How High Can You Go?

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Here’s an amazing statistic as reported in “B of A says merger on despite Countrywide woes:”

Countrywide said last week that 90-day delinquency rates in its $28.42 billion adjustable rate mortgage portfolio climbed more than 900% from a year earlier, up to 5.4% from 0.6% during the same period last year.

The lender also warned that 71% of its ARM borrowers are making only the minimum payment allowed — and that 80% of those loans had not required borrowers to verify their income prior to receiving funding.
[emphasis added]

An increase in delinquency rates of 900%? OK, I can see how this can happen given the unwinding of the credit and housing bubble. I can also understand that these numbers can/will get worse. What I do not get is the fact that B of A is continuing with its acquisition of Countrywide after having squandered a few billion dollars already:

Bank of America announced in January that it would acquire the rapidly devaluing thrift in a $4 billion deal to be completed in the third quarter of 2008.

The merger would make Bank of America the nation’s largest mortgage lender, with the potential to eventually originate or service more than a quarter of all mortgages in the United States. Analysts said they were not surprised by the uptick and wagered that Bank of America had expected significant increases in delinquencies.

“It would be my guess that [Bank of America] priced a lot of that in and weren’t surprised that the delinquencies are up,” Gary Gordon, an analyst for Portales Partners who has been following Countrywide for almost two decades. “They built in a lot of cushion for the price and were being pretty conservative.”

Gordon said that Bank of America may be willing to take on a greatly depreciated loan portfolio in exchange for the underlying business model Countrywide brings to the table.

“Countrywide built up possibly the best loan servicing and loan origination businesses in the country and Bank of America will basically get those for free and the loan portfolio for a 10% discount,” Gordon said.

The leaves Bank of America ideally positioned if and when the U.S housing slump ends, he said, despite any rough sailing along the way.

“Those delinquency numbers would have probably been known ahead of time, so there no big surprise here,” Gordon said. “All in all, they probably got some benefits that they didn’t pay for, even if delinquencies do keep rising.”

The lender lost $422 million in the last three months of 2007, despite CEO Angelo Mozilo’s pledged to return the company to profitability by the end of January.

I understand that B of A is trying to buy an undervalued asset, but what if that asset no longer exists or becomes worthless by the time the housing slump ends? Those odds seem pretty high to me, so if you know of any reason why this purchase is a financially sound decision for B of A, please share it with me.

Sunday Musings: A Friendly Game Of Texas Hold ‘Em

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Thursday’s report by MarketWatch titled “Let’s see ‘em” reminded me of a poker game like Texas hold ‘em with the only difference that the eventual last guy bluffing will be not the winner but the big loser.

This week, one player after another was forced to show their cards:

Over in London, Carlyle Capital Corp., an arm of private-equity giant Carlyle Group, has failed to meet margin calls from four counterparties and has already received one notice of default.

UBS fell amid fears that the banking giant dumped a $24 billion portfolio of risky mortgages into the market. UBS is believed to have received about 70 cents on the dollar from face value in the sale. See full story.

Back in the U.S., Merrill Lynch & Co. tried to avoid a similar fate for its own issued securities. The nation’s biggest brokerage is raising the payout on its option notes by 17%.

And finally, Thornburg Mortgage Inc. said late Wednesday that it defaulted on several of its financing agreements, among them a $28 million margin call from J.P. Morgan Chase & Co. (JPM:JPMorgan Chase & Co.

The securities and instruments in each case may be different, but the underlying relationship is the same.

Merrill is trying to keep the interest of investors by sweetening terms. UBS as an investor has lost faith that it can recoup the full value of the mortgage securities. Lenders to Thornburg and Carlyle have squeezed the mortgage companies in a bet that they can’t meet obligations. They’ve been proven right, and their payoff will be avoiding future losses and recouping what they can from borrowers.

These credit “calls” are not unlike the ones found in poker. Just as in the game of cards, we are finding out which firms were bluffing.

And this is just the beginning. There are many more players left in these bluffing contests who are hoping for better cards down the road in form of higher prices of the Subprime slime they own before putting down their cards.

As in poker, know when to hold ‘em and know when to fold ‘em can certainly be applied to those companies hoping for a miracle even though all cards were dealt a long time ago.

Need $1 Trillion

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Here’s an interesting question: Why are interest rates on 30-year mortgages rising even as the Federal Reserve slashes interest rates and yields on Treasury Bonds fall?

MarektWatch had this to say about the current mortgage crisis:

The answer is that the mortgage market is short of roughly $1 trillion in capital, according to Paul Miller, an analyst at Friedman, Billings, Ramsey.

The modern mortgage market works with lots of leverage, or borrowed money. Investors, including hedge funds and mortgage real estate investment trusts, buy mortgage securities, but finance a lot of their purchases with this leverage.

FBR’s Miller estimates that $11 trillion of outstanding U.S. mortgage debt is supported with roughly $587 billion of equity. That’s a leverage ratio of 19 to one.

But last year’s subprime meltdown has undermined confidence in the home loans that back these mortgage securities. Now the banks that finance most of these leveraged mortgage investments have started to pull back and impose margin calls, demanding more cash or collateral to back their loans.

This has sparked a de-leveraging cycle in which some highly leveraged mortgage investors have to sell assets to meet margin calls. Forced selling pushes prices lower, sparking more margin calls, which in turn produces more selling and even lower prices.
…
“The immediate impact is that [interest rates on] 30-year fixed-rate mortgages will have to increase relative to Treasuries,” FBR’s Miller wrote in a note to clients on Friday. “That is why we are experiencing pressure on mortgage rates despite the downward movement on the 10-year bonds.”

Rates on 30-year fixed mortgages usually follow the movement of 10-year Treasury bonds, but this relationship has broken down as de-leveraging in the financial system takes hold.

The difference, or spread, between yields on “agency” mortgage securities backed by Fannie and Freddie and those on Treasuries rose to a 23-year high this week, Miller noted.

“It is the leverage game playing havoc with the system,” he wrote.

There are two ways to resolve the problem. Either inject $1 trillion of new capital into the mortgage market, or allow prices of mortgage securities to fall (and interest rates on home loans to climb), Miller said.

The mortgage market won’t be able to raise $1 trillion, so prices have to fall, he warned.

“There is no quick fix here,” the analyst said. “It will take about six to 12 months for the pricing pressure to alleviate on these mortgage assets.”

“This will be painful, but it must be allowed to play out in an orderly fashion in order for the mortgage market to achieve equilibrium,” Miller concluded.

To that I would have to add that the markets have simply priced in a higher risk. No bank wants to take any chances with many being in an insolvent position. As the article said, there is no solution other than letting the market place sort things out. Any intervention or bailout plan will simply postpone the pain and not make it disappear.

No Load Fund/ETF Tracker updated through 3/6/2008

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My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

The bears feasted big time this week as all major indexes headed further into bear territory.

Our Trend Tracking Index (TTI) for domestic funds/ETFs remains now -1.68% below its long-term trend line (red), which means we are in bear market territory.



The international index dropped to -9.53% below its own trend line, keeping us in a sell mode for that arena as well.



For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

Rally Pretense

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Bill Fleckenstein wrote an interesting article called “A great pretender of a rally.” Here are some excerpts:

Over the last couple of weeks, the stock-market action has been remarkable. The bulls have enjoyed a nice rally. It was precipitated by the anticipation that the monoline insurers would be bailed out. Then anticipation turned into reality: The bailout was nothing more than an agreement by the ratings agencies to pretend that the monolines were still worthy of AAA ratings.

Parenthetically, I would just note that the rating agencies continue to be a farce. How could MBIA – — which recently had to pay 14% to borrow money, and whose debt still yields over 13.5% — ever possibly be considered AAA?

If the ratings agencies are to have one shred of credibility again, ever, they might as well start now. But of course, just like every other aspect of the sanity that some of us might like to see break out, it seems to be politically unacceptable for anyone in a position of real responsibility to act like an honest adult.
…
The specter of municipal-bond downgrades is a function of a much larger problem: the unwinding of the credit bubble, which had the housing bubble at its epicenter. The credit bubble that has burst is going to continue to shrink the availability of credit, and the housing bubble that has burst is going to continue to unwind. The United States is not going to escape without a serious recession, which is the outcome preordained by the housing/credit bubble.

As to when folks will confront that reality, let me say this: It takes many years for a certain psychological mindset to take root, and resistance to change is always formidable. Yet when the dominant trend finally changes, that new trend remains in place for a long time.
…
In any case, the determination to suppress the destructive downside of capitalism and ensure permanent prosperity is a terrible idea that will not work. Permanent prosperity, after all, is what socialism was supposed to be about, and we’ve all learned that theory doesn’t work. I continue to find it a sad irony that Wall Street — the alleged bastion of capitalism — would cling so dearly to the hope of socialism.

That’s exactly what the Fed is all about. Its central planners think they can pick the right interest rate with which to run the world, even as the evidence indicates that their efforts over the last 20 years have produced two epic bubbles. This story would strike any sane person as the stuff of nightmare. Sadly, it’s our waking reality.

While I have read a number of Bill’s articles over the years, there have been many I couldn’t agree with. This one, however, hits the nail on the head in that reality and the consequences of the unwinding of the bubble have not been accepted by Wall Street.

This is not a negative view of things to come, simply my realistic expectation that every cause has an effect and this one has not played itself out to a point where a painless turnaround appears to be possible.

Dodging A Bullet

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The market dodged a bullet yesterday doing what it does best when pushed sharply to the downside: Look for a life savor in the rumor mill. It eventually found one in the form of news of a possible bailout for bond insurer Ambac Financial Group. At this point it’s only a rumor, but it helped the market, with the Dow down some 220 points, to reverse course and only end up down 45.

Adding to weakness early in the morning were Fed Chairman’s Bernanke’s comments that more needs to be done to help troubled homeowners. His suggestions ranged from using loan modifications like lower interest rates, to an extension of the maturity of the loan, or even a write-down of the principal balance.

Yes, you read that right; I did not make this up. To hear the Fed chief make these kinds of suggestions tells you how bad things are in bubble land. Do I detect a bit of desperation here?

Be that as it may, the markets ended up mixed for the most part on day where another sharp sell off a la Friday was a distinct possibility. Here’s how our Trend Tracking Indexes (TTIs) fared:

Domestic TTI: -0.51%
International TTI: -8.57%

We’re still staying away from both of these markets and are hanging on to only a few sector positions. Many sectors have had their bull market for a while, and I will be watching closely with my trigger finger closely wrapped around our sell stop points.