June 16, 2008

How Hard Does CA Hit the 2nd Liens?
by Reggie Middleton

This is a little anecdotal, non-scientific snapshot of the returns 2nd lien lenders can expect in the San Diego Foreclosure market.

From a BoomBustBlogger:

"I manage a large real estate team in San Diego and we do a ton of foreclosures with almost 200 REO's either assigned, on the market or in escrow. We started charting the drop in prices on a webpage at www.foreclosure-hotlist.com The "previous value" includes previous sales, the foreclosure amount or the amount of the previous debt. You are right on the money with the call on the top-end HELOC's. They are getting killed right now, there is no equity to protect them and they are sacrificed by the Senior loan who still isn't getting their debt covered by the sale. Add to this the problem we face on short-sales. All of these securitzed debt products mean that in some cases there is no one who can negotiate to take a smaller payoff. All they can do is accept payments, accept payoffs or foreclosure... nothing in-between."

From the reader's site (red font is my annotation):

Here is the latest list of San Diego Foreclosures that already have a deep discount of 10% or more.

These are all bank-owned properties listed by the Gary Kent Team.

For more information on any these properties, call 858-457-5368 and a team member will be ready to help you.

Make sure to check out Gary Kent Seminars for our upcoming Foreclosure Seminar on July 12, 2008

Now, let me include a snippet from the Wells Fargo Drill Down to put this into perspective:

Wells Fargo observations

Loan portfolio:

Sizeable Real Estate loans exposure in troubled markets: Wells Fargo had $148 bn loan in 1-4 Family Mortgages (WFC has a high correlation to industry-wide losses) which represented nearly 38% of the banks' total loan. Out of these loans nearly 51% comprised junior lien mortgage loans (much higher probability of total loss and no recovery). After C&D loans, real estate loans have highest NPAs as proportion of total loans. In 4Q2007, real estate 1-4 family first mortgage NPAs to total loans stood at nearly 1.91% of total loans with total NPAs of $1.4 bn. In terms of geographic exposure, real estate loans from California and Florida comprised 33% and 4% of total real estate loans (i.e 13% and 2% of WFC's total loan portfolio).

WELLS FARGO	1Q-2008	4Q-2007	3Q-2007	2Q-2007
Loan Composition
Commercial	92,589	90,468	82,598	77,560
Other real estate mortgage	38,415	36,747	33,227	32,336
Real estate construction	18,885	18,854	17,301	16,552
Lease financing	6,885	6,772	6,089	5,979
Total commercial and commercial real estate	156,774	152,841	139,215	132,427
Real estate 1-4 family first mortgage	73,321	71,415	66,877	61,177
Real estate 1-4 family junior lien mortgage	74,840	75,565	74,632	72,398
Credit card	18,677	18,762	17,129	15,567
Other revolving credit and installment	55,505	56,171	57,180	53,701
Total consumer	222,343	221,913	215,818	202,843
Foreign	7,216	7,441	7,889	7,530
Total Loans	386,333	382,195	362,922	342,800

Wells Fargo haa increased their loan assets every quarter for the past 4 quarters. Those past 4 quarters are just past the peak of the largest equity real asset and credit bubble of the century? Question: Why is Wells Fargo increasing the amount of these quickly depreciating assets on its books while the underlying properties are rapidly decreasing in price?

Large Second Lien Home Equity exposure with rising NPAs: As of 3Q2007, Wells Fargo had second highest home equity loans exposure among all US banks in absolute amount. In 1Q2008, Wells Fargo had $83 bn loans in home equity comprising nearly 19% of total loans and a staggering 174% of its shareholder's equity.

• Within its home equity exposure 37% of loans are in California comprising 7% of its total loan or 64% of its shareholders equity.

• In 1Q2008 Wells Fargo's annualized loss rate on home equity loan portfolio increased to 2.12% from 1.42% in December 31, 2007.

• As of December 31, 2007 nearly 29% of the bank's home equity exposure had LTV greater than 90%. With housing prices expected to continue to decline over the reminder of 2008, Wells Fargo's significant exposure in high LTV home equity loans with concentration towards California could pose a much harder time for the bank in the quarters to come.

A more granular view of Wells Fargo's loan portfolio shows us the following (I've highlighted areas to take notice of)...

WELLS FARGO	1Q-2008	4Q-2007	3Q-2007	2Q-2007
% Change
Commercial	2.3%	9.5%	6.5%	7.3%
Other real estate mortgage	4.5%	10.6%	2.8%	2.5%
Real estate construction	0.2%	9.0%	4.5%	4.3%
Lease financing	1.7%	11.2%	1.8%	8.8%
Total commercial and commercial real estate	2.6%	9.8%	5.1%	5.8%
Real estate 1-4 family first mortgage	2.7%	6.8%	9.3%	9.3%
Real estate 1-4 family junior lien mortgage	-1.0%	1.3%	3.1%	4.2%
Credit card	-0.5%	9.5%	10.0%	6.7%
Other revolving credit and installment	-1.2%	-1.8%	6.5%	0.5%
Total consumer	0.2%	2.8%	6.4%	4.8%
Foreign	-3.0%	-5.7%	4.8%	10.7%
Total Loans	1.1%	5.3%	5.9%	5.3%
Loans 90 Days or More Past Due and Still Accruing
Commercial	29	32
Other real estate mortgage	24	10	140% increase??
Real estate construction	15	24
Lease financing	68	66
Total commercial and commercial real estate	314	286
Real estate 1-4 family first mortgage	228	201
Real estate 1-4 family junior lien mortgage	449	402
Other revolving credit and installment	532	552
Total consumer	1,523	1,441
Foreign	40	52
Total Non Accural Loans	1,631	1,559

Increasing provisions and chare-offs

In 1Q2008, WFC's NPAs increased from 1.16% of total loans over 1.01% in 4Q2007. Overall NPAs increased to $4.5 bn from $3.9 bn in 4Q2007. NPAs in real estate construction loans witnessed highest increase of 49% to $438 mn in 1Q2008. NPAs of C&D loans stood at 2.32% of total C&D loans, followed by real estate 1-4 family mortgage (1.91%) and lease financing (0.83%)

Wells Fargo's gross charge offs increased to 0.46% of total loans compared to 0.37% of total loans in 4Q2007. C&D loans witnessed the highest increase in charge-offs with an increase of nearly three-fold to $29 mn in 1Q2008, showing signs of increased stress in these loans. Real estate 1-4 family junior lien mortgage, credit card loans and Other revolving credit and installment had charge-offs of 0.61%, 1.68% and 0.98% to total loans, respectively.

However despite increase in NPAs and increase in charge offs, Wells Fargo provision for credit loss sequentially declined to $2.0 bn in 1Q2008 from $2.6 bn in 4Q2007. (0.52% of total loans in 1Q2008 from 0.68% of total loans in 4Q2007) raising concerns over possible inadequacy of provision amount.

From April 1, 2008 onwards, Wells Fargo has changed its home equity charge-off policy to 180 days from 120 days previously. Amid current deteriorating credit markets with residential sector showing no signs of recovery, it is quite understandable that the bank has changed the policy in a bid to defer recognition of provision and charge-offs.

WELLS FARGO	1Q-2008	4Q-2007
Delinquency as a % of Loans
Commercial	0.03%	0.04%
Other real estate mortgage	0.06%	0.03%
Real estate construction	0.08%	0.13%
Lease financing	0.99%	0.97%
Total commercial and commercial real estate	0.20%	0.19%
Real estate 1-4 family first mortgage	0.31%	0.28%
Real estate 1-4 family junior lien mortgage	0.60%	0.53%
Other revolving credit and installment	0.96%	0.98%
Total consumer	0.68%	0.65%
Foreign	0.55%	0.70%
Total Non Accural Loans	0.42%	0.41%
NPA's
Commercial	588	432
Other real estate mortgage	152	128
Real estate construction	438	293
Lease financing	57	45
Total commercial and commercial real estate	1,235	898
Real estate 1-4 family first mortgage	1,398	1,272
Real estate 1-4 family junior lien mortgage	381	280
Other revolving credit and installment	196	184
Total consumer	1,975	1,736
Foreign	49	45
Total Non Accural Loans	3,259	2,679
GNMA loans	578	535
Other	637	649
Real estate and other nonaccrual investments	21	5
Foreclosed assets:	1,236	1,189
Total NPA's	4,495	3,868

I'd like to repeat this so it is not wasted on anybody: From April 1, 2008 onwards, Wells Fargo has changed its home equity charge-off policy to 180 days from 120 days previously. Amid current deteriorating credit markets with residential sector showing no signs of recovery, it is quite understandable that the bank has changed the policy in a bid to defer recognition of provision and charge-offs.

So, have the implemented this policy in other areas after the last filing, or previously without disclosing it. Did I miss it in the footnotes somewhere? Now, all of thier Delinquencies and NPA numbers are suspect! See chart below...

WELLS FARGO	1Q-2008	4Q-2007
Delinquency as a % of Loans			% increase
Commercial	0.03%	0.04%	-11%	<-- Questionable!
Other real estate mortgage	0.06%	0.03%	130%
Real estate construction	0.08%	0.13%	-38%	<-- Questionable!
Lease financing	0.99%	0.97%	1%
Total commercial and commercial real estate	0.20%	0.19%	7%
Real estate 1-4 family first mortgage	0.31%	0.28%	10%
Real estate 1-4 family junior lien mortgage	0.60%	0.53%	13%
Other revolving credit and installment	0.96%	0.98%	-2%	<-- Questionable!
Total consumer	0.68%	0.65%	5%
Foreign	0.55%	0.70%	-21%	<-- Questionable!
Total Non Accural Loans	0.42%	0.41%

I expect recoveries in the red font below to drop precipitously. The yellow highlight shows where there is already weaknes in recoveries in earier quarters.

WELLS FARGO	1Q-2008	4Q-2007	3Q-2007	2Q-2007	1Q-2007
Recoveries						% increase	% of total
Commercial	31	35	35	25	24	-11%	13%
Other real estate mortgage	1	1	2	3	2	0%	0%
Real estate construction	1	0	1	0	1	100%	0%
Lease financing	3	5	3	4	5	-40%	1%
Total commercial and commercial real estate	36	41	41	32	32	-12%	15%
Real estate 1-4 family first mortgage	6	4	6	6	6	50%	3%
Real estate 1-4 family junior lien mortgage	17	14	14	16	9	21%	7%
Credit Card	38	30	29	30	31	27%	16%
Other revolving credit and installment	125	111	105	139	149	13%	53%
Total consumer	186	159	154	191	195	17%	79%
Foreign	14	15	15	17	18	-7%	6%
Total Recoveries	236	215	210	240	245	10%	100%

Despite all this, Wells Fargo seemed to have found a way to sell the MBS for their loans at a profit!

Extraordinary gains offsetting loan write-downs in 1Q2008

Out of net income of $ 1,999 mn in 1Q2008, Wells Fargo recorded an extraordinary gain of $323 mn and $94 mn on gain on sale of mortgage-backed securities and increase in mortgage servicing income, respectively. These gains were partially offset by $263 mn write-down of mortgage loans and $63 mn write-down on commercial mortgages held for sale. Additionally the bank also recorded unrealized loss on securities available for sale of $598 mn in 1Q2008 compared with unrealized gain of $680 mn in 4Q2007. Be aware of the margin for abuse in valuing MSRs (mortgage servicing rights, etc.). If the mortgage is likely to go into default and be foreclosed upon, it is unlikely the servicer will be able to monetize future revenue streams from servicing the mortgage. Also, be aware on non-descript mark ups and gains. The entire world had to eat sh1t due to plummeting MBS values for almost a year with literally no market for these securities. How did those genius at WFC manage to sell their MBS securities with little or no market, and sell them at a gain of $323 million on top of it. The guys at Countrywide, Lehman, Bear Stearns, Morgan Stanley, Merriill Lynch, UBS, HBOS, and a whole hell of a lotta other folk (including me) are dying to know!

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

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