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Tag Archives: FDIC

Guan Jianzhong, Chairman of Dagong Global Credit Rating Co. Ltd

Bloomberg reports that China’s Dagong Global Credit Rating Co. reduced its credit rating for the U.S. to A+ from AA citing a deteriorating intent and ability to repay debt obligations.

Having worked on both sides of the world, I have come to associate such statements with shortsightedness. My past experience as a senior research analyst for a brokerage firm in Asia-Pacific would suggest that we are going to see problems in China by 2012.

In this blog post we take a look at how consumers could cope with the Mortgage Mess. Yes, we need strong banks otherwise the Dagong rating will be fulfilled, but this economy is 70% consumer driven. We therefore need stronger consumers, as strong consumers underpin the health of the banks, and not the other way around. Using China as an example, as China’s income per capita rises its banks and financial services companies become more confident of themselves, therefore the Dagong ratings comment above. 

I want to inform our readers that QuantumRisk’s CMBS Property Risk Analytics promotion ended September 10, 2010 per an earlier newsletter. The new pricing, valid until March 2011, is available here.

Home Prices Sag in August 2010

The State of the Housing Market
In my August 2009 blog post Have we hit the Housing Bottom? I had suggested that the house prices will bottom in 1Q 2010. Given the graph, I must say that this was a pretty good estimate of timing. 

The second question I had attempted to answer then, was home price recovery sustainable? My answer at that time was that it was more likely not.

The economic analysis presented by HiddenLevers (see picture) suggests that house prices are struggling to maintain an upward momentum. 

Why? There are two reasons. First the glut in foreclosed homes (1 in 4 for sale are foreclosed) will keep supply substantially greater than demand. Second, 1 in 6 homes in foreclosure translates into 1 in 6 homeowners who will not be able to participate in homeownership for at least 7 years or a 15% reduction in demand.

The graph shows that house prices are now hovering in the 68% to 71% range of their 2006 peak values.  From an economic cycle perspective, the housing industry collapsed before the commercial property industry. Given a 15% reduction in residential ownership capacity, it is very likely that commercial property sector will recover before the residential sector does. That is, the trough in the residential sector will be longer than that of commercials.

What is not reported in the news is the residential vacancy rates. A friend of mine who works for a utility company told me a few weeks ago, this utility is seeing 1 in 7 homes vacant. This is 50% more than reported by US Census Bureau for 2Q. That means rental incomes will not increase in the medium term. It also means that utility revenues will fall by 14%.

Some other bank just increased the difficulty of Chief Executive Officer Brian T. Moynihan 'hand to hand combat' over mortgage disputes.

The Next Big Wave: Legal Risk
Most of us are focused on market, credit & operational risks, but the next big wave will be legal risk.

I recently found out that banks are selling the second mortgage on foreclosed homes to debt collectors. Sure this maybe legally possible but lets weigh the pros & cons. The pros. Maybe banks think they can get back they principal in the second mortgage by selling the second mortgage to a debt collector. Sounds great, high fives to the managers who thought up this one. And at worst you don’t even have to write it off your balance sheet just yet. Kudos.

But wait. Does anyone really think they can get their money back from homeowners who could not even pay their first mortgage? Especially if they are unemployed? It also raises another question, what was the function and scope of collateralization?

Now the cons. What this action has done is to clarify that in the event of a foreclosure / repossession, the bank recognizes that collateralized debt survives ownership and can be put back to owner / originators. (Check with legal counsel for an informed opinion.) In the United States one cannot have one set of laws for one group of people and another set for another group of people.

Therefore, investors who bought RMBS bonds can now recognize that their securitized bonds survive any asset ownership issues, and banks are now liable for securitized bonds because they survive ownership.

I found out about a bank’s access to your personal funds some years ago. When I contacted the FDIC about it they said they could not do anything about it. Some mortgage contracts include a single sheet document that states that the bank has the right to move your funds around to keep your mortgage current. This I believe is antithetical to the securities law because securities law does not allow financial services companies to move funds around for a client for the benefit of the company.

The problem here is given such a ‘contract’ will or does the bank have the right to reach out to your 401(k) or similar funds?

Prime fixed rate foreclosures jump

How Consumers Can Protect Themselves
There are several ways consumers can protect themselves from future messy mortgage problems:

 1. House Pricing: The graph above (picture in State of the Housing Market, above) suggests that with today’s market conditions a home buyer should consider as an upper limit a purchase price of about 70% of the 2006 appraisal. If the housing situation deteriorates, this 70% number will drop. Looking at CMBS for guidance, this number can get to be as low as 54%.

 2. Appraiser Selection: Before purchasing, get an appraisal of the property by an appraiser who does not have links to banks as this minimizes banker bias.

 3. Mortgage Origination: If you are purchasing a foreclosed property, it is not recommended that you get your mortgage from the same bank that foreclosed the property. Why? At least in theory, in the event that there are ownership issues, you have a different bank behind you. 

 4. Safeguards: Given the state of the housing market, it would be prudent for the home buyer not rush into a purchase as the housing market is not likely to recover anytime soon. If you do so, you would need to have staying power. Therefore, before making a purchase, here are some points you should consider:

 4.1 Title Insurance: Don’t sign an S&P if you cannot get title insurance.

4.2 Deposit: Make your deposit conditional upon getting a clean title.

4.3 Indemnification: Require that the seller and/or the mortgage provider accepts liability for any future ownership claims in the event of the failure of the title insurance company. The lesson of 2008 was that many securitized bond credit enhancements (credit insurance) turned out to be worthless when the economy as a whole turned south.

4.4 Survival: Require that in the event of a foreclosure/repossession that all collateralized claims (1st, 2nd & 3rd liens) cannot survive the ownership.

4.5 Delinquency: Require that the mortgage provider cannot start foreclosure proceedings until the mortgage is at least 90 days past due. In the state of Colorado there are no laws to prevent a lender from foreclosing on day 2. Yes, even I was surprised by this, and know of at least one recent case where the foreclosure proceeding was started on day 50. 

4.6 Miscellaneous Contracts: Do not allow the mortgage lender have access to your other funds. Remove all such ‘subcontracts’ from your S&P agreement.

 5. Walk Away: If there are any doubts about the price, property or claims on the property, walk away. This market in not going to recover any time soon, and there will be plenty of second chances.

 There are many really good managers in banks, but as a general rule banks rotate their managers. So the great manager you see today could be replaced by a rogue manager tomorrow. Therefore do not feel ‘uncomfortable’ including these conditions in your S&P. You may even have to hire your own legal counsel to protect yourself. Remember it is wiser to walk away then to be burdened by a debt for a property you no longer own.

Summary
The real sad story is that we will eventually see 1 in 6 families homeless. To put things into perspective, James Fry, founder of Mean Street Ministry, reports that when he started this ministry about 10 years ago, there were 2 suicides per year, today there are 2 a week. We as a family have known James Fry, his family & his ministry for many years. Let us in Thanksgiving help someone in return.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational / educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position. Nor is this blog post to be construed as investment advice. 

Contact: Ben Solomon, Managing Principal, QuantumRisk
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It is critical for investors & real estate professionals to know which cities to invest in and which to stay away from for the time being.

We are very pleased to announce that CoStar’s Watch List featured some of our May 2010 Analytics in their article, “Impact of CRE Distress Varies Widely Market to Market” receiving more than 10,000 reads within 24 hours. A sample report for All Properties is available at http://www.QuantumRisk.com/.  

Our July 2010 CMBS Property Risk Analytics** (CPRA) shows that CMBS defaults & losses vary across the US by city from 0.0% to 80.0% defaults & 0.0% to 78.0% loss severities. Defaults rates continue to increase but loss severities continue to decline. How?

July 2010 CMBS Default Rates

The July CMBS Property Risk Analytics shows that the CMBS default rates continue to increase, and is at 5.79%. Note the graph is a snap shot of the CMBS pipeline as of the end of July 2010.

July 2010 CMBS Severity of Loss 

The July CMBS Property Risk Analytics shows that the CMBS severity of loss (before recovery) continues to decline and is now at 5.51%. Note, the severity of loss numbers do not include loss due to appraised value reductions. Note the graph is a snap shot of the CMBS pipeline as of the end of July 2010.

FDIC’s Mixed Report on Banks
FDIC’s list of “problem banks” reached 829 in 2Q 2010, NY Times August 31 2010. Even so, bank earnings continue to rebound posting $21.6 billion industry profits. “Across nearly every category, troubled loans started falling for the first time in more than four years. The sole exception was commercial real estate loans, which continued to show increased weakness. Still, the nation’s 7,830 banks remain under pressure.”

 New York Times / Jonathan Ernst / Reuters

“Without question, the industry still faces challenges,” Sheila Bair said in a news statement. “But the banking sector is gaining strength. Earnings have grown, and most asset quality indicators are moving in the right direction.” The agency expects a “recovery, sluggish and slow”.

The FDIC is cautioning that even though the outlook is becoming positive it may not be positive enough for a strong recoveery. On the other hand Russell Abrams of Titan Capital Group LLC, is betting the market is underestimating the likelihood of a crash (Bloomberg August 30, 2010)

So whose outcome is more likely, the FDIC’s small positive or Abrams’ second market crash leading to a double dip recession?

Will This Recession Be A Double Dip?
Our CMBS Property Risk Analytics shows that defaults are increasing but loss severities are declining. Apparently contradictory behaviors when you take into account that defaults and loss severities are usually positively correlated.

What is happening in the economy is that up to about a year ago CMBS defaults were dominated by newer loans that were backed by over priced (compared to today’s) valuations. Therefore, the large severity of losses late in the pipeline. The more recent defaults are from much older loans. Therefore smaller severity of losses early in the pipeline.

This tells us two things. First, industry losses that were primarily driven by over priced valuations have been fully absorbed by the industry – good news. Second, the industry losses has transitioned to a second stage, insufficient revenue. That is the more established older loans are defaulting due to insufficient business revenue.

It is this second stage that worries me. Our CMBS Property Risk Analytics shows that at the national level City DSCRs – a proxy for business revenue – are at 1.366 (April), 1.367 (May), 1.376 (June) and 1.397 (July). About constant between April, May, June and a 2.3% increase in July.

Could the July 2.3% increase be a one off ‘bump’ in the reported data?

Looking at the national level City Occupancies, our CMBS Property Risk Analytics show that City Occupancies were at 88.22%, 88.51%, 90.16% & 89.33% respectively. That is in the last 4 months there has been a general upward trend in CMBS City Occupancies of 0.5% increase per month – also good news – and if sustainable will reflect a general economic environment that will avert a second market crash & double dip.

Therefore, in my opinion a double dip recession is unlikely and I disagree with Russell Abrams opinion that a second market crash is likely to occur. I concur with Sheila Bair that even though a recovery is in place, at this point in time, a recovery is not likely to be as fast as we would like it to be.

Disclaimer: There is a certain amount of opacity in any business. For example the collapse of Lehman Brothers took us all by surprise. Therefore, if for example a major bank were to collapse that would alter this expected outcome.

CMBS Property Risk Analytics Pricing & Promotion
For Single Users, the CMBS Property Risk Analytics monthly reports are priced as follows:

 Item Title Monthly Price
QR CPRA Retail $135.00
QR CPRA Office $135.00
QR CPRA MultiFamily $135.00
QR CPRA Hotels/Lodgings $135.00
QR CPRA All Properties $370.00

 

The prices shown do not include discounted annual price, sale tax for Colorado residents/companies or Multi User pricing. For more information on pricing visit our website http://www.QuantumRisk.com/.

The corresponding April, May, June & July reports will be provided free for all 12-month or annual subscriptions paid by September 10, 2010. For PayPal payment instructions, please contact Ben Solomon. Note, an email address is required for receipt of ftp user id, ftp password and decryption password for each monthly report.

A sample report is available at http://www.QuantumRisk.com/Subscriptions/QRCPRA/SampleReports/(00)CMBSPropertyRiskAnalytics(2010-04)01-AL-SampleReport.zip

How the CPRA Report is Generated?
Every month we analyze reported data on more than 85,000 properties backing more than 52,000 loans to identify default probability, loss severity before recovery, loan to value ratio (LTV), debt service coverage ratio (DSCR), occupancy rates & change in property appraisal value for more than 400 U.S. markets, by property type, by city, by SMSA/MSA by state across the US. Five property type reports are generated: All Properties, Lodgings/Hotels, MultiFamily, Office & Retail.


** Property Risk Analytics is the registered trademakr of QuantumRIsk LLC.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position. Nor is this blog post to be construed as investment advice. 

Contact: Ben Solomon, Managing Principal, QuantumRisk
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The New York Times article, Regulators Feud as Banking System Overhauled, presented an interesting insight into the regulatory world. In essence the opposing points of view are,

(1) John C. Dugan, the Comptroller of the Currency, blasted a proposal to impose stiff new insurance fees on banks as unfair to the largest banks, which he regulates.
(2) Sheila Bair, chair of the Federal Deposit Insurance Corporation, says that the large banks had wreaked havoc on the system, only to be bailed out by “hundreds of billions, if not trillions, in government assistance.” Sheila Bair regulates the smaller banks.

In my blog post, We Need a Non-Linear Risk Capital Scheme, I showed that the Obama Administration had indeed allocated TARP funds fairly uniformly at 2.69c of TARP per $1 of bank assets across the industry. However, the banking industry like many industries is relatively opaque. What the TARP allocation allowed us to infer was that professional bankers tend to underestimate their risk as these risk increase.

These inferences taken with my earlier blog post, TARP, a Post Event Risk Capital, shows that the 20 biggest TARP recipients received more TARP than the 20 smaller TARP recipients when normalized for risk capital or equity. The biggest recipients received on average $15.9 billion TARP each, or 54%.77 of their equity, while the smaller recipients recieved on average $0.12 billion or 24.94% of equity.

The hard data shows that Sheila Bair is correct, that big banks were undercapitalized for the risk they were taking compared to the smaller banks. This does not mean that the smaller banks were risk averse, just that the bigger banks were more risk seeking than the smaller banks. And this makes logical sense because the bigger banks could better afford to pay for resources to delve in and exploit exotic (with hindsight) high risk instruments.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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Most forecasters try to be middle of the road, but try to cushion the downside, and ‘enhance’ the upside. The scenario below could become a reality and could lead to an extended recession well into 2011.

1. The raw data suggests that pump prices triggered the house price collapse. The logical cause and effect would be spiking gas prices eliminated many peoples’ discretionary incomes.

2. This reduction in discretionary income rippled throughout the economy as a reduction in consumer spending, a finite budget showing up as reduced demand for goods and services.

3. Therefore, the housing collapse, the mortgage mess, and the banking crisis. But would not have been as severe as it is now if the sub-prime mess was not waiting in the wings.

4. If the Fed/FDIC has underestimated the severity of the banking crisis as Nouriel Roubini  has suggested, we are going to see more bank failures, and further tightening of credit. This may be the case if their methodology addressed mean loss rather than percentile loss (eg CVaR). I’ll research the methodology and will let you know what I think. But don’t get me wrong, I have great respect of Bernake, Bair and Geithner.

5. My crude estimate is that $2.00/gallon is the threshold price for point of inflexion between +ve and –ve economic growth. Gas prices at the pump have exceeded $2.00/gallon. If I am correct we are going to see further slowdown and more job losses.

Therefore, this crude analysis suggests that the Fed/FDIC/forecasters have underestimated this recession severity in the presence of oil price increases, and just may be our recession will last well into 2011.

Benjamin T Solomon
Managing Principal
QuantumRisk LLC

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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