Whither the Orphans?

As we discussed earlier this month, the US Federal Reserve's program to buy up Mortgage Backed Securities ended at midnight March 31st and the market was now on its own for the first time in over one year.

Bond fund manager's like Bill Gross have begun steering more of their money away from bonds as Washington unplugs the economic life support programs that kept rates low through the financial crisis.

Yields have started to climb and twice in a span of two weeks we have seen Canadian banks raise their mortgage rates despite no action from the Bank of Canada.

And looming in the background is the plight of the Orphans.

Several years ago the Harper government changed the rules allowing alternate lenders access to the Canadian mortgage market.

US players such as Xceed Mortgage Corp., GMAC Residential Lending and Wells Fargo were allowed access to Canadian markets to offer mortgages to high risk clients.

In other words they offered Canadian subprime mortgages to clients who could not qualify for CMHC mortgages.

But in the wake of the financial crisis of 2007/2008, the business of subprime loans has dried up. Prior to 2007, there were at least a dozen subprime lenders in Canada and it was the fastest-growing sector of the entire mortgage market cornering about 5% of the total market.

But most of those lenders have either changed their business or closed up shop.

Compounding the dilemma is the fact that in the meantime the rules around home loans have been tightened and the federal government has raised the minimum down payment required for Canada Mortgage and Housing Corp. insurance.

So what's to become of all those Canadian subprime clients?

No one knows for sure how big the problem really is because there is no central database tracking these mortgages. In a Financial Post story this week, Ivan Wahl chief executive of Xceed (one of the biggest players in Canada until it recently converted to a bank) stated the subprime market in this country grew to about $11-billion in 2006, the year before things started to implode.

When the credit crunch hit, most of these US companies bailed out of Canada.

And what of the Canadians who had mortgages through these companies?

They were informed that their mortgages could not be renewed and as these companies were closing their subprime businesses, they would have to find another lender.

But the little lenders who had been so eager for their business back in 2005 have disappeared. That left the big banks and insurance companies, but they won't lend to these unqualified subprimers.

The end result... our own looming subprime-mortgage mess.

Industry insiders say that, as an estimated 30,000 so-called "orphan mortgages" reach maturity, these borrowers will have no choice but to default and trigger a flood of foreclosures.

"This thing is a wave and it's just starting," says Eric Putnam, formerly with a subprime lender, now managing director of Debt Coach Canada, a company that provides financial and bankruptcy advice to consumers.

Now the subprimer's are only a small portion of the huge Canadian mortgage pie, but so were the American subprimers.

And since the vast majority of these subprime loans were made around 2005 - 2007, it means they're coming due over the next two years.

Should we simply let them fail and default?

They don't qualify for CMHC insurance because they present a severe risk. But will allowing them to fail be one small domino that triggers a similar fate as the US experience - especially given housing prices will come under pressure from rising interest rates?

The mortgage industry is so concerned about the situation that it recently approached the federal government with a request for a bailout.

According to Mr. Putnam and others, it wants the federal government to participate in a $1-billion fund to help finance the coming flood of orphan mortgages.

Is this fair?

And if these high risk, unqualified borrowers get CMHC insured mortgages, shouldn't other Canadians be entitled to the same treatment?

During the credit bubble, Canadian subprime lenders funded themselves through the asset-backed commercial paper market. The loans they made were packaged up and sold to securitization pools and then to investors in the form of ABCP.

But when the commercial paper market froze up in the financial crisis, lenders were suddenly left without a way to fund their businesses.

"Investors are no longer willing to continue on and these mortgages were not insured by the Canada Mortgage and Housing Corp., so the borrowers are not going to be able to move to another lender in today's environment," Mr. Putnam says.

It presents a disturbing dilemma for the Canadian taxpayer.

=====================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

So what, exactly, happened yesterday in the stock market?

Why did the stock market drop so dramatically in the last hour of trading yesterday? Here's the story from Bloomberg:

• "Oct. 21 (Bloomberg) -- U.S. stocks tumbled in the final hour of trading after analyst Dick Bove downgraded Wells Fargo & Co., erasing an earlier rally spurred by better-than-estimated results at Morgan Stanley and Yahoo! Inc. Wells Fargo, the largest U.S. home lender this year, slid 5.1 percent after Bove of Rochdale Securities cut the shares to “sell” and said earnings were boosted by mortgage-servicing fees rather than improving business trends."

Okay... so what?

First off you have to appreciate that Richard Bove is a screaming bull when it comes to the major banks in the United States.

More importantly, he's highly respected. Tim Smalls, head of U.S. trading at Execution LLC in Greenwich, Connecticut had this to say about Bove, "he has a very good following and very long track record of consistency.”

But that's not the best of it. Bove - cheerleader of major bank stock and shill for the likes of Fargo - was on CNBC yesterday morning raving about Wells Fargo.

Then he saw Fargo's numbers.

Faithful readers will recall we thoroughly eviscerated Wells Fargo back in April when the Bank stunned the world by proclaiming it had just finished its most profitable quarter ever. To say we were incredulous is an understatement

And when Bove saw Fargo's most recent report, he (finally) came to a similar conclusion and dramatically switched his assessment of Fargo from "buy" to “sell”; a stunning turnaround from someone who had just that morning been singing the bank's praises.

Bove said the “most disturbing” thing about Fargo’s results is that loan losses seem to be accelerating. Assets no longer collecting interest climbed 28% to $23.5 billion from the second quarter, while the reserve to cover future loan losses grew by $1 billion from the second quarter to $24.5 billion.

What they mean when they say "assets no longer collecting interest", they mean foreclosed homes that no one is paying back anymore. They're UP 28%! And Fargo is has INCREASED the reserve for future losses to $24.5 billion. That represents a potential of almost $50 Billion in loan losses (the size of Canada's record breaking deficit).

The fact of the matter is that the US banking system remains basically insolvent as unemployment soars and the economy worsens. People are walking away from their homes in the United States in record numbers as home prices continue to nosedive.

And what the Wells Fargo numbers tells us is that the loan losses that the major US banks have been hit with are STAGGERING and the problem continues to worsen.

Meanwhile many banks continue to play a sleight-of-hand game by creating a shadow inventory of unreported foreclosed homes. These are homes that are sitting empty because their mortgage holders have walked away but the banks haven't 'officially' foreclosed on them.

They do this in a vain attempt to stem the glut of product hitting the housing market and driving down prices.

These shadow inventories are still incredibly high and hide the full extent of the housing collapse in the United States.

Fargo has only admitted to $23 billion of bad loans. What does that number look like when you include Wells' shadow inventories? We're willing to bet Fargo's reserve of an additional $24.5 billion doesn't even begin to cover it.

The banks recent record profits are a sham because (as pointed out in April) the government has allowed them to use manipulative regulation and accounting standards to play a shell game that allows them to defer taking the losses from the housing bust (mark to market, among others).

It's like they are pretending it never happened.

And as you may recall, the burst in the stock market after quantative easing was announced was propelled by Wells Fargo and their announcement of 'record profits'.

Back in April we said, "the more information that comes out, the more disconcerting the stability of the bank appears. Watch for Fargo stock to drop like a rock when complete financial statements come out. And with it could go investor confidence in the latest market rally."

That reckoning may not fully play itself out yet... but one thing is now very clear; it's coming.

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

More on Wells Fargo, yesterday's market rally and an update on a previous post

.

Faithful readers know that I have beaten up on Wells Fargo in the past because of it's dramatic financial balance sheet turnaround.

Critics have raised concerns that the stunning improvement in their financial situation has more to do with bookkeeping manoeuvres than the fundamental improvements.

Enter the infamous 'stress tests' of the 19 largest financial firms in the US. These 'tests' are a centerpiece of the Obama administration's plan to stabilize the banks. Some critics have decried the process as weak and ineffective, an artificial attempt to instill confidence in America's financial system.

Regulators have said they will not allow any of the 19 firms to fail because it would be too dangerous for the rest of the financial system. Wells Fargo holds billions of dollars in mortgage, construction and credit card loans.

And based on the results of their 'supposedly sound' quartly balance sheet released last month, Fargo stock has almost doubled in value.

Which make the latest leaked results of the 'stress tests' even more disturbing.

Wells Fargo is one of several banks that regulators will force to hold larger buffers to protect them against possible future losses, according to two people familiar with the matter who spoke on condition of anonymity because of the sensitivity of the process.

Apparently regulators have told Wells Fargo to shore up its finances after the stress tests showed the bank would have trouble surviving a deeper recession.

What happened to the outstanding quarterly results that had Wells Fargo on an excellent financial footing?

-------------------------------

In the Markets yesterday...

Yesterday, at about 11:05am, the Canadian Business News Network declared that different conditions were driving the market upward for the day. The BNN host stated that "gains appear to be driven by investors who are jumping into the market for fear of missing out on the rally".

Hmmm...

'Green shoots' that are nothing more than signs the economy is doing less worse, instead of getting better & impulse stock buying because investors fear they are missing out on the rally.

Perhaps you recall yesterday's post about the three stages of a bear market trap?

Don't look now, but I think the canary in that cage over there is dead.
-------------------------------
Update Post

You will recall that on Saturday April 25, 2009 I made the following post titled "Deja Vu - all over again". On that day the phrase that pays was 'corporate-style subprime loans'.

I cautioned that the next big financial disaster looming on the horizon in the United States was commerical mortgages structured just like the subprime housing loans.

Today the Miami Hearld published a story sounding a warning over this exact issue. Quoting the article, "Thousands of commercial mortgages valued at hundreds of billions of dollars are approaching a renewal date. By some estimates, two out of every three will no longer meet the original loan conditions and won't be able to refinance. And with prices for commercial properties expected to plunge, a vicious cycle may unfold much as it has in the nation's housing market.

A commercial mortgage meltdown is likely to prolong the nation's economic recovery. The falling prices in commercial real estate will lead to additional bank losses at a time when banks are sapped by home mortgage defaults and soaring credit card defaults. This could lead to future additional taxpayer assistance for the banks."

Hmmm... make that TWO dead canary's in that cage.

==================

Email: village_whisperer@live.ca

Wells Farce-Co?

.

At the beginning of last week I made a post about how Wells Fargo Bank had stunned the world by proclaiming it had just finished its most profitable quarter ever. Stock market investors jumped on the news with blind faith and the bank's stock soared. What sent Wells shares soaring was a three-page press release in which the San Francisco-based bank said it expected to report first-quarter net income of about $3 billion. Wells disclosed few details of what was in that figure. And by pushing the stock up 32 percent that day to $19.61, investors sent a clear message: They didn’t care.

As I said, we will watch the Fargo situation unfold with interest as questions were being raised about the Banks optimistic appraisal of it's financial situation.

On April 22nd the company will be releasing its first-quarter results and the flurry of speculation is intensifying.

We already talked about how Wells’s earnings may have gotten a boost from an accounting maneuver, since banned, that it used last year as part of its $12.5 billion purchase of Wachovia Corp. Specifically, Wells carried over a $7.5 billion loan-loss allowance from Wachovia’s balance sheet onto its own books.

Once it took control of the reserve from Wachovia, Wells was free to start dipping into it to absorb new credit losses on all sorts of loans, including loans Wells had originated itself.

It appears to be a very deceiving slight of hand. Had Wells completed its purchase of Wachovia on Dec. 31, it wouldn’t have been allowed to carry over the allowance had it completed the acquisition a day later. On Jan. 1, new rules by the Financial Accounting Standards Board took effect prohibiting such transfers. A Wells spokeswoman, Janis Smith, declined to comment.

As if that were not enough, other interesting tidbits are now coming out.

The most closely watched measure of a bank’s capital these days is a bare-bones metric called tangible common equity. While the term doesn’t have a standardized definition under generally accepted accounting principles, it typically means a company’s shareholder equity, excluding preferred stock and intangible assets, such as goodwill leftover from past acquisitions.

Measured this way, Wells had $13.5 billion of tangible common equity as of Dec. 31, or 1.1 percent of tangible assets. Yet in a March 6 press release, Wells said its year-end tangible common equity was $36 billion. Wells didn’t say how it arrived at that figure.

Even more disturbing is Wells’s Dec. 31 balance sheet. On it is a $109.8 billion line item called “other assets.” What’s in that number? For that breakdown, you need to go to a footnote in Wells’s financial statements. And here’s where it gets comical.

The footnote says the largest component was a $44.2 billion bucket that Wells labeled as “other.” Yes, that’s right: The biggest portion of “other assets” was “other.” And what did this include? The disclosure didn’t say.

That $44.2 billion is more than Wells’s tangible common equity, and no one knows what it is comprised of.

The more information that comes out, the more disconcerting the stability of the bank appears.

Watch for Fargo stock to drop like a rock when complete financial statements come out.

And with it could go investor confidence in the latest market rally.

==================

Email: village_whisperer@live.ca