Subprime mortgages are no longer our biggest problem. For the third straight month, option adjustable-rate mortgages (option ARMs) are going delinquent faster than subprime mortgages.
Option ARMs usually provide three options for payment. You can make the regular payment of principal and interest. You can make the interest only. Or you can make a minimum payment that doesn't even cover the interest. The partial interest payment adds the unpaid interest to the principal. That's what more than 80% of option-ARM borrowers choose. With housing prices still in freefall, option-ARM borrowers' debts are growing while the value of their underlying property continues to plummet... an obvious recipe for default.
As of April, 36.9% of ARMs were at least 60 days past due while 19% were in foreclosure. About 34% of subprime mortgages are delinquent and 14.5% are in foreclosure.
While option ARMs make up a smaller part of the mortgage market than subprimes, several banks' balance sheets hold high concentrations of them. Wells Fargo got stuck with $115 billion of the loans when it bought Wachovia. JPMorgan holds $40.2 billion of them... "The realization of the issues related to option ARMs is just the beginning," said Chris Marinac, director of research at FIG Partners.
But the big banks won't experience anywhere near the pain the smaller, regional banks will feel regarding commercial real estate... The Fed estimates the commercial property market at $6.5 trillion – one-third the size of the housing market. And commercial property loans outstanding sit at around $3.3 trillion, half of which are held by banks. Despite being much smaller than the housing market, these commercial loans will still wreak havoc on the regional banks...
In 1993, less than 2% of U.S. banks had exposure to commercial real estate that totaled more than five times their Tier 1 capital. By late 2008, that number jumped to 12% and included some 800 banks and thrifts. California-based property consultants, Foresight Analytics, estimates the U.S. banking sector could experience $250 billion in commercial real estate loan losses, which could cause another 700 banks to fail.
In the current issue of Extreme Value, I found a regional bank with 64% of its loans in risky commercial mortgages, so-called C&I loans (business loans) and commercial construction loans. As I told my readers, it made the wrong loans at the wrong time in all the wrong places. If the situation plays out as I expect, you could make anywhere from 50% to 100% before the year is out. To get access to the full report, click here.
If this deal goes through, we'll have a clearer picture of commercial real estate values and just how much regional banks will suffer... Private-equity firm Starwood Property Group announced yesterday it's "bidding on a bank." Without naming the bank, CEO Barry Sternlicht said the bank in question is heavily concentrated in real-estate lending and has more than 110 construction loans.
Insiders identified the bank as the poster boy of excessive condominium lending, Corus Bankshares. We've been telling you about Corus' greed and mismanagement for more than a year... Corus is most highly concentrated in Florida and California, but has condo loans on the brink of default all over the country.
More bad news from the commercial real estate sector... Malls are looking like ghost towns, and rents are dropping as a result. Rents are falling because mall leases have "co-tenancy" agreements. That's where the mall agrees to give you a break on the rent if certain big stores leave the mall or if a certain number of stores are empty. Tenants can have their rent cut as much as 50% while the mall looks for new tenants to fill the void. Chico's and Charming Shoppes (which owns Fashion Bug and Lane Bryant) have both saved millions on rent so far this year.
Falling rents can't be good for the owners of malls and other retail centers. Nor can they be good for the banks, insurance companies, and investors who have lent them money.
Goldman Sachs announced a 65% jump in second-quarter earnings to $3.44 billion ($4.93 a share) – up from $2.09 billion a year ago. The numbers include a $426 million dividend related to paying back its TARP loan. Analysts expected earnings of $3.48 a share.
Investment-banking revenue was down 15%. Once again, Goldman's magical, mystical trading department produced the best results. They must be the smartest people in the whole, wide world... or maybe they're just the most well-connected. Whatever the cause, Goldman winds up on the winning side of everything, impossible as that is. And as far as I know, no one is investigating how this profit-in-every-possible-scenario machine really works.
I'm no expert on Goldman Sachs, and there's a great deal about investment banking I'll never know, but no one throughout history has been smart enough to be right all the time... though many have been crooked enough.
The rewards for being smart (crooked?) enough to be right every time are enormous. Goldman set aside $6.65 billion (half of revenue) in the second quarter to compensate its employees, all of whom are above average, like the children of Lake Woebegone. Total compensation for the first half of the year was $11.36 billion – up 33% from the same period in 2008. As the rest of the world melts down, Goldman's compensation hits new heights.
Despite a blockbuster quarter at Goldman, Jeff Clark thinks the bank is setting up for a massive fall. But he's not going short yet... He's waiting for shares to hit a certain point and trip a specific "sell" indicator. He's keeping Short Report readers abreast in his Direct Line. To make sure you don't miss Jeff's short sale in the financial sector, click here...
New highs: Addax Petroleum (AXC.TO).
In the mailbag, we don't know if Soros is pulling the strings... but he sure is yanking your chain... feedback@stansberryresearch.com.
"Why do people that get paid so much money to begin with need an incentive (bonus) to do their job? They have an incentive where I work too, it's called a pink slip. What the hell is it that George Soros did? My understanding is that he is a brilliant investor." – Paid-up subscriber Ignorant Dupe
"The public needs to open their eyes and pay attention to Obama's actions. He is nothing more then a highly educated idiot, whose puppet master is Soros." – Paid-up subscriber Tom
"How should a patriotic American feel when Soros openly states that he desires a New World Order where the United States is taken down to an appropriate level of influence? If that is not enough, he openly bragged that the Obama presidency and the financial crisis were 2 of the 3 accomplishments fulfilling his life's work... There is absolutely no doubt in this subscribers mind that Soros sees himself as the initiator of a new world order where the USA is just another state in the order, no more and no less. His support for Obama and Obama's obsession with the world order appear to position him as the Soros New World Order CZAR!" – Paid-up subscriber Bill
Ferris comment: Alright, alright... let's just get this out in the open: Soros is Elvis.
Regards,
Dan Ferris
Medford, Oregon
July 14, 2009