Randomly Noted

Here’s a great quote from the Financial Crisis Inquiry Commission report that  was released earlier today:

“It didn’t take Sherlock Holmes to figure out this was bogus.” That’s from Prentiss Cox, then an assistant attorney general with the state of Minnesota. He was talking about loan applications he reviewed from a mortgage lender who later went bust,

Cox received 10 boxes of applications from the mortgage lender and began to pull out random files. Here a pretty healthy mortgage was given to a disabled borrower in his 80s who used a walker and was described in the loan application as being employed in light construction.

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If other banks report the kind of earnings numbers that came out of J.P. Morgan today, suffice it to say the banking industry is certainly on the road to recovery. Strong earnings and revenue numbers were impressive. But the numbers that really stood out to this blogger were some of those that are the bread and butter of an investment bank (and commercial bank that does investment banking).

Investment banking fees were up in the three major categories: equity underwriting fees of $489 million were up 22% from the prior quarter. Debt underwriting fees of $920 million were up 17% from the prior quarter. And advisory fees of $424 million were up 10% from the prior quarter.

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We learn today that giant insurance company Allstate has sued BankAmerica and its Countrywide Financial unit over a bum investment. It seems Allstate bought $700 million of Collateralized Debt Obligations from Countrywide which were backed by residential mortgages originated by the mortgage lender. Allstate believes Countrywide misrepresented  the quality of the portfolio.

Well, we don’t know yet the merits of this case – and we don’t know exactly what Countrywide disclosed in the offering documents for this CDO (were these stated-income mortgages? was performance of the mortgages listed in the documents? default rates? delinquencies?) To be sure, Countrywide originated some really bad mortgages and it is entirely possible that some of those made their way into the CDO Allstate bought.

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General Electric reported earlier today that its earnings and sales were a little softer than everyone expected them to be although orders for new equipment and services grew in the third-quarter – a sign business is picking up.

But one of the clear challenged that remains for GE is its real estate portfolio in its GE Capital unit. The company reported today that its real estate business lost $405 million. Now, that’s better than the $538 million loss in the year-ago quarter, but it shows that the weight of bad loans continues to drag down GE Capital.

The company also noted that it has $1.4 billion in non-performing loans, so, more losses are likely. It wrote off $222 million of losses from that real estate loan portfolio.

They all wanted to be like Mike (remember the Michael Jordan commercials from yesteryear?)

In this case, they were every Wall Street firm. And Mike was Goldman Sachs. There was this envy of by every Wall Street firm to be as successful as the secretive Goldman Sachs.  It was strong in equities, bonds, investment banking. And so, when Stan O’Neal took control of Merrill Lynch, the idea was that he wanted to compete with the likes of Goldman. More risk was taken on, a big cultural shift was underway. In one year, Merrill went from a firm with 45 billion to $6 billion exposure in subprime mortgages to one with $55 billion. It went overboard with collateralized debt obligations.

It’s hard to imagine how the European credit crisis that hit hard many of the banks there could have an effect on bondholders of a housing agency in the U.S. whose reason for being is to provide affordable loans for first time home buyers. But that’s what could play out for investors – likely Mom and Pop types – who hold some $3 billion of mortgage revenue bonds issued by the Ohio Housing Finance Agency.

The housing agency, and apparently many other municipalities, have invested some of their funds in guaranteed investment contracts issued by a company called Pallas Capital Corp. The Ohio agency has some $106 million tied up with the Pallas GICs.  Some investors look to GICs as a means to extract a little extra yield. It’s not known what these particular securities were yielding.

Pallas sold GICs and then invested those proceeds in reverser repurchase agreements that were collateralized by a pool of structured finance and corporate assets, according to Moody’s Investors Service Inc. Moody’s recently downgraded the Pallas GICs because “the GICs are a direct pass-through rating of the reverser repo counterparty, DEPFA Bank. You know what’s coming next – DEPFA was recently downgraded on its ability to pay back short term loans.

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Greece is thousands of miles away. But the debt crisis of that country and others in the Euro-region have had implications for companies big and small here – especially those with low credit ratings. These companies have been unable to borrow money, either from banks or the public debt markets, because of the renewed concerns of leverage. Investors and banks worry about a borrowers ability to repay principal and make interest payments.

The chart above, which accompanies a story by Jodi Xu on Dow Jones Newswires, shows the drop off in issuance of new loans and bonds in the below-investment grade arena. As Xu noted in her story, just when confidence was returning to the markets earlier this year, along came the Greek debt concerns and the ripple effect touched here – even for companies with no link to what was going on in Greece.

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Given everything that has happened to the financial services industry here and in Europe over the past few years, you’d think it might be a hard sell for a bank to consider selling its shares to the public. But that’s exactly what a small Seattle bank is proposing to do later this year in an offering designed to not only shore up its capital base, but prepare it to make acquisitions.

Fortune Bank wants to raise as much as $400 million in new capital in an offering that has yet to be filed with the Securities and Exchange Commission but one, the company said in a press release, will be underwritten by major Wall Street firms (to be named in the future). So, here we have this tiny bank ($126.2 million in assets), that wants to raise almost three times that amount so it can go out and buy other banks in FDIC or non-FDIC acquisitions. By the way, it lost $133,000 in the most recent quarter (end of March) and lost $5.5 million in the December quarter.

So, with so little details behind its plans and how small the bank is, why would someone want to buy into the offering?

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This Dow 10,000 thing is getting very old.

The U.S. stock market slid below 10,000 as measured by the Dow Jones Industrial Average yet again. Piercing that level on the upswing happened for the first time back in 1999. That’s right, 1999.

Call me an optimist, but we’ll eventually again head through and above 10,000. Maybe even today, as the stock market slightly recovers from its worst intra-day levels.

The issue is Europe. First was the worry whether certain European countries, Greece prominently among them, would be able to to continue to sell debt  and repay outstanding sovereign debt in full.

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Here’s a mind boggling stat: April has become the second highest month ever in terms of junk bond issuance with $31.8 billion of bonds sold. And pushing that volume was refinancing, not M&A activity, which is usually the case behinmd high issuance months. Newswire reporter Michael Aneiro notes that at the beginning of 2009, as the financial crisis was fully taking hold, junk bonds on average were trading around 61 cents on the dollar. Today, that average price is 99.5 cents.

What appears to be behind the demand for new issuance is investor appetite for higher returns. But we’ve heard this story before. This push for higher returns must not morph into investors not carrying about risk. That’s what lead to the financial crisis just a few years ago.