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Survey Finds High Level of Loan Failure AP 9-05 A third of home loans originated by mortgage brokers failed to close in August as investors shied away from riskier borrowers, a new survey says. The survey of 1,700 mortgage brokers sponsored by trade publication Inside Mortgage Finance comes as numerous lenders that catered to subprime borrowers with weak credit close down and lenders back away from riskier lending practices common in recent years. There's a problem with funding commitments not being honored," by lenders, said Thomas Popik, who designed the survey for Washington-based research firm Campbell Communications. Three years ago, Popik said, a survey of real estate agents found that only 4% of transactions failed to close on average. The survey also found that some homebuyers backed away from deals last month. Some may be waiting to see if market improves, while some sales may fall apart because sellers are unable to get financing for their new home, Popik said, noting that sales agreements often are contingent on buyers selling their current home. The survey also found that nearly half of borrowers with adjustable rate mortgages were not able to refinance their loans. That's a major concern of policymakers as an estimated that 2.5 million mortgages given to borrowers with weak credit will reset at higher rates by the end of next year, according to the Federal Deposit Insurance Corp. Mortgage brokers account for about one-third of total mortgage originations, and have originated a larger share of loans to riskier borrowers, so the percentage of failed loans in the entire market may be smaller. Nevertheless, the results provide another indication of how the housing market's troubles are continuing. Total subprime lending was down more than 50 percent in the first half of the year as lenders pulled back from risky loans. Countrywide Financial Corp. was the top subprime lender, followed by Citigroup, HSBC Holdings, Merrill Lynch subsidiary First Franklin Financial Corp. and Wells Fargo, according to Inside Mortgage Finance. The Meaning of Libor David Gaffen, WSJ 9-07 When the Federal Reserve and other central banks take actions as they have in the last few weeks, the aim is to reassure people – to essentially get investors to a position where they believe the financial system is running smoothly. But market indicators such as LIBOR suggest investors haven’t gotten the message. The London InterBank Offered Rate, or LIBOR, generally trades a few hundreds of a percentage point above the federal-funds rate. It’s a key global benchmark, sort of a “traded version of the fed funds rate,” according to Guy LeBas, fixed income strategist at Janney Montgomery Scott. As such, it’s an important benchmark for determining lending rates on big corporate deals, mortgages and other lending markets. The thing is, as the Wall Street Journal pointed out a few days ago, that rate has been out of whack for some time. Of late one-month LIBOR was traded at 5.82%, higher than the Federal Reserve’s discount rate of 5.75%. It means banks are not willing to lend short-term money to each other for fear that, as Mr. LeBas says, “the next person you lend to will be the one who goes out of business.” There are a number of reasons for this, not the least which has to do with tightening in credit markets, but economists say it has to do with supply. Lots of banks are holding cash on their balance sheets, essentially locking it away in a safe, and they’re doing this because of the asset-backed commercial paper market, which has frozen up. Many European banks have credit lines to big issuers of this paper, and because nobody wants to take on more of that paper, those companies instead are looking to borrow using their credit lines — making banks more needy for cash so they can build up reserves. “More than $1 trillion of commercial paper is set to come due in the next six weeks a big test for commercial paper market and worry for the banks,” writes David Rosenberg, chief North American economist at Merrill Lynch. What they’re worried about is when the CP issuers will need that funding, because if they do, banks don’t want to tie up their reserves lending to other banks. “Banks are reluctant to lock up liquidity and lock in a larger balance sheet by giving a 3-month loan to another bank, even at rates that would normally seem extremely attractive,” says Robert Sinche, head of forex strategy at Bank of America. And here’s the other thing: there doesn’t seem to be much the Fed can do about it. The Fed and ECB have already been goosing the markets with liquidity through reserve operations, and while cutting the federal-funds target (currently 5.25%) might help, it isn’t likely to decrease the spread between that rate and LIBOR. Why Banks Should Account For Conduits David Reilly, WSJ 9-11 When Allstate or AIG write insurance policies on hurricanes or car crashes, they account for possible losses. When banks write the equivalent of an insurance policy in the murky world of commercial paper, they don't record the commitment until a problem erupts. Banks such as Citigroup, J.P. Morgan Chase and Bank of America have written what amounts to more than $250 billion in insurance to an important collection of affiliates in the past few years. In good times, these affiliates -- known as conduits and structured investment vehicles -- raise money in the commercial paper market and use the cash to finance investments. When they can't raise money in commercial paper markets, they can in some cases turn to the banks for loans. The commitments banks make to fund their affiliates are known as "liquidity backstop agreements." Given the turmoil in commercial paper markets recently, it would be nice to know more about them. But bank shareholders are largely in the dark about the potentially huge exposure. Banks do make some disclosures to regulators and investors about the agreements. But they don't have to record them on their books until something goes wrong. Conduits themselves are also kept off bank balance sheets. Accounting experts are now clamoring for a change to the potential black hole in disclosure. "Banks need to do a better job of letting the capital markets know what their exposure is to these kinds of vehicles and how it's changing," says Edward Trott, who recently retired as a member of the Financial Accounting Standards Board, which sets U.S. accounting rules. One remedy: Treat liquidity backstop agreements like derivative contracts and make banks account for them just as if they had written an option for a stock or bond. That would involve adjusting their value as the market changes. Until it happens, investors are going to have to scramble to figure out which banks are most exposed. Is it safe to buy bargain bank and brokerage stocks? Michael Sivy, Money Magazine 9-07 My first article for money appeared in 1980, and since then I've learned two things about the stock market. The first is that it's easier to spot when stocks are near a bottom than when they're at a top. Investor enthusiasm seems to have no bounds when stocks are rising, but at some point declining stocks get support from the fundamental value of their underlying businesses. The second thing I've learned is that if you're smart enough to spot bargains after any kind of market crisis, you'll almost certainly buy too soon. With a few exceptions, like the rebound immediately after the 1987 crash, crushed stocks need months to recover. Rush to buy and your money will remain stagnant - or worse, you could get hammered in a final sell-off. The recent collapse in financial stocks, caused by the subprime mortgage crisis, will create exactly the kind of bargains that can boost your long-term returns - as long as you're patient and willing to wait for the correction to run its course. In two similar cases, the savings and loan crisis of 1989-90 and the fallout from the 1998 implosion of the Long-Term Capital Management hedge fund, financial stocks rebounded by more than 50% within two years of hitting a bottom. Once this current correction comes to an end, financial stocks will likely offer some of the best values in the market. They were cheap before, often yielding 3 percent or more in dividends. Once the stocks finish falling, their price/earnings ratios will be even lower and their yields even higher, of course. And most important of all, they'll be less risky, since the worst of the financial sector's problems will have come to the surface. Get the timing right To fine-tune your investing strategy, it helps to understand why the present crisis has come about. Soaring housing prices and low interest rates encouraged lenders to offer loans to home buyers who might not otherwise have qualified. Wall Street found ways to repackage these riskier home loans in ways that made them appear safe, encouraging even more lending. And homeowners found that they could live beyond their means by using credit cards and then periodically refinancing their houses to pay off the card balances. The merry-go-round couldn't continue indefinitely. This year a critical number of homeowners defaulted. It has devastated the portfolios of some hedge funds that are loaded up with mortgage-backed debt securities, and it sent some of the country's biggest mortgage lenders reeling. And because those debt securities are so widely distributed, many money managers aren't even sure how vulnerable their holdings are. There's fear that banks and brokerages may have losses far greater than anyone expects. As a result, financial stocks have fallen an average of 12 percent from their May highs, and some lenders, such as Countrywide Financial, are down by a third or more. Already, Countrywide has attracted the attention of Warren Buffett and received a $2 billion investment from Bank of America. But they've got strategic reasons to ally with Countrywide. You don't. In fact, history argues that you should wait to buy financial stocks. In the previous panics of the past two decades, once the major decline in financial stocks began it lasted more than six months, and it was significantly worse than the decline of the overall market. In the savings and loan crisis, where mortgage lenders had made large numbers of irresponsible loans, financial stocks dropped almost 50 percent over a period of 12 months. That compares with a drop of only 20 percent for the S&P 500. The second decline has its roots in the 1997 East Asian financial crisis. Long-Term Capital Management, a hedge fund that used computers to profit from small price discrepancies between U.S. and foreign bonds, collapsed when the debt crisis disrupted bond-price patterns. The stock market turmoil that resulted lasted for seven months. During that time financial stocks dropped 34 percent; other major market sectors lost 20 percent to 30 percent. Buy the strongest stocks Once the decline is over - and as the examples above suggest, that could take several more months - you should be able to find great bargains among financials. The best mix of risk and return will be among the higher-quality banks. They'll likely get dragged down along with the weaker stocks in the sector, but they'll have the least chance of developing crippling problems. Stocks worth considering include Bank of America and Wells Fargo, both of which are in the Sivy 70. Brokerages, which may be far more directly involved in troubled mortgage securities, will also likely be driven down to bargain levels. For the best risk-return balance, it makes sense to avoid those with the greatest problems, such as Bear Stearns, and gravitate instead to diversified giants such as Merrill Lynch. And spread your risk among a variety of banks and brokerages. You could do this through a sector fund, such as Fidelity Select Financial Services, or through an ETF such as Financial Select Sector SPDR, Vanguard Financials or one of the iShares Financials. Don't worry about catching the absolute bottom in financial stocks. I prefer to miss the first few points in a rebound rather than jump in too early and see my investments sink further. Especially when history suggests patience will prove a virtue. Ratings & Dividend Changes On 7-20 KEY declared a dividend of 36.5 cents/share payable on Sept. 14 to shareholders of record as of Aug. 28. On 8-14 STI declared a dividend of $0.73/share payable on September 14, 2007, to shareholders of record on September 1, 2007. On 8-21 WB increased it's dividend to 64 cents/share from 56 cents/share payable Sept. 17 to shareholders of record Aug. 31. On 9-21 Lehman Brothers reiterated their ratings on several banks: BAC at Equal-weight; BBT at Underweight; C at Overweight; CBH at Equal-weight; FITB at Equal-weight; FHN at Equal-weight; JPM at Overweight; MI at Equal-weight; RF at Underweight; USB at Overweight; WB at Overweight, and ZION at Equal-weight. Home Page Factoids Previous Update |