Altruistica

"Altruistica": Seeking a return to full financial disclosure and regulatory oversight. A financial market analysis blog for "entertainment purposes" only by an experienced CFA seeking new hedge fund engagements for investment writing and analysis. The author has experience investing internationally, running a hedge fund, making angel investments, and helping launch five startup companies. Investors should do their own due diligence.

26 January 2007

KBH FINALLY Subject to an SEC Probe-'bout time


So we wrote about this KB Homes outrage in November and now CNBS's Steve Liesman is humping a story that Commerce Dept reported new home sales were up 4.8% in December. But these phony numbers are "seasonally" adjusted and don't adjust for that pesky 45% cancellation rate. All one can say is that these numbers are a bad joke. The warm weather in December got the homies building busily in a normally weak month. So the seasonal adjustment was HUGE !
http://altruistica.blogspot.com/2006_11_01_altruistica_archive.html

SEC steps up KB Home options probe
NEW YORK (Reuters) - KB Home (NYSE:KBH - News), whose long-time chief stepped down following an internal probe into stock-options awards, said on Friday that U.S. regulators have opened a formal investigation into its options practices. The company, the No. 5 U.S. home builder, received notice of an informal inquiry in August. It said in a regulatory filing on Friday that it was notified on January 19 that the U.S. Securities and Exchange Commission is now conducting a formal investigation.

In a formal probe, the SEC has the power to subpoena documents and other information from a company. KB Home "has cooperated with the SEC regarding this matter and intends to continue to do so," the company said in the filing. In November, CEO Bruce Karatz retired after 34 years with KB following an internal report that showed the company used incorrect measurement dates for stock option grants from 1998 to 2005. Karatz agreed to repay about $13 million in gains he received from mispriced options.

Karatz, like other heads of publicly traded home-building companies, saw his compensation soar in recent years thanks to the U.S. housing boom. He took in nearly $45.6 million in the fiscal year ended November 30, 2005, including base pay, bonuses, restricted stock and stock option grants, up about 29 percent from $35.3 million in 2004, according to Salary.com, a compensation specialist.

The U.S. housing market has slowed markedly in the past year.

KB is among more than 160 U.S. companies that are the focus of government investigations or are undertaking internal probes into options practices. The focus is on options that were backdated to increase their value to recipients, mostly top executives.

KB said in December that it expects to restate financial results for 2003 through 2005 and the first half of 2006 because of options pricing errors. It has said it expects a noncash expense of about $41 million spread over several years.

25 January 2007

BBB Crashes while NAR Deletes Criticism of shill David Lereah on Wikipedia


This story really cuts into the housing cheerleading going on.
The NAR is getting more desperate. Someone who is a Wikipedia user sent this information to me: You'll like this. Someone at a NAR IP address, deleted criticisms of David Lereah from his Wikipedia page, Here are the diffs: I restored the deleted material. Basically, someone from the National association of Realtors deleted from Wikipedia's David Lereah page the part that read: Lereah has been criticized for encouraging the rise of the United States housing bubble. According to an interview in the Chicago Tribune, "In October 2005 Lereah was busy calling the bubble believers `Chicken Littles.' Many of the predictions espoused by the `Chicken Littles' are fast becoming closer to reality. David Lereah has lost credibility because of his irresponsible cheerleading."[4] Lereah said that he has been forecasting a decline in sales for some time: "For three years, I've said, `This is the year that sales will come down.'" It is a real low to delete legitimate criticism of Mr. Lereah from Wikipedia. If you type in David Lereah into Google the third hit is this blog. Take that Lereah! The National Association of Realtors (NAR) is an organization that is out to help Realtors receive more money from transactions of housing units. It's stated interest is to help Realtors. They are not here to help the public. They use deception and cheerleading by paid shills like Mr. Lereah to promote their harmful agenda.


MBA: Mortgage Applications Decrease del.icio.us reddit
Source:Calculated Risk (CalculatedRisk) Jan 24, 2007 1:50 p.m. -
http://economy-chat.com/aggy/tag/index/
Rate spike not likely to help these guys- MBI Begins to Collapse, CORS Next??
The Mortgage Bankers Association (MBA) reports: Mortgage Refinance Applications and Purchase Applications Both Decrease (UPDATE: link added) Click on graph for larger image. The Market Composite Index, a measure of mortgage loan application volume, was 611.3, a decrease of 8.4 percent on a seasonally adjusted basis from 667.2 one week earlier. On an unadjusted basis, the Index decreased 5.7 percent compared with the previous week and was up 3.8 percent compared with the same week one year earlier. The Refinance Index decreased by 9.6 percent to 1848.8 from 2045.8 the previous week and the seasonally adjusted Purchase Index decreased by 8.4 percent to 402.7 from 439.7 one week earlier. Mortgage rates increased: The average contract interest rate for 30-year fixed-rate mortgages increased to 6.22 from 6.19 percent ... The average contract interest rate for one-year ARMs increased to 5.91 percent from 5.85

And now the NAR claims prices are UP YEAR OVER YEAR- Who are they kidding???
Existing-Home Sales Ease, Supplies Tighten In December; 2006 Historically High
Existing-home sales eased but prices stabilized as inventories tightened in December, while 2006 was the third-highest sales year on record, according to the National Association of Realtors®. Total existing-home sales – Total existing-home sales – including single-family, townhomes, condominiums and co-ops – eased 0.8 percent to a seasonally adjusted annual rate1 of 6.22 million units in December from a level of 6.27 million in November. Sales were 7.9 percent lower than a 6.75 million-unit pace in December 2005. There were 6,480,000 existing-home sales in all of 2006, down 8.4 percent from a record 7,075,000 in 2005. The second highest total was 6,779,000 in 2004; NAR began tracking home sales in 1968.

David Lereah, NAR’s chief economist, said home sales remain historically high. “Despite all of the doom-and-gloom stories and dire predictions over the last year, 2006 was the third strongest year on record for existing-home sales,” he said. “It looks like we’re moving beyond the low for the housing cycle last fall, and buyers are responding to historically low interest rates and competitive pricing by home sellers. In addition, a tightening inventory of homes on the market is supporting prices.”
Total housing inventory levels fell 7.9 percent at the end of December to 3.51 million existing homes available for sale, which represents a 6.8-month supply at the current sales pace – down from a 7.3-month supply in November. The national median existing-home price2 for all housing types was $222,000 in December, which is unchanged from December 2005. The median is a typical market price where half of the homes sold for more and half sold for less. For all of 2006, the median price was also $222,000, up 1.1 percent from a median of $219,600 in 2005.
We're getting kinda nervous and here's the new NAR Prezzie to Pump:
According to Freddie Mac, the national average commitment rate for a 30-year, conventional, fixed-rate mortgage was 6.14 percent in December, down from 6.24 percent in November. The December rate was the lowest since October 2005 when it averaged 6.07 percent. NAR President Pat Vredevoogd Combs, from Grand Rapids, Mich., and vice president of Coldwell Banker-AJS-Schmidt, said the market has clearly settled with some minor monthly fluctuations. “We expect home sales to rise modestly over the course of this year,” said Combs. “Although local markets vary, price appreciation will be below normal in most of the country this year, but we’re looking for slow, steady gains in both home sales and prices through 2008.”

Single-family home sales slipped 1.3 percent to a seasonally adjusted annual rate of 5.44 million in December from 5.51 million in November, and were 7.2 percent lower than the 5.86 million-unit pace in December 2005. In all of 2006, single-family sales declined 8.1 percent to 5.68 million, the third strongest total on record. The median existing single-family home price was $221,600 in December, which was unchanged from a year ago. For all of 2006, the median single-family price was $222,000, up 1.4 percent from 2005. Existing condominium and cooperative housing sales rose 2.1 percent to a seasonally adjusted annual rate of 777,000 units in December from an upwardly revised level of 761,000 in November.

Even condo prices are up, according to NAR????? IN what world?
Last month’s sales activity was 12.2 percent lower than the 885,000-unit pace in December 2005. After setting 10 consecutive annual records, condo sales for all of 2006 fell 10.4 percent to 803,000 units, the third highest year on record. The median existing condo price was $227,000 in December, which was 0.3 percent above a year ago. In all of 2006, the median condo price was $221,800, down 0.9 percent from 2005
.

24 January 2007

Vasco Data Services (VDSI-NAZ) - Corporate Computer Security Steps Up


Investment Thesis: Chicago-area security company Vasco Data Services (VDSI-OTC) offers a pure play on increased corporate spending on institutional data security as a provider of open standards-based hardware and software security systems. Operating from a strong European franchise, VDSI’s software business in the U.S. is accelerating due to established banking data processor Fiserv (FISV).
Key Investment Drivers:
• Leading player in online verification, the fastest growing segment (+30%) of the information security business;
• Two other competitors acquired last year at big revenue multiples (6-7x) and the industry appears to face further consolidation;
• VDSI has a strong competitive position in Europe due to smart cards and US business is growing rapidly due to alliance with bank processing leader Fiserv;
• Core banking client base has now committed to using “tokens” sold by VDSI and others for online AND mobile user (e.g. client) authentication; and
• Upcoming catalysts may come from eBay and 2007 earnings guidance (+50%).

Online Security Segments Consolidating:

The online verification industry is consolidating and recent deals suggests that corporate adoption of such systems is well underway, and will be integrated into enterprise storage and processing systems. VDSI, RSA (now part of EMC: NYSE) and Aladdin Knowledge Systems (Nasdaq:ALDN) operate in the hot field of user identification and access authorization through, among other things, special “keys” used on VPNs (corporate virtual private networks). In acquiring RSA last summer for $2.1B (6.5x revenues), EMC made a strategic entry into a complimentary field to its core storage business which it anticipates annual potential sales of $1 billion within a few years. IBM's responded last August 2006 by buying RSA competitor Internet Security Systems (ISSX), raising the stakes for other enterprise systems operators. Microsoft (MSFT), Symantec (SYMC), Hewlett-Packard Co. (HPQ), Oracle (ORCL) and SAP (SAP) could all be looking to acquire a mid-sized pure play security company. EMC’s Security Division just reported a 26% revenue gain to a $500m annual revenue run rate, incorporating the RSA acquisition, noting that the “strong performance reflected continued traction for RSA's consumer identity protection solutions as a result of federal guidelines for stronger authentication practices in online banking and concerns over credit card fraud and identity theft.”

As Microsoft prepares to release its new Vista operating system, many technology analysts are concerned about the security and privacy shortcomings in the new release. So many corporations have already become more aggressive about security of their data, especially since Symantec and other consumer security providers have been unable to prevent security breaches. However, the security business has already gone vertical- online banking and e-commerce customers are being equipped with their own digital passes (or “tokens”) to access information.

Competitors: VascoData Aladdin SafeNet SecureComput
VDSI ALDN SFNT SCUR
Revs(FY06E) $ 76.5m $ 88.0m $ 290.1m $ 180.5m
Revs (FY07E) $110.0m $ 96.6m $ 316.8m $ 250.2m
EPS (FY06E) $0.33 $ 1.07 $ 0.88 $ 0.25
EPS (FY07E) $0.45 $ 1.14 $ 1.33 $ 0.24
P/E Ratio (F) 31.1x 15.3x 17.7x 26.9x
PEG Ratio .62x 1.10x .83x 1.79x
VDSI: Strong European Positioning and US Strength from Fiserv Alliance:

With a $400m market cap, VDSI is hardly an institutional name. Yet it’s emerging as a world-leader for strong user authentication, with in excess of 550 international financial institutions and approximately 3,300 blue-chip corporations and governments located in more than 100 countries. VDSI’s European business has been booming with online user identification broadly accepted, with a recent VDSI contracts with leading Belgian bank KBC and Allied Irish Banks announced in January 2007. A VDSI smart card addition last year improved its competitive standing. In May 2006, VDSI announced its acquisition of Logico Smart Card Solutions of Vienna, Austria, an authentication storage specialist with extensive experience in smart card based authentication.

New Online and Mobility Applications Compelling Additional Safeguards:
Banking via telephone and wireless mobile devices has become an important delivery channel for financial institutions. As with Internet banking, telephones and wireless devices afford great convenience for bank customers, but unfortunately they too are prone to phishing and other forms of attack. The Federal Financial Institutions Examination Council instituted regulations in late 2005 that banks need to safeguard customer data. U.S. financial institutions had dragged their feet on online authentication but now efforts to increase client protection are being used proactively for differentiation. VDSI is the leading provider of that more than 100 U.S. financial institutions have integrated VASCO solutions into their Internet banking offerings. VASCO's alliance with Fiserv, Inc. (Nasdaq: FISV), a U.S. Fortune 500 company that provides information management systems and services to 17,000 clients in the financial industry, has been a catalyst for the growth. VDSI added 29 banking customers in Q306 and is planning to double its domestic sales force in 2007. Banks represent currently 86% of sales, but a variety of businesses, governments and others use their products worldwide.
VDSI Could Move on eBay PayPal News and Upcoming Analyst Meeting:

Online authentication service and software providers are the fastest growing segment of the security business at 30% annually, with coming news flow likely to highlight VDSI. VDSI and a few other ‘industrial strength’ security providers deliver user authentication software and hardware for the financial world, remote access, e-business and e-commerce via its Digipass hardware and software security products. On January 24, eBay plans to offer PayPal users security tokens in a bid to strengthen the security of its payment service, and Vasco's authentication-token product is likely to be introduced as part of that service. And since the company has beaten analyst expectations by a third in the last two quarters and is poised to conduct a major analyst meeting on January 31, then some hedge funds and larger institutions are likely to take notice. VDSI will report Q406 earnings then and expectations are for revenue of $25.72 million and earnings of 11 cents a share, according to a consensus of First Call analysts. FY 07 earnings are slated to reach $107m in revenues and $0.43 of earnings, but guidance should be increased at the analyst meeting to $110m and $0.45 of earnings. A real catalyst would be a contract signing by a U.S. banking major, such as Citicorp which has been in discussions with VDSI since fall.

Disclosure: TMV owned a long position in VDSI as of 1/24/07

Housing Crisis Deepens on the Coasts


More Californians at risk of losing homes
David Streitfeld of the LA Times details the ongoing disconnect between mortgage loan defaults and household financial crises. Now jump to the bottom and read the CRL study which projects $164B in mortgage losses and 22m homeowners foreclosed.
The number of Californians defaulting on their mortgage loans is rising rapidly, according to figures released Tuesday, providing striking evidence that more people are at risk of losing their homes. Default notices jumped 145% in the last three months of 2006, accelerating a trend that began in late 2005 as home sales started to cool. It was the largest number of default notices in any three-month period since 1998.

"Analysts" don't consider a 8 year record for defaults significant?? How can that be?
Analysts said the increase was not worrisome — yet. But if the number continues to escalate, it could drag down home values in certain communities, they warned. "So far, this isn't alarming," said John Karevoll, chief analyst at DataQuick Information Systems, which compiled the data. But if default notices "keep going up at this rate, it could get nasty fast," he added.

And, amazingly enough, it's first time home buyers who are vulnerable. The mortgage industry abandoned decades' old lending standards to provide "exotic" no-doc loans to people for more they could afford to service. Default notices more than doubled to nearly 40K in Q406 while foreclosures SOARED sevenfold. Analysts???
Home markets that are most vulnerable include the Inland Empire and the Central Valley, both of which drew throngs of first-time buyers even as the housing boom was ending. Such homeowners are the most at risk of losing their homes because they have relatively little equity in their properties, making it harder to refinance their mortgages. Default notices are the initial step in the foreclosure process. In the fourth quarter of last year, lenders issued such notices to 37,273 borrowers across the state, warning them that they were at risk of foreclosure, compared with 15,196 during the same period a year earlier, DataQuick said. But foreclosures also are on the rise. There were 6,078 in the last quarter of 2006, up from 874 a year earlier.

Analysts are unmoved... plenty o'jobs out there...
Today, the economy is healthy and unemployment has rarely been lower. "I really don't see any distress out there," said Chris Comer, a mortgage broker at Pacific Capital in San Marcos, Calif. "Most people getting notices of default are figuring out ways to get those mortgages current by any means possible so they're not kicked out in the street." Most people, but not everyone. James Brown, a 66-year-old retired insurance agent in Salinas, Calif., has a history of heart trouble. When he had an operation in 2005, he said, "the doctor gave me a 50-50 chance I'd die on the table. So I did a stupid thing: I refinanced the house." Brown's goal in tapping his equity was to give his wife, Monica, a $100,000 cushion after his death. But he didn't read the paperwork carefully, and didn't realize that his monthly loan payment would skyrocket. There was also a problem with the operation: It worked. A year or two earlier, that would have been nothing but good news. In the early part of the decade, Brown recalled, "property values went crazy." "People pulled up in Silicon Valley and went to Salinas, and paid here what they had been paying there," he said. But Brown awoke to a different world. With the new loan, his payments went to $4,500 a month from $2,900. The $100,000 in equity he pulled out of the house went to his medical expenses and other bills. The property has dropped in value to $750,000 from $899,000, leaving him without enough equity to refinance. He arranged to sell the place, but the prospective buyers couldn't qualify for a mortgage. In September he gave up and stopped paying the mortgage. He's now in default, speeding toward foreclosure. "Three times a week, they call and say, 'Where's my money?' " he said. "If I hadn't survived, everything would have been fine."


Brown's situation illustrates a potential wild card in the housing market that barely existed a decade ago. Lenders have invented all sorts of newfangled loans, many of which are reset to higher interest rates after a fixed period. The ability of borrowers to repay such loans, particularly in a weak market, is untested.

"People are living on the edge, and they can't help it with the price of houses," said Barbara Swist, a Costa Mesa mortgage broker who is helping Brown sort through his options. "They have good jobs but they bought over their heads, buying into the American dream."

South FL Condo Inventory Soars 111% Watch out for Corus Bankshares !


South Florida home sales up?, prices down-Inventory rises 95% from a year earlier
Home sales in South Florida's Broward County edged up in December, as a massive selection of inventory and lower prices lured buyers into the market, according to statistics provided by the Realtor Association of Greater Fort Lauderdale. Single-family home sales totaled 599 last month, up 1 percent from 593 sales a year earlier. The median home price slid 7.9 percent during the period -- from $379,900 to $350,000. Overall the market appears to be returning to reality," said RAGFL President Christine Hansen. "Home prices are stabilizing and resemble figures from what we would consider 'typical' markets, which is a positive sign." The 10,679 single-family homes listed for-sale last month represented a 95.4 percent increase from the 5,465 listings in December 2005, indicating a strong buyer's market. In the condo-townhome market, total available inventory rose to 14,704 listings last month from 6,968 a year earlier -- a 111 percent increase. The median condo price, however, actually gained 2.5 percent during the period to $199,750.

The downside from the "lure of the American dream" is also the opinion of the Center for Responsible Lending, a nonprofit advocacy group based in Durham, N.C. Last month, the center issued a lengthy analysis explaining how millions of so-called sub-prime loans would soon turn bad. Sub-prime loans are made at higher rates — and include more onerous terms — to borrowers who don't qualify for lower-cost "prime" mortgages. Sub-prime foreclosures would increase the most, the authors concluded, in states that had seen strong price appreciation during the boom. That would include New York, Virginia, Maryland and particularly California. The borrowers most at risk are naturally those who bought most recently
The Center estimates that a quarter of the sub-prime loans made in the Central Valley city of Merced last year will result in foreclosure. That would be the highest rate in the country, based on the center's calculations. Eight other California cities, including Vallejo, Bakersfield, Fresno and Stockton, were among the top 15 projected foreclosure rates. That geographic focus is consistent with Tuesday's DataQuick numbers. The Central Valley, with about 6.5 million people, had 8,531 defaults and 1,646 foreclosures in the last three months of 2006. Los Angeles County, with 10 million people, had fewer of each. For the state as a whole, the Center for Responsible Lending projects a failure rate of 21.4% for 2006 sub-prime loans, a level exceeded only by Nevada and Washington, D.C. Foreclosed homes are typically sold at a discount, which can hurt property values of nearby houses.

Report Reveals 2.2 Million Borrowers Face Foreclosure on Subprime Home Loans; Homeowners to lose at least $164 Billion in Sub-Prime Loans
A new CRL study reveals that millions of American households will lose their homes and as much as $164 billion due to foreclosures in the subprime mortgage market. The “Losing Ground” study is the first comprehensive, nationwide review of millions of subprime mortgages originated from 1998 through the third quarter of 2006. CRL finds that despite low interest rates and a favorable economic environment during the past several years, the subprime market has experienced high foreclosure rates, and we project that one out of five (19.4%) subprime loans issued during 2005-2006 will fail.

21 January 2007

Why Backdating Equals a Criminal Windfall


Broadcom TRIPLES its executive stock option ("ESO") charge to $2.2BILLION! And the stock soars 7% on that sanguine news. Options issues to purchase 240 MILLION Shares. UFB!

Stock option errors result in $2.22B charge for Broadcom
Broadcom Corp. will take charges of $2.22 billion to correct accounting flaws related to misdated stock option grants. The restatement of financial statements from 1998 to 2005 with the Securities and Exchange Commission completes the company's investigation into the stock-option grants. The restatement is the largest so far among companies that have looked into its grant practices. According to the company, the charge so large because the company issued options to purchase nearly 240 million shares to employees from June 1998, the time of the company's initial stock offering, through May 2003, "a period of unprecedented market volatility."



ESOs are usually granted at-the-money, i.e., the exercise price of the options is set to equal the market price of the underlying stock on the grant date. Because the option value is higher if the exercise price is lower, executives prefer to be granted options when the stock price is at its lowest. Backdating allows executives to choose a past date when the market price was particularly low, thereby inflating the value of the options.

An example illustrates the potential benefit of backdating to the recipient. The Wall Street Journal (see discussion of article below) pointed out a CEO option grant dated October 1998. The number of shares subject to option was 250,000 and the exercise price was $30 (the trough in the stock price graph below.) Given a year-end price of $85, the intrinsic value of the options at the end of the year was ($85-$30) x 250,000 = $13,750,000. In comparison, had the options been granted at the year-end price when the decision to grant to options actually might have been made, the year-end intrinsic value would have been zero.

Funny, this article details how options backdating awareness has existed since 2003 or earlier, if you believe Wal-mart insiders.
David Yermack of NYU was the first researcher to document some peculiar stock price patterns around ESO grants. In particular, he found that stock prices tend to increase shortly after the grants. He attributed most of this pattern to grant timing, whereby executives would be granted options before predicted price increases. This pioneering study was published in the Journal of Finance in 1997, and is definitely worth reading.

In a study that I started in 2003 and disseminated in the first half of 2004 and that was published in Management Science in May 2005 (available at http://www.biz.uiowa.edu/faculty/elie/Grants-MS.pdf), I found that stock prices also tend to decrease before the grants. Furthermore, the pre-and post-grant price pattern has intensified over time (see graph below). By the end of the 1990s, the aggregate price pattern had become so pronounced that I thought there was more to the story than just grants being timed before corporate insiders predicted stock prices to increase. This made me think about the possibility that some of the grants had been backdated. I further found that the overall stock market performed worse than what is normal immediately before the grants and better than what is normal immediately after the grants. Unless corporate insiders can predict short-term movements in the stock market, my results provided further evidence in support of the backdating explanation.

19 January 2007

FALLING & FALLEN SUBPRIME IDIOTS


A very worthwhile read on the housing market.


Any serious analysis of the USEconomy must begin with an update on housing. In a nutshell, both housing starts and permits have fallen significantly, new home construction remains at high levels, inventories persist at near record levels, and consumer expenditures are overdue for a grand plunge. The banking distress has begun, let it be known. To call a housing bottom here is perilous, absurd, and probably highly inaccurate. Regard any such bottom proclamation as extremely biased, replete with vested interest, and probably intentionally falsified with a clear bias. Check the person’s employer. In my view, the housing bust has at least two and three more years of bleeding damage to go.

Nothing has changed on the imminent risk from the housing decline to the US banking system and USEconomy. Among the various corners of the banking system, losses have been finally felt with mortgage portfolios and their bonds. The big banks, which serve both as creditors and counter parties to hedge funds, have unloaded substantial amounts of mortgage bonds at a discount to their clients in secret deals to elude public detection, otherwise seen as the initial writedowns. They wish to avert a public panic. With 40% of banking system assets tied either to MBS bonds or to home loan portfolios, the regional banks will suffer huge losses. Home valuation at a national level cannot be reduced by a few trillion$ without corresponding asset loss in the mortgage bonds. Expect at least one regional bank to go bankrupt. Certain large bank subsidiaries might go bust, absorbed by the parent with huge losses incurred. Others will be gobbled up in convenient acquisition mergers to hide the effect. We are perhaps only several months away from banking systemic distress from the housing bust. Deep public concern is still at least one or two years away, which will reach a peak when their certificates of deposit are deemed at risk or seized. Gold will love that. Imagine millions of people in doubt, seeking real safety no longer perceived available in banks!

The most recent high profile mortgage distress signal came from HSBC, the world’s third largest bank in marketcap size behind Citigroup and Bank of America. What an unmitigated disaster their acquisition was in 2003 of Household International, a lender to subprime borrowers. HSBC increased their loan loss reserves to $1.38 billion in Q3 from $1.25 billion in Q2, and reported a 3.99% delinquent rate (over two months past due) for mortgages, car loans, and credit cards. They admit not to doing their homework before the acquisition of Household, a financial firm specializing in deadly adjustable mortgages. Concern over an infectious spread from the mortgage divisions of banks to the unsecured loan portfolio is acute. The word ‘implosion’ fits very appropriately to describe what has begun in the mortgage finance sector, worthy of the photo from a website (http://ml-implode.com) which tracks the littered dead within the industry.

The KILLING FIELD list in the mortgage industry grows like a Who’s Not Who: OwnIt, Harbourton Mortgage Investment, Mortgage Lenders Network, Secured Funding, Origen Wholesale Lending, and more (see my report). Add several others like the subsidiary at H&R Block which has taken huge losses. Others will fall without any doubt whatsoever. The only question is the location, impact, and time required to spread the acidic damage. What is striking about the list is not the lack of recognition of their names, but rather the prominence of some of their creditor broker counter parties, big Wall Street names. Lenders relaxed standards in order to sustain business and their own jobs, not to mention bonuses and origination fees per loan. The inside word is that a credit crunch approaches quickly. The crisis will undoubtedly become a massive fraudulent enterprise where aggressive lenders will be accused of having pushing reckless home loans to people who were totally uncreditworthy. The issue was also fees for bond market underwriters, who rushed to convert loan packages into mortgage bonds, quickly offloaded to the unsuspecting public or foolish Wall Street firms. Watch more pushback by savvy Wall Street, and lawsuits like the one filed last summer by Bear Stearns to reject defective bonds.

The Center for Responsible Lending estimates that 2.2 million American homeowners will likely lose their homes via foreclosure. Default rates are terrible in many regions of the nation, not confined in any way since a systemic problem. One in five subprime mortgage customers who purchased homes in the last two years is likely to enter foreclosure, amounting to 1.1 million people. The most alarming conclusion made from the study, after analysis of more than six million mortgages since 1998, is that the risk of default is independent of the credit score of the borrower. The failures are occurring regardless of income and past credit history. In 1994, only 5% of mortgages underwritten were risky subprimes. Now the subprimes comprise over 25% of the mortgage industry, totaling over $600 billion in 2005. Abuses of negative amortization, piggyback loans to cover down payments, and other stretched deals are discussed in the January Hat Trick Letter report, as are the key specific factors tipping homeowners over the edge into foreclosure. The most dangerous bank system risk might not be the failures so much as the skewed internal underwriter risk controls, and policy for loan loss reserves. Piggyback loans are insane since they directly enabled loans which would not have been approved. They are called “silent seconds” since their loan-to-value lenders only report the first mortgage. Mortgage industry data is thus skewed and biased. Shocks are next.

MORTGAGES EARN DEBT DOWNGRADES

Early damage has finally begun to grip the ABX index for “BBB” credit insurance. The credit default swaps (CDS) market concerns standard insurance for the vast collection of bonds, including many types of mortgages. Foreclosures mean deceased returns on investment within mortgage portfolios for banks. The BBB type refers to subprime mortgage loans, as measured from a broad basket of size and regional locations. The ABX index has fallen suddenly in the late autumn and continues to fall. Relative to its own market, a drop of over 5% is large indeed. As quasi-insurer having invested in CDS contracts, your risk premiums rose and you profited like with a stock held. The index indicates a sudden decline in high risk mortgage conditions. The mortgage industry is unraveling precisely as my forecasts indicated last year. The concept of the credit default swap contracts is exactly the same as those pertaining to the General Motors bonds collateralized to car loans in summer 2005. As the bonds are damaged, the CDS contracts rise in value. The BBB index below absolutely screams of a widening crack in the mortgage industry, certain to extend into the banking system balance sheets. The scale of the BBB index is inverted to reflect fallen value of the mortgage portfolios.
Most USEconomic growth in this hollow recovery is attributed to equity extractions by an estimated 75%. In fact, it is tied to the major bulk of growth. Since the early 1990 decade, quarterly cashout loans against home equity have jumped by a remarkable 10-fold rise over a 10-year period. To claim its removal will be insulated from the overall USEconomy makes no sense whatsoever. This is the stuff of recessions. Home mortgage equity withdrawal has been sliced by 71% in the most recent four quarters reported up to 3Q2006. The impact will be felt broadly and deeply, especially at a time when adjustable mortgages are reset to higher monthly payment requirements.

Let it be known that banks and brokerage houses are shifting risk to hedge funds en masse, whose managers are traditionally more insane and driven by steroids. Nowhere is the Weimar trait more evident than in global credit and their derivative growth, whose magnitude is permitted to grow unchecked by collusive if not corrupted government agencies without any regulation.


Uber-blogger immobilienblasen explains further that the US housing forecast by the biggest bond investor in the country, PIMCO, is insanely sanguine. "PIMCO believes the most likely scenario for the U.S. in 2007 is that growth will remain below trend at about 2%, owing to the influence of the ongoing housing market correction and its expected impact on the labor market and consumer spending. That should all add up to a soft landing for U.S. growth and the global economy after the strong growth of the past few years. But we see the risks as skewed to the downside in the U.S., owing to the potential for a sharper-than-expected slowdown in housing that spills over into other sectors of the U.S. economy and slows consumer spending ( While we believe the rest of the world can take in stride a U.S. soft landing, a harder landing in the U.S. creates the potential for greater spillover effects and a harder landing for the global economy."

18 January 2007

Capital One Financial (COF) Big Miss...Lowered Guidance

Capital One-COF reports Q4 EPS $1.14 vs. consensus est of $1.24
COF sees 2007 EPS $7.40-$7.80 vs. consensus est of $8.11, which includes $430M of costs and charges. The company plans on buying back $2.25B worth of shares starting in Q2. So what will support the shares in the near term??? When you listen to the call, the quarter would have been a lot worse without the 42% gain Y-Y in the credit card business to $337m. Of course, the loan charge-off and allowance for future losses soared, but no wire service carried these negative details.

Capital One quarterly results, 2007 forecast, miss analyst estimates; North Fork benefits delayed
COF75.82, -0.71, -0.9% ) said. The company said it expects to make between $7.40 and $7.80 a share in 2007. Analysts were expecting fourth-quarter profit of $1.24 a share and 2007 earnings of $8.11 a share on average, according to a Thomson First Call survey. Capital One said it's still targeting $275 million of pre-tax synergies from its North Fork acquisition, but said most of these savings will be realized late in 2008 because of the "challenging" interest rate environment and the time it will take to convert to a single deposit platform and brand.

Downsizing is complete from the North Fork and Hibernia acquisitions with $8.5B in loans sold off in 2006, half out of COF and $1.5B of legacy housing loans from Hibernia and $4B of residential whole loans out of North Fork plus $5.5B of short-term residential housing securities. What a mess !!

CORS Missed and Conversion Lending Nearly Ceased

Condo lender Corus (or Porous) Bankshares (CORS-NYSE) missed last night and warned further about the condo lending opportunity and the real estate outlook in total.

"It should be no surprise that Corus, with a loan portfolio invested almost exclusively in loans to condominium developers, is feeling the effects of the nationwide slowdown in the housing market. Evidence of this slowdown is clear from the 39% decline in our pipeline of Pending Loans as compared to December 31, 2005. However, when analyzing our loan originations, it is important to differentiate between conversion loans and new construction loans. Our origination of construction loans in 2006 totaled $3.3 billion, which was up 24% from the amount of construction loans originated in 2005. Unfortunately, the conversion of apartments to condominiums all but ceased and, as a result, originations of conversion loans dropped dramatically in 2006 to only $546 million. The first quarter of 2006 was the last time we originated a meaningful amount of conversion loans, and we don't anticipate that changing in the near future.

"Aside from the effects on our new loan origination volumes, the slowdown in the housing market is also impacting Corus in terms of credit quality of loans already on our books. We have seen various projects that are experiencing slower sales of condominium units and/or lower prices than the developer or we would like. While construction projects are clearly not immune to the forces of the slowdown, conversion projects are presently displaying more obvious signs of weakness. We currently have two condominium conversion loans where we have discontinued the accrual of interest. While we have had other loans that have displayed signs of weakness, borrowers or their financial backers have been willing to step up to the plate and invest additional dollars, sign financial guarantees or take other actions that ultimately strengthen the loan from our perspective.

Where's the detail, Glick-boy??

"When foreclosure appears to be the best course of action for addressing a problem loan, we will not hesitate to do so. We believe that our loans were underwritten conservatively, leaving room for our loan amounts to increase or the collateral values to decrease and still have the Bank get repaid in full. As a result, we have no intention of agreeing to a workout if a borrower approaches us with the attitude that we should leave him in control of the project and give him all of the upside if the market turns around, but leaves the Bank to take all of the downside risk.

Here's what they said in October:
http://seekingalpha.com/article/18683

"Aside from the effects on our new loan origination volumes, the slowdown in the housing market is also impacting Corus in terms of credit quality of loans already on our books. We have seen various projects that are experiencing slower sales of condominium units and/or lower prices than the developer or we would like. While construction projects are clearly not immune to the forces of the slowdown, conversion projects presently seem to be displaying more obvious signs of weakness. [b]So far, we can report that we have only one condominium conversion loan which is nonaccrual and one additional loan listed as a Potential Problem Loan. However, we have had numerous other loans that have experienced meaningful problems, but in these cases, the borrowers or their financial backers have stepped up to the plate and invested additional dollars, signed financial guarantees or taken other actions that have strengthened the loan from our perspective." (For now.)


Hmmn, I smell a rat here..

"We have yet to experience any situation where we have had to foreclose on a property nor have we incurred any losses, but it would not surprise us if we did. We believe that our loans were underwritten conservatively, leaving room for our loan amounts to increase or the collateral values to decrease and still have the bank get repaid in full. However, we will not hesitate to foreclose if the borrower does not support a loan that is in distress. In general, we would not agree to a work-out if a borrower approaches us with the attitude that we should leave him in control of the project and give him all of the upside if the market turns around, but leaves the bank to take all of the downside risk."

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