News Alert: Vicious Credit, Economy, Market Cycle Spotted
We interrupt our regularly scheduled posting to warn you that our early storm warning system has
detected more early signs of bad credit weather. Over the weekend our alert news monitors found a new wave of back-on-balance sheet adjustments, Fannie Mae issued worse than expected news, both GSE's (FNM, FRE) announced that they would be restricting new mortgage loans and guarantees. And (H/T CalculatedRisk) Fannie's conference call tells us that the books closed in June but there were significant deteriorations in July MORE THAN THEY ANTICIPATED when putting together their books. As you can see from the early warning reserve dashboard Fannie has both upped its' reserves and doesn't begin to cover its' risks. Making a huge Treasury equity investment increasingly likely, indeed mandatory to keep them from sliding into major default (dare one say the BK-word ?) and at least threatening to follow Merrill in throwing existing stockholders to the wolves of insolvency.
What's It All Mean: the Vicious Circle Grinds On
READINGS
UBS Agrees to Auction-Rate Pact UBS has agreed to buy back nearly $19 billion in auction-rate securities, in a settlement with the New York Attorney General, the SEC and regulators from Massachusetts and other states. A once-obscure corner of the bond market is triggering one of the messiest Wall Street scandals in years -- and potentially the largest mass bailout of American individual investors ever. On Friday, facing allegations of wrongdoing over its sales of so-called auction-rate securities, UBS AG agreed to buy back from investors nearly $19 billion of the investments as part of a settlement with federal and a group of state regulators. It will start buying from individuals and charities in October and from institutional clients in mid-2010. UBS was the third major firm this week to vow to buy back the securities, which allegedly were improperly sold as higher-rate equivalents for super-safe money-market funds. UBS, Merrill Lynch & Co. and Citigroup Inc. have committed to taking back a total of more than $36 billion of the instruments. Other financial firms are expected to follow suit. Auction-rate securities are a kind of debt that soared in popularity in recent years. They let issuers such as municipalities and student-loan organizations borrow for the long term, but at lower, short-term interest rates. The rates reset at periodic auctions, hence the name. Wall Street sold more than $330 billion of these securities to more than 100,000 individuals and other investors. State regulators from Massachusetts and New York have sued Merrill Lynch and UBS for civil fraud, with the UBS case now settled. Regulators from several states have also shown up on Wachovia Corp.'s doorstep demanding documents; the bank says it is cooperating. A New York state official has accused Citigroup of destroying documents, a charge Citi has denied. Federal prosecutors are preparing to file criminal charges against two former Credit Suisse Group brokers who allegedly lied to investors about auction-rate securities. It's rare that Wall Street firms make good on client losses, and the size of the auction-rate payments is unprecedented. But a review of several recent regulatory cases reveals the legal pressure facing Wall Street, and shows that some authorities believe the auction-rate market, which was created in the mid-1980s, got out of control. Regulators say that financial firms, at various times, secretly propped up failed auctions; misled investors on the safety of the securities; pressed brokers and research analysts to sell the very securities executives were trying to unload; and resisted client demands for relief. WSJ Auction Rate Security Graphic
Fannie Mae Loss of $2.3 Billion Exceeds Forecasts Fannie Mae reported a wider-than-expected second-quarter loss of $2.3 billion and said it expects more heavy losses from the surge in home-mortgage defaults. Mounting losses at both Fannie and Freddie Mac, the two main providers of money for home mortgages, are limiting their ability to buy and guarantee home loans. That may mean higher interest costs for consumers.
"What are losses going to be? Where is credit going to go? Where are home prices going to bottom? How long is that going to last? What's the overall impact of the macroeconomy? What is funding liquidity in the capital markets? All of these scenarios that everybody has are highly, highly sensitive to the variables and the assumptions that you make. And none, in my view, are conclusory enough to have full visibility into where they wind up in '09" -- Dan Mudd, Fannie president and CEO.
Fannie chopped its quarterly dividend to five cents per common share from 35 cents but said it still may need to raise more capital, beyond the $7.4 billion in proceeds from share offerings in May. Congress last month gave the Treasury authority to make loans to Fannie or Freddie or buy shares in them, and some analysts say they think the Treasury eventually will have to shore the pair up by acquiring sizable equity stakes. Losses are turning out worse than generally forecast largely because home prices have fallen more steeply than expected, particularly in such states as California, Florida, Arizona and Nevada, Fannie executives said on a conference call with investors. That means Fannie and Freddie recoup less money from sales of foreclosed homes. Prices for single-family, detached homes in July were down 28% from a year earlier in California and down 17% in Florida, according to data to be released Monday by First American LoanPerformance. For the U.S. as a whole, the decline was 11%. WSJ Reserve Impacts Graphic
Mortgage Giants to Buy Fewer Risky Home Loans Gaping losses at Fannie Mae and Freddie Mac are causing the two mortgage giants to slow their purchases of home loans at a time when the government is counting on them to help prop up the housing market. The reductions and associated measures that the companies are taking are likely to drive up home mortgage rates, which are near their highest levels in a year. Concern over the companies’ financial health was heightened on Friday when Fannie Mae reported a second-quarter loss of $2.3 billion. The deficit was three times what analysts had forecast and was the company’s fourth consecutive quarter in the red. This week, Freddie Mac reported a $821 million loss for the quarter. Although Fannie Mae’s revenue was up slightly — to $4 billion, an increase of $200 million from the previous quarter — its expenses related to foreclosures and other credit losses soared to $5.3 billion, up from $3.2 billion in the previous three months. In light of their losses, both companies have indicated they will slow the number and types of loans they are purchasing. Fannie Mae executives, in a conference call with analysts on Friday, said they intended to reduce the growth of the company’s loan portfolio and stop buying riskier so-called Alt-A mortgages by the end of the year. Fannie Mae will also begin charging more to guarantee loan repayments, a step that is likely to push mortgage rate higher. “Fannie and Freddie’s decision to curtail support of the mortgage market is going to make mortgages more expensive for potential home buyers, which is going to hurt the overall economy,” said Howard Shapiro, an analyst at Fox-Pitt, Kelton. “They’re the only real buyers in this market, and they’re going to buy less. That’s really bad news.”
Fannie Mae: Q2 Ended in June, but July was Worse (by CalculatedRisk). Opening comments from the conference call (hat tip Brian): “You will recall, by way of background, that even though our second quarter books closed on June 30, subsequent events factor in, and in fact, heavily weight our outlook and our expectations going forward. And those events in July loom significantly in that calculus. That week of July 7 was one of the worst Fannie Mae has experienced in the debt and equity markets. The Treasury-fed backstop plan that was announced on July 13 calmed the market somewhat, and the passage of the Housing bill on the 26th of July added more certainty. But on the downside, July was a tough month for our credit performance. We experienced higher defaults and higher loan loss severities in the markets that were experiencing the steepest home price declines. And that gave us higher charge-offs than we had experienced in any month in the second quarter, and higher than we had expected. We also saw a higher proportion of foreclosures coming from states and products with higher loan balances, which increases the absolute dollar losses. In terms of severity, the loss that we experienced when a loan defaults also increased from 19 basis points in the first quarter to 23 basis points in the second quarter. And that rose again in July to 27 basis points. We are now seeing average initial charge off severities of 40% for loans in California. Home prices have cratered in certain markets since the peak -- Cape Coral, Florida, down 50%; Las Vegas, down 35%; northern Virginia, down 30%; and in California, Modesto, and Stockton, down 50%; Riverside, down 40%. The list goes on. Alt-A foreclosures have doubled in southern California. Our average serious delinquency rate in Florida increased in June to over 3% -- four times the average on our total book of business last year. Almost 2% of the loans in our Florida book are now referred to foreclosure. So, the housing market has returned to earth fast and hard. Some signs do offer rays of positive light. Foreclosures actually fell in Michigan . Same-period home sales were up in California . And as the GSEs provide most of the liquidity to the primary market, that market is functioning, and a safe center of credit risk pricing and product is being restored. All told however, that story all put together led us to again revise our credit loss estimate upward from the year, from 13 to 17 basis points to 23 to 26 basis points. And that, as you will note, commensurately drives our addition to loss reserves of almost $4 billion."