Summary
Adverse news continues to sprout headlines describing the expansion of delinquencies into new corners of the US bank and thrift loan portfolios. The Mortgage Bankers Association reported that 1Q2008 mortgage delinquency and foreclosure rates continued to expand abovemuch 4Q2007 levels and are now much higher than 1Q2007. How many forced transactions (e.g., Countrywide - Bank of America) or outright failures are likely? Which institutions are inching closer to the edge of extinction?
Analysis
The popping of the nationwide housing bubble has certainly received a wide following from general and industry media alike. Clearly, excesses have been booked, and baked, by a growing number of lenders who are now reporting significant declines in year over year earnings. Upon closer inspection, there is growing evidence that not just one or two (e.g., subprime mortgages, home equity lines of credit) loan strategies produced the current value destruction. The MBA's 1Q2008 delinquency report disclosed that just four states (California, Florida, Arizona, Nevada) accounted for a high percentage of residential mortgage delinquencies and foreclosures. Specifically, these four states produced:
1. 62% of the foreclosures started on prime ARM loans, and 84% of the increase in prime ARM foreclosures;
2. 49% of the subprime ARM foreclosures started in 1Q2008, and 93% of the increase in subprime ARM foreclosures;
3. 29% of the prime fixed rate foreclosures, and 60% of the increase in those foreclosures; and
4. 25% of the subprime fixed rate foreclosures, and 53% of the increase in those foreclosures.
Regulators have already tuned their review and examination criteria in anticipation of a significant increase in problem institutions. The number of banks and thrifts on the problem list has risen to 90 (1Q2008) from the 35 year low of 47 (3Q2006 - a good proxy for the bubble popping). This total is still way below the cyclical high of the early 1990s at 1,089 institutions (4Q1991). However, that total really reflected the accumulation of many brain dead institutions that had to wait for the S & L bailout legislation that authorized the Resolution Trust Corporation and over $125 billion in funding.
Institutions that were big pay-option ARM lenders appear at risk, especially if their portfolios are concentrated in these four states. Wachovia, Downey Savings, First Federal of California, IndyMac Bank, and BankUnited are in this group. Other lending strategies that were heavily focused on residential construction are also suffering. Corus, Franklin Bank, and Ocean Bank are in this group.
Weeds may spread to other portfolios if oil remains stuck above $100 a barrel for the remainder of 2008. The impact on the broader economy and especially consumer spending could spread to commercial real estate, commercial & industrial, small business and unsecured consumer loans. Liquidating bad loans and foreclosed property takes time to cure. It always has.
