As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves

October 12th, 2010 by Reggie Middleton

As those that follow me know, I have been bearish on US banks since 2007. That bearish outlook resulted in massive returns ensuing years, just to have nearly half of it returned due to rampant shenanigans and outright fraud. Needless to say, it pissed me off – but it did much more than that. It created a re-bubble before the bubble that was bursting had a chance to fully deflate. As a result, what we have now is one big mess that is getting messier by the minute.

On Friday, July 16th, 2010 I posted “After a Careful Review of JP Morgan’s Earnings Release, I Must Ask – “What the Hell Are Those Boys Over at JP Morgan Thinking????”. The impetus of such was that this bank that all seem to be in awe of was taking a big risk in order to pad accounting earnings for a quarter or two. Below is an excerpt of my thoughts:

Trust me, the collateral behind many more mortgages will continue to depreciate materially as government giveaways and bubble blowing for housing fade!

The delinquency and NPA levels drifted down a bit, but they are still at very high levels. Charge-offs came down but the reduction in provisions has been quite disproportionate bringing down the allowance for loan losses. In 2Q10, the gross charge- offs declined 26.6% (q-o-q) to $6.2 billion (annualized charge off rate – 3.55%) from $8.4 billion in 1Q10 (annualized charge off rate – 4.74%). But the provisions for loan losses were slashed down 51.7% (q-o-q) to $3.4 billion (annualized rate – 1.9%) against $7.0 billion (annualized rate – 3.9%) in 1Q10. Consequently, the allowance for loan losses declined 6.2% (q-o-q) from $35.8 billion from $38.2 billion in 1Q10. Non performing loans and NPAs declined 5.1% (q-o-q) and 4.5% (q-o-q) respectively. Thus, the NPLs and NPAs as % of allowance for loan losses expanded to 45.1% and 50.7%, respectively from 44.6% and 49.8% in 1Q10. Delinquency rates, although moderated a bit, are still at high levels. Credit card – 30+ day delinquency rate was 4.96% and the real estate – 30+ day delinquency rate was 6.88%. The 30+ days delinquency rate for WaMu’s credit impaired portfolio was 27.91%.

While the lower provisioning was able to beef up the bottom line in this quarter, the same is not sustainable in the future as JPM cannot afford to reduce its allowance for loan losses substantially. This is a one shot, blow your wad and go to sleep deal!  There is no margin for error in the future, and one can only assume that the reason this was done was to pad accounting earnings and to take advantage of the extremely short term, and obviously naïve, memory of the financial media and retail/institutional investor. Given the high charge-off rates and delinquency levels, the provisioning will probably need to be bolstered again in the not too distant future.

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The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008!

October 12th, 2010 by Reggie Middleton

Now that the Robo-Signing scandals have achieved full notoriety through the media, it is time to address the real issues facing investors in bank stocks. We also believe that the media is staring at the wrong target. Each major media outlet is copying what is popular or what the next outlet broke as a story versus where the true economic risks actually lie – which is essentially the real story and where the meat actually is. This is what is truly at stake – the United States is now at risk of losing its hegemony of the financial capital of the world! Why? Because when we had the chance to put the injured banks to sleep and redirect resources to into new productivity, we instead allowed politics to shovel tax payer capital into zombie institutions as they turned around and paid it right back out as bonuses. As a result, significant capital has been destroyed, the original problem has metastized, and the banks are still in zombie status, but with share prices that are multiples of the actual values of the entities that they allegedly represent – a perfect storm for a market crash that will make 2008 look like a bull rally! For those who feel I am being sensationalist, I refer you to my track record in making such claims.

The Japanese tried to hide massive NPAs in its banking system after a credit fueled bubble burst by sweeping them under a rug for political reasons. Here’s a newsflash – it didn’t work, it hasn’t worked for 20 years, and despite that Japan is embarking on QE v3.3 because it simply doesn’t believe that it is not working. Here are the steps the US is consciously taking it its bid to enter a 20 year deflationary spiral like Japan, and may I add that these steps were clearly delineated on BoomBustBlog ONE YEAR ago (Bad CRE, Rotten Home Loans, and the End of US Banking Prominence? Thursday, November 12th, 2009), so no one can say this is a surprise.

Step one: Hide the Truth!

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The Complete, 63 pg Google Forensic Valuation is Available for Download

October 8th, 2010 by Reggie Middleton

This is, by far, the most extensive single forensic analysis and valuation we have ever done. It weighs in at 63 pages and covers all angles Google. I have decided to make the entire document available to all paying subscribers – access it here File Icon Google Final Report and pro and institutional subscribers can make use of the accompanying valuation model to adjust and tweak assumptions as they see fit – File Icon Google Valuation Model (pro and institutional).

This paragraph from the report pretty much sums up my opinion of the market’s and the sell side’s view of Google…

The key to appreciating how Google will make money on an open-source mobile platform such as Android resides in understanding the strategy behind Android and Google’s business model. It is important to understand that Google’s core competency from a revenue perspective is advertising, but its core competency from a strategic perspective is leveraging it cash cow revenues from advertising into high risk/high return ventures with relatively long horizons for return on investment. This rather old fashioned way of conducting business and investing can (and has since the beginning of investing) yield stellar results over time; unfortunately its value is often lost on the “what’s happening next quarter” crowd (often found in many retail investors, traders, long only institutions that are focused on quarterly and annual performance reports and the sell side of Wall Street) – particularly as the ROI horizon is extended while the venture requires constant capital to build momentum. With regards to Android, the open platform has allowed Google to incur minimal costs associated with the software development while the company has left the task of hardware development, marketing and customer service to hardware and carrier partners. In its Q2 conference call Google management reiterated that costs associated for mobile development was “immaterial” to Google. This, in and of itself, is a significant feat being that Android’s development cycle is nearly 3x as rapid as its closest competitors – Blackberry, Symbian, and iOS, Android has exhibited record growth for the industry and Android has probably already come close to capturing the top spot in the US for units shipped as well as growth rate and is on track to be 2nd globally in units shipped and 1st for growth rate. The strategic ROI is absolutely phenomenal and it would not be wise to assume the financial ROI will not follow.

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How Likely Is Greece to Default? It Would Be a Downright Miracle If They Didn’t! Numbers Don’t Lie, Although Some Sovereign Reporting Agencies Do! Let’s Walk Through the Math…

October 7th, 2010 by Reggie Middleton

I’m going to cut to the chase here and skip over the theoretical mumbo jumbo that has been thrown around the apparently untenable Pan-European Sovereign Debt Crisis. Greece suffers from several things that, which combined and viewed from a historical perspective, has little or no precedent in terms of a country pulling itself out of without default (economic default, as in not paying your bills as promised) – at least to my knowledge.

Lies have been told, retold, and are continuing to be told!

It has been caught misrepresenting the economic condition of its county so many times in the very recent past that it has lost credibility with the markets. This string of misrepresentations (a very polite way of saying lies – after all I can come out and tell the truth, this is a blog, isn’t it?) are actually ongoing. See Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! and Here Comes Those Pan-European ‘I Told You So’ Again, Greece Busted Number Fudging for the nth Time:

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The Research In Motion Forensic Valuation and Analysis is Released to the Public

October 7th, 2010 by Reggie Middleton

Now that Research in Motion has reached our valuation target and offered the opportunity for material gain for our subscribers, I have decided to released the full 45 page professional Forensic Valuation report to the public. It is quite extensive, and has been quite accurate to date - RIMM Forensic Analysis and Valuation – Professional & Institutional: Formerly available to Pro and institutional subscribers, now released to the public. You will have to register for a free subscription to the site to download.

BERJAYA

And from the valuation section of our Forensic Report (those who have downloaded it can refer to page 30)…

BERJAYA

As you can see, we did a phenomenal job at anticipating the share price fall and the practical floor. Those of you who used options and/or leverage with proper risk management should have benefited handsomely. Of course, this particularly industry segment moves much more rapidly than most, which is why we have taken the opportunity to add flexibility in our valuations and analysis (page 32)…

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The Truth Goes Viral, Part 2: Italian Towns Damaged by Derivatives, Downtown Brooklyn Real Estate, Goldman Sachs, JP Morgan, Europe’s Overbanked Status, Reggie Middleton, Matt Taibbi, and Simon Johnson – All in One Video

October 5th, 2010 by Reggie Middleton

I present to you a very well made 45 minute documentary on big banks, derivatives, US real estate and the root causes of the Pan-European Sovereign Debt Crisis! Yes, it covers a lot, and it also has a list of colorful and insightful characters sharing their insights.

This is a viral video that hasn’t made a lot of leeway in the states yet (it was just released yesterday), but is going viral in (of all places) Amsterdam and the Netherlands – the birth place of irrational exuberance with $30,000 Dutch Tulips selling at a bargain…  Because it was different that time! Click here for the video: The Attack on Europe: Debt and Redemption, produced by VPRO Backlight and aired on BBC2. For those who aren’t fluent in Italian and Dutch, I have provided breakpoints that are in English for you to skip to:

  • 7:22 Matt Taibbi on IR swaps, big banks and small Italian towns (for those of you who don’t know, Matt Taibbi wrote that scathing piece in Rolling Stone on Goldman Sachs – The Great American Bubble Machine | Rolling Stone Politics
  • 10:32 More Matt Taibbi on derivative products
  • 27:10 to hear Matt Taibbi, Goldmans Sachs’ biggest fan (what would you guys think of a Matt Taibbi/Reggie Middleton collaboration?)
  • 28:40 Simon Johnson, former  Economic Counsellor and Director of the Research Department at the IMF, called for European boycott of Goldman Sachs (Simon Johnson — Biographical Information – IMF
  • 30:30 Matt Taibbi
  • 31:29 Simon and Matt
  • 31:46  to 37:43 Yours truly, Reggie Middleton in Downtown Brooklyn on the banks and the truly distressed sovereigns. It resumes at 38:15, but you should watch it through to get the feel for the subject matter at hand. By the, the discussion on derivatives here gets quite interesting, be sure to view the whole piece.
  • 46:35 resumes in English with some basic, common sense advice

I have made available below a lot of background info on Goldmans Sachs, JP Morgan, and the sovereigns in question. I will do a walk through of a European soverign nation’s practically guaranteed default in a few days, publicly on the blog, in full detail – complete with facts and numbers, the stuff you don’t see very often in the mainstream media. I will also attempt to update my big bank research and findings with data from the ground and independent sources in time for earnings. The banks have no more than one quarter left before the truth catches up with them… Then, we are back to 2008.

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The Truth Goes Viral, Pt 1: Housing Prices, Economic Sales and the State of Depression

October 5th, 2010 by Reggie Middleton

As promised, I discussed my thoughts on the Case Shiller index (a complex statistical construct that excludes many of the factors currently dragging on the housing market) being quoted in the mainstream media as if it was the S&P 500, its shortcomings, the true state of housing sales value in America and what’s in store for the near future.

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Pay Attention to the National Association of Realtors and Their Chief Marketing Agent At Your Own Risk!

October 4th, 2010 by Reggie Middleton

Note: See me discuss this topic live on Bloomberg TV, Monday October 4th, 2010 at 4:30 pm!

The National Association of Realtors is a marketing engine, yet their data and their economist’s opinions are quoted regularly in credible, mainstream financial news shows and newspapers. WHY???!!! On that note… Bloomberg reports: Pending U.S. Sales of Existing Homes Increase 4.3%

Oct. 4 (Bloomberg) — The number of contracts to purchase previously owned homes in the U.S. increased for a second month, a sign the housing market is beginning to stabilize. The National Association of Realtors’ index of pending home resales rose 4.3 percent in August, more than forecast, after a revised 4.5 percent gain the prior month that was less than initially estimated. Compared with the same month a year ago, pending sales were down 18.4 percent.

The rise is most likely due to investor’s active in the more liquid low end of the market getting double counted as they flip inventory. There is demand in the $275k and lower strata and there is a steady stream of distressed properties as well. Investors buy the distressed properties at wholesale prices and turn around and flip them at retail prices (which were where the wholesale prices were just a few months ago). This usually occurs in a few months, sometimes in less than a month. The NAR numbers fail to filter out these investor flips, hence practically all of this activity is double counted, and this activity (the flip investor) is actually the hottest part of the market. Of course, this is not addressed and the numbers are simply presented in an unrealistic form.

Home sales have steadied after plunging in the months following the expiration of a housing tax credit. Unemployment projected to stay above 9 percent through 2011 may depress demand in coming months even as record-low mortgage rates and lower prices make homes more affordable.

No, they have not been steady. See the chart below.

Housing is “bouncing along the bottom, unable to gain any traction, but with little reason to believe it’s going to go any lower,” said Eric Green, chief market economist at TD Securities Inc. in New York. “All of the froth has been eliminated from the bubble and all we need now is for confidence to turn higher and job growth to accelerate.”

125% LTV loans, Freddie and Frannie distorting the market, moratoriums and cessations on foreclosures (the only way to clear the market and move towards true price discovery), tax incentives in a falling market, MBS purchases, ZIRP, no mark to market – exactly how does this guy figure all of the froth has been eliminated from the bubble? If anything, .gov is trying their best to insert froth into a burst bubble!

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Those Who Blindly Follow Housing Prices Without Taking Other Metrics Into Consideration Are Missing the Housing Depression of the New Millennium.

October 4th, 2010 by Reggie Middleton

Note: See me discuss this topic live on Bloomberg TV, Monday October 4th, 2010 at 4:30 pm!

As illustrated in the post “, many mainstream media outlets and investors (retail, institutional and professional included) have become to reliant on the easy to quote, easy to publish and convenient to manipulate Case Shiller home price index. While an econometric marvel, it is not perfect. As a matter of fact, the imperfections that it does have happen to materially and significantly minimize the influence of the factors which actually contribute greatly to the current housing malaise. This, in and of itself, is significant enough of a reason for interested parties to look past the Case Shiller index in to other metrics that can help give a more accurate picture of what is actually happening on the ground.

Subscribers have access to all of the data and analysis used to create these charts, in addition to a more granular application, by state in the SCAP template and by region in housing price and charge off templates – see

Click here to subscribe.

Another problem that I see as I scan the popularly followed financial rags, TV broadcasts and blogs is the sole (or nearly so) reliance on price data to gauge the health of the market. Prices can be very misleading if viewed in a vacuum, and most view the Case Shiller index which itself is a flawed metric if not used properly, in a vacuum. Often, by the time prices start shifting, it is too late to take advantage of the opportunities, or escape the damage from the lack thereof. At the very least, one can be mislead into a false sense of complacency.

Case in point, is the following of price data when dealing with new, single family houses. On September 2nd, I wrote “More Doom and Gloom: Homebuilders Making Better Money as Hedge Funds than Home Builders” wherein I attempted to illustrate exactly how bad the home building situation looked 4 years after the homebuilder market had tanked. I excerpt:

We looked into Lennar to see the impact of the distressed investments group (which is the companies’ Rialto segment) on its operations. Key observations regarding the same are summarized below:

  • Rialto segment which the company started reporting (from 1Q10) is described by the company as, “Our Rialto segment provides advisory services, due diligence, workout strategies, ongoing asset management services and acquires and monetizes distressed loans and securities portfolios. In its 3QFY10 transcript with regard to segment’s description the management said, “Simply put, we purchase large and small portfolios of loans and REO at distressed prices and then we work through those assets one at a time to resolve them at retail payoff. It’s all about making money by managing the process of purchasing wholesale and selling retail – purchasing in bulk and selling one at a time. Admittedly, the assets are a little bit more complex, but this is where we excel.”

BERJAYA

So, why is Lennar’s most profitable division essentially a hedge fund that buys and sells bad mortgages and REOs? Because the need to build houses is dead and will be so for some time. Meanwhile, the need to deal with excess distressed inventory is strong, and will get significantly stronger as time goes on. See for yourself difference one’s outlook makes when looking at housing value transactions, as adjusted for inflation as compared to prices (which in the case of Case Shiller, exclude the drags on pricing such as flips, investor properties, vacation/2nd homes, condos, and REOs)…

 

BERJAYA

You should be saying to yourself, “Damn, that’s a big difference!!! Why are homebuilders still in business?”. That, my dear readers, is a very good question. Of course, they can all just transform into government subsidized hedge funds and trade with no risk, no cost money from the government through the PPIP program.

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Is the US Government About to Forgive Mortgage Debt? Let’s Crowdsource Our Way Through a Scenario or Two!

October 1st, 2010 by Reggie Middleton

Is it possible for the US Government to choose to forgive mortgage debt? Sounds outrageous? Read on for the legal theory behind this claim and let me know what you think? I thought it was little esoteric as well, but as I looked deeper… Well, I’ll let you be the judge.

A lot of attention accrued to Representative Grayson’s calling out of foreclosure fraud, and for good reason. The story is absolutely amazing, and kudos to a member of congress that defends his constituency.

It’s not as if other entities have failed to take notice. ZeroHedge has its usual witty commentary regarding the possibility of foreclosure transactions potentially being unwound due to fraudulent foreclosure activity. The NYT ran an article stating that Fitch will look into lowering the credit rating of companies that participated in the submission of inappropriate foreclosure paperwork, which apparently seems to include an awful lot of companies. It goes on to state (as excerpted by Zerohedge):

Fitch Ratings said that Wednesday it was asking mortgage companies about their internal processes for executing foreclosure affidavits. If it finds the processes lacking, Fitch will consider downgrading the company’s rating.

The agency also said if the issue is widespread, the resulting delays and extra costs to foreclose could increase losses related to residential mortgage-backed securities.

Here’s the twist. A lawyer who happens to have followed my writings over the years has suggested that most are missing the big picture in focusing on fraudulent foreclosure documents. He contends (and I’m paraphrasing here, these are not my words, per se) “that since the U.S. has ownership interest in many (if not most) delinquent and distressed mortgages, this fact will be counted as policy in litigation. As a consequence it matters A LOT if you can say that your client has a Fifth Amendment Due Process right (or third party beneficiary Federal common law right) to a HAMP modification which is in FACT a minimization of the risk of default (not that flaky 31% number) BECAUSE, among other things, the U.S. has no economic incentive to foreclose”. Now, I am no lawyer and thus the legal issues are beyond my domain, but I must admit I found the theory interesting. So, I’ve decided to crowdsource this one in anticipation that some of the more astute legal minds can shed some light on the validity of the theory. I’ll supply the financial stuff in this post, and I’ll rely on the legal eagles to peer review the theory.

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