrower's assets or income. Fannie's Chief Daniel Mudd said the vintages performing the worst in a four-year average book were late '05, '06, or early '07. This should not come as a surprise as housing prices peaked in 2005, and mortgage lenders dropped like flies in early 2007, causing what is the biggest problem for current mortgage borrowers: the lack of ability to refinance. The inability of overextended borrowers to refinance into a more favorable loan is the root of surging delinquencies leading to foreclosures. It is such a big problem that I don't believe any government plan will be able to adequately address it.
Here is the link to a fantastic post on a UK blog which follows the path of one single mortgage pool of $500 million in Alt-A loans securitized by Washington Mutual in May 2007. The average credit score of the pool was 705, 92.6% was originally rated AAA, even though only 11% provided full documentation of assets. Less than one year later, in April 2008, 29.07% of the pool was 60 days delinquent or more, 13.87% was in foreclosure and 6.21% was an REO (the property had reverted to the lender after foreclosure.) These numbers grow worse and worse every month. When I hear the pundits talking about the prices of MBS being grossly understated due to unrealistic default rates priced in, I wonder if they've looked at some of these stats. This particular pool, which was not even subprime, is looking at potential default rates of over 50% and it isn't even a year old. Then I look at FNM's statement that it has $344.6 billion in Alt-A exposure. I scratch my head at why everyone rushed out to buy FNM's stock yesterday. Then I go to Costco and buy my alloted bag of rice for the day.

CIT Announces Common and Convertible Preferred Stock Issuances Totaling $1 Billion

Joining the chorus of financial institutions desperate to beef up capital in today's uncertain markets is CIT, who announced concurrent offerings of common stock and convertible preferred today after the close of trading. The funniest thing about this offering (I'm sure you never believed there could be humor in a stock offering) is that CIT is using some of the net proceeds from the sale of the common to pay dividends to the outstanding preferred stock holders as well as interest to the outstanding junior subordinated notes. So, if you're actually buying into this stock offering, the company is taking your money and handing it out to other investors before it begins to deal with its major liquidity issues.

Nevertheless, issuing gobs of common, convertible, or preferred stock is the current thing to do as evidenced by:
1.) Citigroup, who plans to sell $6 billion of hybrid bonds.
2.) NCC, who is raising $7 billion, as noted below this morning.
3.) JPMorgan, who issued $6 billion of hybrid bonds.
4.) Wachovia, who raised $8 billion in common and preferred stock.
5.) Washington Mutual, who raised $7 billion.
6.) Lehman who issued $4 billion in convertible preferred stock, and UBS who is planning a major rights issue.
7.) Did I forget someone? I'm sure I did. Oh, that's right. My mother. I called my mother and told her that investors were dying to throw billions of dollars at any financial institution, even if it was carrying tons of assets it doesn't know how to value. So she's opening a bank, collateralized by some old shoes and is issuing a $2 billion convertible preferred. Give her a call if you're interested.

The Stock Buyback Scam

One of the great lessons future business leaders learn in business school is that stock buybacks are great. It is hammered into their skulls in class after class. It's tax efficient! It counteracts dilution! Blah blah blah. I propose that, on the contrary, stock buybacks are terrible for long term stockholders because they temporarily prop up the price of the stock so that insiders can sell at more favorable prices. Furthermore, companies tend to buy more stock in good times, thus paying a premium for their own shares. In fact, companies are locking in enormous losses in their stock trading. Washington Mutual just issued 176 million shares of stock at $8.75. In 2006 and 2007 WM purchased approximately 150 million shares of its own stock at an average price of $43.48. The company just punted $5.2 billion dollars trading its own stock. Wachovia's 10K shows it spent approximately $8.4 billion purchasing its own stock in the past three years for about 150 million shares. A bit of simple math shows that Wachovia paid around $52 on its own stock. Today it announced it was issuing shares at $24 for a loss of $4.2 billion. Let's see, buy at $52, sell at $24. Even my nine month old baby knows that's a bad trade, and she tries to eat her socks.

The stock market is littered with companies that are being forced to issue shares at enormous discounts to where they purchased shares a year ago. In Barron's this weekend, there was a small blurb that noted the $589 billion in buybacks companies engaged in last year. Furthermore, S&P was quoted as saying that buybacks would continue to be strong in 2008. I beg to differ. Take the stock issuance frenzy in financials, add one part freeze in current buyback programs, add another part major problems raising capital due to credit market fiasco and what do you get? I'm certain you don't get strong buybacks in 2008. In fact, I would have to ask if the guys at S&P are smoking crack! Even Whitney Houston can tell you that S&P is dead wrong, and she's the most public crack smoker I know, although I hear, she's finally laid down the pipe. I predict that 2008 will be the year of the backlash against stock buybacks.

Wa Mu Raises Money to Last Seven Quarters...

In case you haven't heard the news, Wa Mu is getting a $7 billion capital infusion from TPG, the big private equity group. WM is selling 176 million common shares for $8.75. So if you are buying the stock right now for $12.50 or so, you're a chump! Separately, yet somehow strangely related WM reported a "preliminary" first quarter loss of $1.1 billion. Initially, TPG's capital infusion was rumored to be around $3 billion. Then the number went up to $5 billion. Now it is $7 billion. I guess TPG wanted their investment to last at least seven quarters, so they could collect some management fees from their investors. Seriously, this may prove to be a very good investment for TPG, but it's difficult to know at this point. WM holds $58 billion in option arms in its $110 billion loan portfolio. Furthermore, WM has $60 billion in home equity loans as well as an addition $20 billion in subprime home loans and home equity loans. We'll see how many of those option arm borrowers pick the option of walking.