May 14, 2007

IndyMac's solution to nobody wanting to buy their Alt-A liar's loan cancer? Hold on and pray.

A bit wonkish, but follow me...

So a mortgage company like IndyMac pays mortgage brokers to get suckers (oops, Home Debtors) to sign up for toxic "liar's loans", then repackages the hot potatoes and sells them off to the market (China, hedge funds, etc) as CDO's (collaterized debt obligations).

It was good business the past few years, when home prices were going up and it was tough to lose on a home.

Not anymore.

Now those toxic liar's loan Home Debtors (i.e. the Casey Serins and failed flippers of the world), with home prices plummeting, stop making the payments, and eventually just turn in the keys.

So the market that was buying up the junk got wise, that the loans ain't gettin' paid back, and now IndyMac has a choice - sell the hot potatoes on down the stream for significantly less than face value, or hold 'em and hope things turn around (yeah, right!).

An honest and ethical company if they chose Option B would increase their reserve for bad debt, and reflect the market value of their junk paper on their balance sheet. But IndyMac thinks they're above that. And we all know how this ends.

Yup, I'm short IndyMac via October put options. I'm betting they'll have to come clean by then (they do have auditors, don't they?)

This article spells it all out. Enjoy. One word: Enron.

Lending's next tsunami? Borrowers in the credit niche above subprime are missing more home loan payments. Another crop of lenders is trying to regroup and stem loan losses.

Michael Perry, chief executive of IndyMac Bancorp, is stubborn when it comes to delinquent loans.

He refuses to ditch them, even as they expand rapidly on the books of Pasadena-based IndyMac, which has two units based in Irvine and is the largest U.S. lender in a credit category dubbed "Alt-A," which is one level above the risky subprime niche. It turned in a company record of $90 billion in loans last year.

During an April 26 conference call with analysts, Perry said the company didn't sell a single dud loan in the first three months of the year because no one wanted to pay what he thinks they're worth. No way is IndyMac selling to a hedge fund for "pennies on the dollar," Perry said.
In that time, IndyMac's sour loans and foreclosed real estate ballooned 75 percent to $324 million.

"We are not going to fire-sell when we have the intent and ability and expertise to work through those loans and sell them ourselves," he said.

But Indymac and others who deal in Alt-A loans, such as Impac Mortgage Holdings of Irvine and Downey Financial of Newport Beach, may not have time to wait. The same problems shaking up the subprime market are now emerging in the Alt-A industry.

What's more, a Register analysis shows reserves for loan losses by these companies are not keeping pace with delinquent loans. Analysts say the same problem bedeviled New Century Financial of Irvine last year – and that helped send the once-top U.S. subprime lender into bankruptcy court after its financial backers lost faith in its accounting and liquidity.


Anonymous said...

When does a "loan" become a "gift"? Methinks several people are going to find out soon enough.


Anonymous said...

Crash and burn baybee!!

showmenouns said...

Just gives the top brass some more time to get their golden parachutes ready.


Rordogma said...

Maybe they can sell the CBOs on Ebay. Package them with some "used lingerie" and they might sell to some rich perverts.

Ooh SNAP...What about Big Lots...they love to off-load crates of crap to people who don't know better.

NFLcr8zy said...

Going short on IndyMac will be easy money.

Anonymous said...

in a word "greed". that noose is getting so tight around their necks they are loosing air to their brains and can't think clearly. The noose is greed. When everyone else is selling at a loss not them. oh well you can't serve two masters because you will love one and hate the other. I am thinking not to many kind words are being said about the people who signed up for these loans in the board room. But they still love that money.

Matt said...


Thanks for linking to my article. If anyone wants to see IndyMac's answers to my questions, or some of them anyway, you can check out my blog posting:
Are you going to learn much? Not really, but it's a small window into their heads.

Hayley said...

Well lets hope if they keep kicking the consequences downstream eventually people will actually be able to connect the dots.

OK, realistically, lets hope that things get so bad via high costs of living that people balk at Congress playing the bullsh** compassion card.

Mark in San Diego said...

Orange County Register was late to the party - but is doing great!!. . .finally some investigative reporting!

Dragonsbane said...

I hope you have October '09 puts because experience tells me (bad experience) that bubbles last longer than anyone thinks they will. BTW - the Auditors won't help you with this one. Either the CEO comes clean, the market rolls over or your puts expire worthless. By July the time value on those puts will start disappearing very quickly. Good luck though, I'm cheering for you (and hoping you sell those things and buy something further out for your own good).

BTW - I prefer fardated, DEEP in the money puts.

SeattleMoose said...

ha the monkey desperately holding onto the marbles in the glass jar, refusing to let go and run, even as the hunters approach!!!!

Got Moosemunch? (sorry Neil)

keith said...

Matt I've linked your blog on my blogroll, nice work! And the indymac exchange is so good I'm posting here:

. IndyMac’s allowance for loan losses of $67.6 million on March 31 amounts to a 44.11% coverage of non-performing loans held for investment. That’s down from 57.51% on Dec. 31, 2006 and 106.12% on March 31, 2006. Why is the company decreasing that ratio amid a housing market correction? Don’t executives expect more delinquencies going forward as well as higher costs to deal with non-performing loans and REO?

A. We reserve for loans prior to them rolling to non-performing status. As a percent of total held for investment loans, our allowance for loan loss ratio increased to 75 basis points at March 31, 2007 from 61 basis points at December 31, 2006. Additionally, our allowance for loan losses is 4.25 times annualized charge-offs at March 31, 2007, as noted on page 30 of the attached earnings presentation. Said another way, the ALL is sufficient to cover 4 years worth of charge-offs based on current levels. If charge-offs were to quadruple from current levels, the ALL is sufficient to cover charge-offs for another year. It’s important to note that during good times, the allowance for loan losses is always higher relative to non-performing assets (NPAs) and in times like this, the allowance will always come down.

Q. In a related question to above, some analysts say IndyMac has insufficient reserves for present and future delinquent loans. What’s the company’s response?

A. First of all, let me start by saying that reserves held to cover losses, not delinquent loans. Page 23 of attached earnings presentation shows the four reserves we have in various areas of our balance sheet related to delinquencies. Similar to above specifically to the ALL, we believe we are adequately reserved in all of our risk areas. We have just recently completed extensive review by our public auditors, as well as the OTS, and we were not directed by either to change our reserve levels.

Q. I understand from the first quarter conference call the company is moving from market-to-market accounting to portfolio accounting. Please elaborate on why it’s doing this. If nonperforming loans are held longer on your books amid a housing correction, won’t they just cost the company more in the long run?

A. No, we have not changed our accounting methods. In accordance with generally accepted accounting principles, held for sale loans are accounted for at lower of cost or market value (LOCOM). The fair market value of delinquent loans is less than cost, and accordingly, we have marked those loans down to their lower market values. However, the fair market value of the performing loans is above cost, and therefore those loans are held at the lower cost value.

Q. During the call one analyst noted that IndyMac did not write down the value of residual interest in securitizations to the extent of other lenders. Please explain this.

A. Page 36 of the 10-Q shows the key valuation assumption on our residual securities and you will note that there have been consistent increases in the percentages of remaining cumulative losses reflecting the expectation of higher credit losses in the current environment. As noted in answer 1, we believe that we have established prudent reserves against credit losses.

Q. Also during the call, a question was asked about IndyMac’s loan
delinquencies for Alt-A fixed and Option Arms made last year as having greater delinquencies than the market, and that Alt-A hybrids made last year were performing better but with a steep curve of delinquencies. CEO Mike Perry’s response is that 80-20 loans were the problem. My question is, didn’t the company have reservations last year about making 80-20 loans, which are by definition 100% financing of a home and also allow a home buyer to avoid paying mortgage insurance? After all, government data (OFHEO) show housing price appreciation peaked in the first half of 2005.

A. As we noted in our Shareholders’ letter, given the robust housing market and highly liquid secondary markets (for even the “riskiest loans”) – both of which persisted for years longer than anticipated – and given strong competition in a declining overall mortgage market, Indymac, in order to compete and grow, loosened its lending standards along with everyone else, though in a much more responsible way compared to other lenders. That we did not do this to the same extent as many other lenders is evidenced by the fact that our mortgage production in 2006 had an average FICO of 701 and average combined loan-to-value (CLTV) ratio of 80 percent as compared to an average FICO of 702 and average CLTV of 76 percent in 2005.

Q. What’s IndyMac’s overall percentage of 60 day plus delinquencies (in particular for loans held for investment)?

A. I will direct you to slide 7 of our earnings presentation (attached) which references 30+ % delinquency trends for Indymac vs. the Industry and shows that Indymac’s run rate has been lower than the industry’s. In addition, the 30+ day delinquency percentages showed a decline from Q406 to Q107. With respect to your question regarding 60+ day delinquencies, in Q107, Indymac had 1.78% for 60+ day delinquencies. There is no comparable industry data at this time for 60+ day delinquencies for Q107, however, in Q406, the industry percentage for 60+ day delinquencies was 2.01%.

Q. Looking at the big picture, how much of the subprime mess is spreading to Alt A?

A. Please refer to page 6 of our earnings presentation. While we have seen spread widening in Alt-A, we expect late Q107 spread widening to effect our MBR margin by 12 bps as opposed to the 183 bps decline in the MBR margin for subprime. I would also ask that you take a look at our March 15, 2007 press release in which we discuss a) our minimal exposure to subprime b) the strength and performance of our Alt-A portfolio, and c) how our thrift structure and financial performance have provided us with the capital and liquidity to survive the downturns in the mortgage industry cycles.

Q. Some analysts say IndyMac is buying more loans instead of originating them. They say this is a losing model in a market where Wall Street is paying less of a premium for loans and any increase in rates to consumers would result in significant volume declines. In other words, the company will be lucky just to recover costs on such loan buys. What’s the company’s response?

A. I will refer you again to our earnings presentation (page 4) look at our production segment, Indymac earned $44M in earnings and a 26% ROE for Q107. While these numbers are not at the levels they have been at in the past, they are still impressive, and more importantly, profitable results when a lot of our competitors are losing money and/or closing their doors. We have a long history of profitability and continue to remain profitable even through rough market waters.

Q. The overall theme of the accounting issues I have raised is that IndyMac may be postponing its recognition of losses. Please respond. Finally, the death spiral of New Century Financial began with its admission of accounting errors related to loan losses. Is IndyMac making any of the same mistakes?

A. We do a thorough analysis of our risk positions and have established prudent reserves. I also want to re-emphasize our answer to Questions 2 and 3. We have just completed our Annual Exam, as well as our OTS Exam and our reserves have been heavily scrutinized. Finally, in our most recent earnings press release, we provided guidance on our earnings for the remainder of the year, in particular we state, “We anticipate that our second quarter earnings performance will be similar to the first quarter, with an ROE of roughly 10 percent…Our current forecast now shows the ROE in the second half being approximately 13.5% with the fourth quarter ROE at roughly 15 percent…Please keep in mind that the housing and mortgage markets, including the secondary markets for private mortgage-backed securities, remains uncertain, and, as a result, we are internally updating our forecast almost weekly. If our current forecast changes materially, either negatively or positively, from the above, we will alert the market promptly. Lastly, it should also be pointed out that some are predicting a ‘doomsday scenario’ for the housing and mortgage markets. Although we believe this to be unlikely, if that were to occur, our financial performance could worsen materially from what we are currently forecasting.”

Anonymous said...

A company called ACL Services in Vancouver British Columbia Canada. In 2004 Indy Mac bought an anti-money laundering software application from ACK as they suspected they had a problem. Google ACL services check it out.
See a correlation?