WaMu Part II? (Wells Fargo)

WaMu Part II? (Wells Fargo)

The Market Ticker , September 17. 2009

The Market Ticker began publication when I noticed a nasty little thing that Washington Mutual was doing - paying dividends from "capitalized interest" - that is, "funny money" promised to be paid in the future by homeowners who had negative-amortization loans.

In California.

With price-to-income ratios for homes that frequently were running 10x, or more than three times the maximum safe value.

I screamed about this at the time, predicting that WaMu would ultimately blow sky high, and nobody in the regulatory apparatus did a damn thing about it.

WaMu did in fact blow up and was "forcibly" folded into JP Morgan.

Is it happening again, but in a different venue, this time with Wells (and perhaps elsewhere)?

According to sources currently working out these loans at Wells Fargo and confirmed by Dan Alpert of Westwood Capital, when selling tranches of commercial mortgage-backed securities below the super senior tranche, Wachovia promised to pay the buyer’s risk premium by writing credit default swap contracts against these subordinate bonds. Should the junior tranches eventually default, then the bank is on the hook.

Uh huh. Ain't that nice? We'll write a CDS and make money twice! Better yet, we called that a "true sale" of the original securitization.

Like hell.

One senior member of Wells Fargo’s commercial loan group who deals directly with the quandary, who spoke on the condition of anonymity, said, “One third of this commercial portfolio we took on from Wachovia is impaired and needs to be completely rewritten. I’ve just hired five more guys and we can’t keep up with the volume of defaults. Southeast Florida and Tampa are serious trouble spots.”

One third eh? Florida? SE Florida? Like Miami. where not long ago I looked up at the skyline to see multiple completed "condo developments" that had a half-dozen lights on (not including the doorman) at 10:00 PM - in a 40 story tower?

Eek.

There was $230 billion in that portfolio when Wells "acquired" Wachovia last year. Was it written down adequately?

Good question.

Was the risk disclosed properly to shareholders at the time of the acquisition?

An even better question.

But the real topper is how Commercial Real Estate loans are frequently done, including a big part of these loans - they're usually interest-only on a reasonably-short time frame (e.g. five years) with the balloon (principal) due on maturity.

This isn't a uniquely "bubble" thing, it in fact has been how commercial real estate (significant projects anyway) have been done for decades. The premise is that the rent and fees will cover the interest and the bank will roll the note at maturity. Interest cost may change but that's no big deal since rents adjust up and down, right?

After all, the actual base value of real estate never goes down, leaving you with a principal balance greater than the net-net value of the property, right?

Where have I heard that tall tale before?

Of course Wells could try to sell the loans off in the market. Or can they? How much is the underlying property worth? Nobody in their right mind is going to give them more than the current value of the property less the discounted cash-flow remaining on the note. What sort of damage would that do to Wells' balance sheet? Can they absorb it even if they wanted to (which from the lack of sales reported in the market they clearly don't!)

Oh yeah, and under the wonderful "accounting rules" banks don't have to disclose the CDS they wrote against those tranches on their balance sheet nor provide maximum exposure - until and unless they blow up in their face, when suddenly that liability "magically re-appears."

This sort of crap is exactly the kind of accounting game that I have been hollering about for more than two years. The fact that these numbers remain undisclosed and are not being volunteered tells me that the banks are likely hiding huge - possibly critical - contingent losses which they have every reason to believe will become realized.

And by the way, this problem is almost certainly not specific to Wachovia/Wells.

But due to the fact that our government allows institutions to hold "off balance sheet" exposures at all, a practice that after ENRON should result in instantaneous indictments and prison terms, we simply do not know how deep this rabbit hole goes - at Wells or anywhere else.

Is the recovery in the stock price of financial stocks (and the market generally) due to actual stronger performance (and a brighter future) or just due to more crafty lies?

And what, pray tell, happens to both if it turns out that in fact there isn't enough capital in these institutions to cover the CDS payments when (not if) the loans (or the complex securities based on them) blow sky high?

What might trigger that? Oh, I don't know..... maybe something like this?

Standard & Poor's Ratings Services recalibrated its ratings criteria for collateralized debt obligations, resulting in the ratings firm's putting about 4,790 CDO tranches totaling $578 billion on watch for downgrade.