Keane global financial services director Vivek Mehra was chewing the fat with one of his industry contacts in the mortgage-securitization industry when the table talk turned to volatility. With adjustable-rate mortgages, balloons, options, floats and other multi-flavored loans littered cross the investor pools, Mehra's cohort did not understand how these secondary holders kept up with them. "We were talking in context of the infrastructure and IT needed to support these complex mortgage products," recalls Mehra. "It was clear these products came on so quickly and so fast that organizations were not prepared."
Mehra remembers the conversation so well because it was with a Freddie Mac svp more than two years ago, when collateralized debt obligations were being filled to the brim with high-risk mortgages, with vaporous odds for eventual payoff.
In judging the subprime blowout of 2007, no one can claim they couldn't see it coming. A piggybacked, zero-down, delayed-interest loan is a bad loan, no matter how much the Street chirps up construction starts or who ends up holding the note. So over the course of the summer, as delinquencies skyrocketed, foreclosure activity took on a "Grapes of Wrath" urgency and somewhere between 60 and 100 undercapitalized non-bank lenders disappeared, taking several hundred jobs with them.
In contrast, the nation's big banks took some glancing blows, but many found opportunity. Even though shareholders have been harsh on Wachovia for its peak-market $24 billion acquisition of Golden West Financial and its collection of California-based ARMs, there are so few subprime loans in Wachovia's chest (less than 0.5 percent of its portfolio) that it boosted its quarterly dividend 14 percent in August. Bank of America and CEO Ken Lewis grabbed a $2 billion stake in Countrywide Financial to protect the nation's largest originator from a credit crunch, while granting BofA a potential long-term bargain that had yet to materialize at press time; Countrywide's stock fell below $18, erasing a paper profit of $700 million in preferred shares bought by the Charlotte bank.
Citibank, meanwhile, bought the mortgage assets of subprime specialist ACC Capital with plans to build out a prime-only residential landing practice. It's the beginning of a wave in which analysts see the large banks building market share across not only lending, but ancillary card, advisory and investment services. "As a result of the blowups, banks will increase market share dramatically in 2008," predicts Richard X. Bove, a financial analyst for Punk, Ziegel & Co. "I think what you're going to see is the banks [will take] a kitchen-sink quarter in which they write off as much as possible to cleanse their balance sheets, so that in 2008 they can function."
One of the banks' problem areas is in high-yield home-equity lines of credit, which institutions have generally kept in-house while sending the lower-rate, first-lien products out into the secondary market, according to TowerGroup research director Craig Focardi. "For them it was a win-win," he says-until, as noted in a TowerGroup consumer-lending report, the rising prime pushed HELOC rates from a low of four percent in 2003-04 to 8.25 percent in 2006, effectively doubling consumer payments.
"They put a lot of these [subprime] mortgages on their books, particularly JPMorgan, and that is a high-yield product which, if it doesn't explode with bad loans, will serve the banks well," says Bove. "My guess is they will get enough bad loans to offset the benefits."
While shaving off risk is healthier for long-term outlooks, these approaches don't mitigate the pressure on consumer-lending divisions, where TowerGroup estimates leaders are still under pressure to deliver annual 10 percent growth rates. And with the subprime mess still unfolding, and Congress debating clampdowns on risky lending, the liquid-leading banks will have to find ways of making things work within the boundaries of more traditional risk, say experts. But they appear, at least, to be gaining most of the field with which to practice. (c) 2007 U.S. Banker and SourceMedia, Inc. All Rights Reserved. http://www.us-banker.com http://www.sourcemedia.com
