Banks Swallow Another $30 billion or So in More Losses as Their Share Prices Surge (Again)

Two months ago I pointed out an anomaly in JP Morgan’s
“blowout” quarterly earnings release - Reggie Middleton on JP Morgan’s
“Blowout” Q4-09 Results. Let’s reminisce…

Warranties of representation, and forced repurchase of
loans

JP Morgan has increased its reserves with
regards to repurchase of sold securities but the information surround
these actions are very limited as the company does not separately
report the repurchase reserves created to meet contingencies. However,
the Company’s income from mortgage servicing was severely impacted by
increase in repurchase reserves. Mortgage production revenue was
negative $192 million against negative $70 million in 3Q09 and positive
$62 million in 4Q08.

Counterparties who are
accruing losses from bad loans, (ex. monoline insurers such as Ambac
and MBIA, see A Super Scary Halloween Tale of 104
Basis Points Pt I & II, by Reggie Middleton circa November
2007,) are stepping up their aggression in pushing loans that
appear to breach certain warranties or smack of fraud. I expect this
activity to pick up significantly, and those banks that made
significant use of brokers and third parties to place mortgages will be
at material risk – much more so than the primarily direct writers.
I’ll give you two guesses at which two banks are suspect. If you need a
hint, take a look at who is increasing reserves for repurchases! JP
Morgan and their not so profitable acquisition, WaMu! 

As I said, losses should be ramping up on the mortgage sector.
Notice the trend of housing prices after the onset of government bubble
blowing: If Anybody Bothered to Take a Close
Look at the Latest Housing Numbers…

PNC Bank and
Wells Fargo are in very similar situations regarding acquiring stinky
loan portfolios. I suggest subscribers review the latest forensic
reports on each company to refresh as the companies report Q4 2009
earnings. Unlike JPM, these banks do not have the investment banking
and trading fees of significance (albeit decreasing significance) to
fall back on as a cushion to consumer and mortgage credit losses.

March 5 (Bloomberg) – Fannie Mae andFreddie Mac may force lenders
includingBank of America Corp., JPMorgan Chase & Co., Wells Fargo & Co. and Citigroup Inc. to buy back $21 billion of home
loans this year as part of a crackdown on faulty mortgages.

 That’s
the estimate of Oppenheimer & Co. analyst Chris Kotowski, who says U.S. banks
could suffer losses of $7 billion this year when those loans are
returned and get marked down to their true value. Fannie Mae and
Freddie Mac, both controlled by the U.S. government, stuck the four biggest U.S. banks with losses
of about $5 billion on buybacks in 2009, according to company filings
made in the past two weeks.

The surge shows lenders
are still paying the price for lax standards three years after
mortgage markets collapsed under record defaults. Fannie Mae and
Freddie Mac are looking for more faulty loans to return after suffering
$202 billion of losses since 2007, and banks may have to go along,
since the two U.S.- owned firms now buy at least 70 percent of new
mortgages.

…

Freddie Mac
forced lenders to buy back $4.1 billion of mortgages last year, almost
triple the amount in 2008, according to a Feb. 26 filing. As of Dec. 31,
Freddie Mac had another $4 billion outstanding loan-purchase demands
that lenders hadn’t met, according to the filing. Fannie Mae didn’t
disclose the amount of its loan-repurchase demands. Both firms were
seized by the government in 2008 to stave off their collapse.

….

The government’s efforts might be
counterproductive, since the Treasury and Federal Reserve are trying to
help banks heal, FBR’s Miller said. The banks have to buy back the
loans at par, and then take an impairment, because borrowers usually
have stopped paying and the price of the underlying homehas plunged.
JPMorgan said in a presentation last month that it loses about 50 cents
on the dollar for every loan it has to buy back.

Striking a Balance

“It’s a fine
line you’re walking, because the government’s trying to recapitalize
the banks, not put them in bankruptcy, and then here’s Fannie and
Freddie putting more pressure on the banks through these buybacks,”
FBR’s Miller said. “If it becomes too big of an issue, the banks are
going to complain to Congress, and they’re going to stop it.” [Of,
course! Let the taxpayer eat the losses borne from our purposefully
sloppy underwriting]

Bank
of America recorded a $1.9 billion “warranties expense” for past and
future buybacks of loans that weren’t properly written, seven times the
2008 amount, the bank said in a Feb. 26 filing.
A spokesman for Charlotte, North Carolina- based Bank of America, Scott Silvestri, declined to
comment.

JPMorgan, based in New York,
recorded $1.6 billion of costs in 2009 from repurchases, including $500
million of losses on repurchased loans and $1 billion to increase
reserves for future losses, according to a Feb. 24 filing.

“It’s become a very meaningful issue, and it
will continue to be a meaningful issue for the next couple of years,” Charlie Scharf,
JPMorgan’s head of retail banking, said at a Feb. 26 investor
conference. He declined to say when the repurchase demands might peak.

…

“I can’t forecast the rates
at which they’re going to continue,” she said. Her division
lost $3.84 billion last year, as the bank overall posted a $6.28
billion profit. “The volume is increasing.”

Wells
Fargo, ranked No. 1 among U.S. home lenders last year, bought back
$1.3 billion of loans in 2009, triple the year-earlier amount,
according to a Feb. 26 filing.
The San Francisco-based bank recorded $927 million of costs last year
associated with repurchases and estimated future losses.

…

Citigroup increased its repurchase
reserve sixfold to $482 million, because of increased “trends in
requests by investors for loan-documentation packages to be reviewed,”
according to a Feb. 26 filing.

“The request for loan documentation packages is an
early indicator of a potential claim,” New York-based Citigroup said.

…

Banks that sell mortgages to
Fannie Mae and Freddie Mac have to provide “representations and
warranties” assuring that the loans conformed to the agencies’
standards. With more loans going bad, the agencies are demanding that
banks turn over loan files, so they can scour the records for missing
documentation, inaccurate data and fraud.

…

The most common include inflated appraisals or falsely stated
incomes in the loan applications, said Larry Platt, a Washington-based
partner at law firm K&L Gates LLP who specializes in
mortgage-purchase agreements. The government agencies hire their own
reviewers who go back and compare the appraisals with prices from
historical home sales, he said.

“They may do a
drive-by for a visual inspection,” he said.

Wells
Fargo said three-fourths of its repurchase requests came from Freddie
Mac and Fannie Mae. While investors may demand repurchase at any time,
most demands occur within three years of the loan date, Wells Fargo
said.

The mortgage firms are looking at every
loan more than 90 days past due and “asking us basically to give them
all the documentation to show that it was properly underwritten,”
JPMorgan’s Scharf said. “We then go through a process with them that
takes a period of time, and literally it’s every loan, loan-by-loan,
and have the discussion on whether or not we actually should buy the
loan back.”

…

Mortgage
repurchases may crimp bank earnings through 2011, Oppenheimer’s
Kotowski said. That’s because the worst mortgages — those underwritten
in 2007 — are just now coming under the heaviest scrutiny, he said.

…

“The worst of the stress is
the 2007 vintages, though 2006 and 2005 weren’t a whole lot better and
2008 wasn’t much better,” Kotowski said.

Next
week, the Mortgage Bankers Association is holding a workshop in the
Dallas area that promises to help banks “survive the buyback deluge”
and “build up your repertoire of lender defenses.” According to the
MBA’s Web site, the workshop is sold out.

 That’s the estimate of Oppenheimer & Co.
analyst Chris Kotowski, who says U.S. banks
could suffer losses of $7 billion this year when those loans are
returned and get marked down to their true value. Fannie Mae and
Freddie Mac, both controlled by the U.S. government, stuck the four biggest U.S. banks with losses
of about $5 billion on buybacks in 2009, according to company filings
made in the past two weeks.

The surge shows lenders
are still paying the price for lax standards three years after
mortgage markets collapsed under record defaults. Fannie Mae and
Freddie Mac are looking for more faulty loans to return after suffering
$202 billion of losses since 2007, and banks may have to go along,
since the two U.S.- owned firms now buy at least 70 percent of new
mortgages.

…

Freddie Mac
forced lenders to buy back $4.1 billion of mortgages last year, almost
triple the amount in 2008, according to a Feb. 26 filing. As of Dec. 31,
Freddie Mac had another $4 billion outstanding loan-purchase demands
that lenders hadn’t met, according to the filing. Fannie Mae didn’t
disclose the amount of its loan-repurchase demands. Both firms were
seized by the government in 2008 to stave off their collapse.

….

The government’s efforts might be
counterproductive, since the Treasury and Federal Reserve are trying to
help banks heal, FBR’s Miller said. The banks have to buy back the
loans at par, and then take an impairment, because borrowers usually
have stopped paying and the price of the underlying homehas plunged. JPMorgan
said in a presentation last month that it loses about 50 cents on the
dollar for every loan it has to buy back.

Striking a Balance

“It’s a fine line you’re
walking, because the government’s trying to recapitalize the banks, not
put them in bankruptcy, and then here’s Fannie and Freddie putting
more pressure on the banks through these buybacks,” FBR’s Miller said.
“If it becomes too big of an issue, the banks are going to complain to
Congress, and they’re going to stop it.” [Of,
course! Let the taxpayer eat the losses borne from our purposefully
sloppy underwriting]

Bank
of America recorded a $1.9 billion “warranties expense” for past and
future buybacks of loans that weren’t properly written, seven times the
2008 amount, the bank said in a Feb. 26 filing. A
spokesman for Charlotte, North Carolina- based Bank of America, Scott Silvestri, declined to
comment.

JPMorgan, based in New York,
recorded $1.6 billion of costs in 2009 from repurchases, including $500
million of losses on repurchased loans and $1 billion to increase
reserves for future losses, according to a Feb. 24 filing.

“It’s become a very meaningful issue, and it
will continue to be a meaningful issue for the next couple of years,” Charlie Scharf,
JPMorgan’s head of retail banking, said at a Feb. 26 investor
conference. He declined to say when the repurchase demands might peak.

…

“I can’t forecast the rates
at which they’re going to continue,” she said. Her
division lost $3.84 billion last year, as the bank overall posted a
$6.28 billion profit. “The volume is increasing.”

Wells Fargo, ranked No. 1 among U.S. home lenders last
year, bought back $1.3 billion of loans in 2009, triple the
year-earlier amount, according to a Feb. 26 filing.
The San Francisco-based bank recorded $927 million of costs last year
associated with repurchases and estimated future losses.

…

Citigroup increased its repurchase
reserve sixfold to $482 million, because of increased “trends in
requests by investors for loan-documentation packages to be reviewed,”
according to a Feb. 26 filing.

“The request for loan documentation packages is an
early indicator of a potential claim,” New York-based Citigroup said.

…

Banks that sell mortgages to
Fannie Mae and Freddie Mac have to provide “representations and
warranties” assuring that the loans conformed to the agencies’
standards. With more loans going bad, the agencies are demanding that
banks turn over loan files, so they can scour the records for missing
documentation, inaccurate data and fraud.

…

The most common include inflated appraisals or falsely stated
incomes in the loan applications, said Larry Platt, a Washington-based
partner at law firm K&L Gates LLP who specializes in
mortgage-purchase agreements. The government agencies hire their own
reviewers who go back and compare the appraisals with prices from
historical home sales, he said.

“They may do a
drive-by for a visual inspection,” he said.

Wells
Fargo said three-fourths of its repurchase requests came from Freddie
Mac and Fannie Mae. While investors may demand repurchase at any time,
most demands occur within three years of the loan date, Wells Fargo
said.

The mortgage firms are looking at every
loan more than 90 days past due and “asking us basically to give them
all the documentation to show that it was properly underwritten,”
JPMorgan’s Scharf said. “We then go through a process with them that
takes a period of time, and literally it’s every loan, loan-by-loan,
and have the discussion on whether or not we actually should buy the
loan back.”

…

Mortgage
repurchases may crimp bank earnings through 2011, Oppenheimer’s
Kotowski said. That’s because the worst mortgages — those underwritten
in 2007 — are just now coming under the heaviest scrutiny, he said.

…

“The worst of the stress is
the 2007 vintages, though 2006 and 2005 weren’t a whole lot better and
2008 wasn’t much better,” Kotowski said.

Next
week, the Mortgage Bankers Association is holding a workshop in the
Dallas area that promises to help banks “survive the buyback deluge”
and “build up your repertoire of lender defenses.” According to the
MBA’s Web site, the workshop is sold out.

The JP Morgan forensic preview is now
available. Remember, this is not subscription material, but a “public
preview” of the material to come. I thought non-subscribers would be
interested in knowing what my opinion of the country’s most respected
bank was. There is some interesting stuff here, and the subscription
analysis will have even more (in terms of data, analysis and
valuation). As we have all been aware, the markets have been totally
ignoring valuation for about two quarters now. It remains to be seen
how long that continues.

Click graph to enlarge

 

 Cute graphic
above, eh? There is plenty of this in the public preview. When
considering the staggering level of derivatives employed by JPM, it is
frightening to even consider the fact that the quality of JPM’s
derivative exposure is even worse than Bear Stearns and Lehman‘s
derivative portfolio just prior to their fall. Total net
derivative exposure rated below BBB and below for JP Morgan currently
stands at 35.4% while the same stood at 17.0% for Bear Stearns
(February 2008) and 9.2% for Lehman (May 2008). We all know what
happened to Bear Stearns and Lehman Brothers, don’t we??? I warned all
about Bear Stearns (Is this the Breaking of the Bear?:
On Sunday, 27 January 2008) and Lehman (“Is Lehman really a lemming in disguise?“:
On February 20th, 2008) months before their collapse by taking a
close, unbiased look at their balance sheet. Both of these companies
were rated investment grade at the time, just like “you know  who”.
Now, I am not saying JPM is about to collapse, since it is one of the
anointed ones chosen by the government and guaranteed not to fail –
unlike Bear Stearns and Lehman Brothers, and it is (after all)
investment grade rated. Who would you put your faith in, the big
ratings agencies or your favorite blogger? Then again, if it acts like a
duck, walks like a duck, and quacks like a duck, is it a chicken???
I’ll leave the rest up for my readers to decide. 

This public
preview is the culmination of several investigative posts that I have
made that have led me to look more closely into the big money center
banks. It all started with a hunch that JPM wasn’t marking their WaMu
portfolio acquisition accurately to market prices (see Is JP Morgan Taking Realistic Marks on
its WaMu Portfolio Purchase? Doubtful! ), which would very well
have rendered them insolvent – particularly if that was the practice
for the balance of their portfolio as well (see Re: JP Morgan, when I say insolvent, I
really mean insolvent). I then posted the following series, which
eventually led to me finally breaking down and performing a full
forensic analysis of JP Morgan, instead of piece-mealing it with
anecdotal analysis. 

1. The Fed Believes Secrecy is in Our Best
   Interests. Here are Some of the Secrets
2. Why Doesn’t the Media Take a Truly
   Independent, Unbiased Look at the Big Banks in the US?
3. As the markets climb on top of one big,
   incestuous pool of concentrated risk…
4. Any objective review shows that the big
   banks are simply too big for the safety of this country
5. Why hasn’t anybody questioned those
   rosy stress test results now that the facts have played out?

You can download the public preview here. If you find it to be of
interest or insightful, feel free to distribute it (intact) as you
wish.

 JPM Public Excerpt of Forensic Analysis Subscription
2009-09-18 00:56:22 488.64 Kb 

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