Refinance Free Credit

Wells Fargo reported its fourth quarter earnings today, and said that earnings fell 38 percent as the bank saw credit quality deterioriate. Net income fell to to $1.36 billion during the fourth quarter, or 41 cents a share, from $2.18 billion, or 64 cents, in the year-ago period.

Much of the drop in earnings came as the bank ramped up reserves for loan losses to $5.52 billion, a net increase of $1.5 billion from the third quarter due largely to expected losses in the bank’s home equity portfolio.

Reinforcing its move to build loss reserves, the pace of HEL charge-offs quickened dramatically during the fourth quarter, increasing 81 percent to $277 million.

More borrowers in trouble
Borrowers were 90 days or more behind on $1.56 billion worth of outstanding loans, excluding insured and GNMA guaranteed loans; $487 million of that amount was attributable to residential first and second mortgages, Wells said.

Total nonperforming assets were $3.87 billion at the end of 2007, a 22 percent increase compared to $3.18 billion in the third quarter. Total NPAs include more than just 90+ day delinquencies.

“The majority of the increase in nonperforming assets was concentrated in the first mortgage loan portfolio ($132 million in Wells Fargo Home Mortgage and $230 million in Wells Fargo Financial real estate) and was due to the national rise in foreclosure rates,” said chief credit officer Mike Loughlin.

“Additionally, due to illiquid market conditions, we have decided to hold more foreclosed properties than we have historically.”

For the record, I personally don’t think Wells “decided” to hold REO; I think that market conditions are making it impossible for Wells, and any foreclosing lender, to actually turn over any of its inventory.

Loan production drops, servicing grows
Origination volume fell 20 percent in the fourth quarter relative to the year-ago period, driven primarily by Wells’ exit from the wholesale channel. Total 2007 loan production was off 7 percent from 2006, at $272 billion.

“Total fourth quarter originations declined 20 percent from 2006 to $56 billion, primarily reflecting actions we took to exit or reduce volume in third party channels for non-prime, non-conforming and home equity products,” said Mark Oman, senior EVP at Well’s Home and Consumer Finance Group. “Retail mortgage originations declined only 3 percent in the quarter.”

Wells’ servicing portfolio continued to grow, however, reaching $1.53 trillion at year-end — up 12 percent from 2006, and enough to make Wells Fargo the largest mortgage servicer in the nation. Countrywide Financial, once the nation’s largest, reported a servicing portfolio of $1.48 trillion at year’s end.

For more information, visit http://www.wellsfargo.com.

Disclosure: At the time this post was published, the author held no positions in WFC.

JPMorgan Chase & Co. said Wednesday morning before market open that net income dropped 34 percent from year-ago levels to $3.0 billion in the fourth quarter, down from $4.5 billion in Q4 2006. Bloomberg reported that earnings missed analyst expectations.

Driving the drop in earnings was a $1.3 billion write down on the Wall Street bank’s subprime positions, including CDOs.

“We remain extremely cautious as we enter 2008,” CEO Jamie Dimon said in a press statement. “If the economy weakens substantially from here – for which, as a company, we need to be prepared – it will negatively affect business volumes and drive credit costs higher.”

Credit costs, of course, are already high. JPMorgan’s retail banking segment saw reserves for loan losses jump to $1.1 billion during the quarter, compared with $262 million in the prior year and an increase of $395 million from the third quarter. Citing weakness in home equity loans, the company said it had charged off $248 million of HELs in the fourth quarter. Subprime charge-offs registered $71 million.

Mortgage banking activity sees improvement
Despite increasing reserves and an accelerating pace of charge-offs, JPMorgan said its retail banking segment posted a 5 percent gain in net income during the fourth quarter as due to “improved results” in mortgage banking.

Mortgage loan originations were $40.0 billion during the fourth quarter, up 34 percent from year-ago production and a 2 percent gain from the third quarter, the company said.

Servicing revenue also took a big jump in the fourth quarter, driven primarily by a gain in the estimated value of the company’s mortgage servicing rights as well as growth in the servicing portfolio. Third-party servicing grew 17 percent during the quarter, JPMorgan reported, driving growth of $67 million in servicing revenue.

Mortgage servicing rights gained $499 million in value, JPMorgan said, due a decrease in estimated future prepayment activity.

While it’s clear the company isn’t avoiding entirely the credit mess being driven by the mortgage industry, the relative success of JPMorgan’s mortgage operations has led many to speculate that it may look to buy a weaker competitor during 2008. Washington Mutual, among others, have been cited by analysts as potential targets.

Disclosure: At the time this story was published, the author held various put options on WM; no positions in JPM.

The Mortgage Bankers Association’s weekly survey of mortgage application volume found a strong surge in refinancing activity as rates dropped to two-year lows to start the new year. Overall application activity was 906.4, an increase of 28.4 percent on a seasonally adjusted basis from 706.0 one week earlier and up 39 percent from year-ago levels.

The application index is calibrated to March 16, 1990; a reading of 906.4 means that application activity is a little more than 9 times greater than when the index was first established.

Refinancing activity increased 43.4 percent to 3575.5 from 2494.2 the previous week — which was shortened by the New Year’s holiday — and the seasonally adjusted purchase index increased 11.4 percent to 461.2 from 414.0 one week earlier. FHA-led refinancing activity also saw a jump, the MBA said, rising 17.6 percent from week-ago levels on a seasonally-adjusted basis.

At least some of the jump, however, was attributed to holiday volatility as much as to mortgage rates that have reached levels not seen since 2005.

“There is alot of volatility in the index right now, even on a seasonally-adjusted basis,” said a mortgage banker reached by HW, who wished to remain anonymous. “It’s tough to adjust the data completely, so I’d put more confidence in the unadjusted annual comparison.”

Refinance share of mortgage activity increased to 62.7 percent of total applications from 57.7 percent the previous week; ARM share of activity decreased to 9.2 from 9.3 percent.

For more information, visit http://www.mortgagebankers.org.

Kudos to Peter Viles for his “L.A. Land” blog in the “latimes.com” website.

Many of the CEOs from my previous post on real estate related stocks that have radically declined in value in 2007 were not only paid huge sums of annual salary last year, but most made their lion’s share of compensation in the form of stock grants, exercised stock options and perks.

By now you’ve heard that IndyMac is cutting another 2,403 jobs, or another 10% of its workforce.

I was at a luncheon a few years back with Mike Perry, the CEO of IndyMac. The previous year Mr. Perry made over $30 million in total compensation.

When asked if he felt he was deserving of making 1,000 times the average pay of an IndyMac employee he responded with, “Damn straight. The stock price and earnings under my leadership has averaged a 20% annual growth for the past five years.”

My mother taught me that turnabout is fair play. If a CEO (and his ego) takes credit for the company doing well in the good times, then the CEO must also take the blame for the company sucking during bad times.

Inquiring minds want to know if Mr. Perry will be paying back 90% of his compensation earned over the past five years as the market has wiped out 90% of his shareholders value in just this past twelve months. Maybe a rather large donation to Habitat For Humanity?

Mr. Perry was the CEO of IndyMac this past twelve months, right? So this devastation of stockholder’s value occurred under his watch, correct?

If you or I were to helm a company that lost 90% of its value in a single year — we would be fired, thrown out on the street with a boot print on our ass, and told never to come back again.

But with a publicly traded company, the Board of Directors lowers the strike price on all our underwater stock options, grants a golden parachute consisting of at least a $100 million severance package, offers continued use of the corporate jet, pays our country club membership, pays for my personal assistant, offers full benefits package for life.

Not bad for screwing up and decimating the shareholders stock value.

Charles Prince, the former CEO of Citigroup (who was just canned December 2007) still retains 1,612,732 shares of Citigroup (C) now trading around $26.94 for a market value of $43,447,000.

So for taking on too much risk without proper management controls that your shareholders have lost $20 billion (so far), Mr. Prince walks away with more money than you or I could spend in a lifetime (well, maybe my ex-wife could spend that).

It’s times like these that make me wish I was a corporate CEO of a publicly traded firm. You can fire my ass and pay me $100 million to go away any time you like.

It must be hard to pay the bills and “send the kids to college” on $140 million annual compensation in 2006 (actual quote from Angelo Mozilo of Countrywide on why he was accelerating his CFC stock sales in 2007 via his 10b5-1 plan).

Could be it is time for Angelo Mozilo to fade away into the sunset, but from the looks of it one could say he’s already spent a tad too much time in the sun (tanning booth). But at least he walks away with $650 million in compensation over the past 10 years.

Instead of the disgraced CEO receiving a $100 million severance package for failing, I propose the CEO be required to pay back all their stock options earned over their management reign.

Next I recommend we bring back public pillory and dangling a large placard around the humiliated CEO’s neck that reads, “I Lost 90% of My Shareholders Value”.

After all the only way to inflict any hardship on a rich man is to take away his money.

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Ocwen Financial Corporation, one of the nation’s larger subprime servicers, said late Tuesday that it is entertaining an offer from a group of investors led by none other than CEO and chairman William Erby to acquire the company for $7.00 per share in cash.

The West Palm Beach, Florida-based company said it had formed a special committee to review the offer.

“I would participate by making a significant investment in the transaction,” Erbey said in a letter to Ocwen’s board, “and I expect that we would provide members of the Company’s senior management team with the opportunity to participate in the transaction as well.”

The letter stated that the investment team was looking to “move quickly” to finalize a deal.

Standard & Poor’s issued a bulletin noting that the proposed deal will not have a negative impact on Ocwen’s rating or outlook.

For more information, visit http://www.ocwen.com.

Markit — home, among other things, to the oft-covered ABX indices — said today that it has launched a performance monitoring platform for the U.S. ABS secondary market.

Launched in response to market conditions, Markit said in a press statement that the new tool — called U.S. ABS Performance Data — is designed to bring greater transparency to the sub-prime mortgage market. The platform combines historical data at the bond, collateral pool and loan level to provide ABS market participants with a source of information for deal monitoring and securitization analysis.

The company hopes to expand the platform to additional RMBS and ABS asset classes in the future.

“Increasingly, ABS investors require a more timely and comprehensive understanding of the collateral underlying each ABS deal,” said Ben Logan, managing director of structured finance at Markit. “[Our] new product aims to bring much needed transparency to the U.S. ABS markets by providing clients with an up-to-date collateral monitoring tool alongside the other unique and valuable content we offer.”

The tool will provide a range of information, including complete bond payment and collateral performance history, as well loan level statistics with data feed functionality.

There have been a slew of ratings downgrades to various subprime and Alt-A deals recently; but there appear to be even more on the horizon, thanks to more changes announced today by Standard & Poor’s.

S&P said it has revised the assumptions it uses for the surveillance of U.S. residential mortgage-backed securities (RMBS) — chief among them, the rating agency said it has bumped up expected lifetime losses for the 2006 subprime vintage to 19 percent. The agency had previously forecast losses at 14 percent.

Beyond the 2006 vintage, S&P also said it will “recalculate lifetime loss expectations for all vintages of U.S. RMBS” — that means not just subprime, and not just 2006.

S&P also said it was extending its expected loss amount over the lifetime of transactions, as well as revising assumptions on the availability of excess spread. Both are technical points, but important to understand.

In your plain-vanilla securitization, losses are forecast over 36 months — the typical ’seasoning’ time, where default activity peaks and then tapers off. By revising its loss curves to cover the entire duration of a deal, S&P is recognizing that the housing downturn is going to last long enough to turn traditional loss assumptions on their head.

In terms of excess spread, the revisions come on the heels of the ARM freeze program — sort of the “default later” problem, if you will. Because borrower defaults may occur later than expected if a deal has a sufficent amount of ‘freezing’ in it, it’s possible that excess spread in a deal may have been depleted by the time a frozen ARM thaws out and defaults. (See an earlier post for an in-depth discussion of this issue).

The rest of S&P’s release provides some insight worth reading [emphasis added]:

Monthly performance data reveals that delinquencies and foreclosures continue to accumulate at an increasing rate for the 2006 vintage. Since July 2007, cumulative losses for all subprime RMBS transactions issued during 2006 have increased 156% to 1.13%. The cumulative loss amount is based on the original balance of the transactions. At the same time, total and severe delinquencies (90-plus days, foreclosure, and REO) have increased 49% and 66%, respectively. As of the December 2007 distribution date, total delinquencies for the 2006 vintage had increased to 28.79% and severe delinquencies were 18.83% of the remaining principal balance of the transactions. This delinquency trend has caused us to increase our expected lifetime loss projection.

Standard & Poor’s last put its RMBS criteria through a major revision in July 2007 (see HW’s coverage here), which lead to wide-scale downgrades of numerous subprime RMBS. I’d expect to see more in the wake of today’s announcement.

For more information, http://www.standardandpoors.com.

California faced a substantial 45.4 percent jump in new borrower defaults as 2007 came to a close, with 32,948 notices of default filed in December, compared to 22,665 in November. December auction sales also increased by 4.1 percent from November, according to a report from research firm ForeclosureRadar, reaching a total of 12,783 properties.

For you non-industry types: in California, the default process generally begins with a notice of default (NOD), and generally ends with a notice of trustee sale (NTS), after which the property is sold at auction to the highest bidder. (The highest bidder these days is often the bank itself.)

A total of 9,001 properties have been sold at auction in just the first eight business days of January, the firm also noted; such surges are common after lender-imposed holiday moratoriums on both foreclosure sales and evictions.

“The impact of the credit crisis that began in August is now clearly starting to show its impact,” said ForeclosureRadar founder Sean O’Toole. “Many analysts fail to understand the delays inherent in the foreclosure process, and I believe we have yet to see the real impact from the ARM resets that began in earnest last October.”

The majority of loans going to auction continue to have been originally made in 2006 (52 percent), 2005 (34 percent), 2007 (8 percent) and 2004 (5.4 percent).

At the county level, notable month over month increases in activity were seen in Riverside, San Bernardino, San Diego, Ventura, Orange, Los Angeles, Santa Cruz, Marin and San Francisco counties, according to the report.

Consumers shied away from adjustable-rate mortgages as 2007 wore on, according to a report released Tuesday by Freddie Mac that said that the interest-rate savings relative to fixed-rate loans has shrunk.

“Disruptions in the capital markets beginning in August and an increase in delinquencies on ARM product has led to a sharp decline in interest-rate discounting and a tightening of credit underwriting on ARMs in recent months,” said Frank Nothaft, Freddie Mac vice president and chief economist.

“A year ago, the initial-rate discount on the popular 3/1 and 5/1 hybrid products was about 1.8 percentage points. In our latest survey, the rate discount had virtually disappeared on these products.”

The survey, based on data collected December 17 to December 21, found that starting rates for ARMs were close to or above rates a year earlier, even though the Federal Reserve had lowered its federal funds target from 5.25 percent to 4.25 percent over the time since Freddie Mac’s previous survey. In contrast, fully-indexed rates had fallen to their lowest levels in three years, resulting in an erosion in the initial-rate discount that had been prevalent in the market during 2005 and 2006.

ARMs accounted for 17 percent of loan applications in October 2007, Freddie Mac said, the lowest since June 2003 when fixed-rate loans were near a 45-year low in interest rates and refinance activity was near a peak.

The initial rate on jumbo 1-year ARMs was about one-quarter of a percentage point higher than on conforming 1-year adjustables, the largest gap in seven years, according to Freddie Mac’s surveys.

For more information, visit http://www.freddiemac.com.

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