Toomre Capital Markets LLC

Real-Time Capital Markets -- Analytics, Visualization, Event Processing, and Intelligence


Lehman Brothers - Fannie Mae Pairs Trade and a Cup of Coffee

Toomre Capital Markets LLC ("TCM") is an active consultancy in the areas of structured finance, risk management and financial engineering. As a result, we have many conversations with numerous people across the spectrum of clients, prospects, former associates and other industry contacts. In the past several months, many of these conversations have touched upon Lehman Brothers, especially given Lars Toomre's personal history of working there and back in the 1980's running that firm's very influential ABS and mortgage derivatives trading business(es).

Given that that specific business area in the fixed-income markets is at the heart of the current credit crunch in the Capital Markets, many have asked more privately just what Lars has been thinking about the on-going market developments. Lars has specifically made a point (until now) on refusing to comment publically about Lehman Brothers and the recent sacking of his former boss, Joe Gregory, who until recently was the President of Lehman Brothers.

On Friday July 11th 2008, yet another contact queried what Lars thought about the on-going melt-down in financial equity securities, particularly those currently in the news such as Fannie Mae, Freddie Mac, Citigroup, Washington Mutual, Wachovia, Lehman Brothers, Merrill Lynch and Morgan Stanley. We talked through the various plus and minuses of these potential investments. This contact, who runs a multi-billion dollar portfolio on a leveraged basis, then asked Lars to put on his theoretical trading hat and suggest some specific trades. Lars demurred.

Wachovia Ken Thompson is Out As CEO

Toomre Capital Markets LLC ("TCM") previously has written about the perils of Pay Option ARMs in the post Option ARMs Spur New Worries and the troubles of one of its largest portfolio holders Wachovia in the post 'Moment of truth' for Wachovia. Now comes the news on the morning of Monday June 2nd 2008 that Wachovia's CEO Ken Thompson is "retiring" immediately at the request of the bank's Board of Directors. Lanty Smith, the current Chairman of the Board of Directors will be taking over as interim CEO and Ben Jenkins, currently vice chairman and president of the general bank, will serve as interim chief operating officer.

According to the press release, "No single precipitating event caused the board to reach this decision, but a series of previously disclosed disappointments and setbacks cumulatively have negatively impacted the company and its performance." One has to wonder though whether buying a large California thrift with an investment portfolio concentrated in negative amortization ARMs at the absolute top of the housing market had anything to do with his firing?

Or perhaps the recent regulatory sanctions had more of an effect than outsiders fully appreciate? Certainly having to settle charges about money laundering and needing to deal with possible collusion charges in the submission of municipal bond reinvestment hedges suggest that the bank did not have strong internal controls. Coupled with the recent OCC actions about its use of customer data with tele-marketing firms, one has to wonder what changed in approximately the last month since Ken Thompson was stripped of the Chairman role? Reader comments and thoughts are welcome.

Slate: Coming 'Jingle Mail' Wave

Toomre Capital Markets LLC ("TCM") wrote yesterday in the post 'Moment of Truth' for Wachovia about Wachovia's surprise first quarter earnings loss and how much of the loss was due to their approximately $130 billion portfolio in pay option ARMs. On Tuesday April 15th 2008, Slate has followed up with the sobering article entitled Here Comes the Next Mortgage Crisis. The subtitle to the article is Subprime was just the beginning. Wait until California's prime borrowers start handing their keys to the bank. For those who are more optimistic that the Capital Markets are nearing the end of the mortgage crisis, they would do well to read this very sobering article written by Mark Gimein.

The main thesis behind this article is that with the California residential real estate prices in a free fall, the phenomena of walking away from a home will sharply increase, even for those with strong credit ratings in the so-called "prime" mortgage category. TCM refers to this walk-away phenomena as "jingle mail" and sadly thinks that this phrase will become part of the national lexicon in the coming two years. The article states "Unfortunately, the crisis in California is going to get much worse, and there is no bailout that will solve it. Why? Because if the first stage of the foreclosure crisis was about people who could not afford their mortgages, the next stage will be about people who have every reason not even to try to pay their mortgages." [TCM emphasis added]

Later the article continues. "… for all the California homeowners who in the next year or two are going to find themselves with the choice of whether, faced with a huge new wave of interest resets and a historic decline in the value of their homes, they will simply walk away. First, those home prices: For a weird few months of the mortgage crisis, statisticians came up with peculiar numbers about home values, rolling out comforting stats showing single-digit declines. Well, that's over. Last month, the California Realtors' association (folks who in October managed to "project" that prices would fall 4 percent in 2008) reported that, actually, California house prices in February fell 26 percent from a year ago. In the places where the foreclosure boom has hit hardest, it's worse."

This sharp decline in California real estate prices is causing many of the mortgage products originated in the 2005-2007 to have current LTV's near or in excess of 100 percent. The article then continues to explain how the decline in real estate prices when coupled with coming "prime" option ARM resets is likely to leave many homeowners with the economic quandary of whether they should remain in "homedebtor" hell servcing more debt than the home is worth or in a nonrecourse state like California simply walk away. The article explains:

'Moment of Truth' for Wachovia

Toomre Capital Markets LLC ("TCM") has written previously about the perils of pay option ARMs in the post Option ARMs Spur New Worries. One of the largest holders of this type of mortgage product is Wachovia, which on Monday April 14th 2008 announced a substantial capital raise simultaneously with the release of its first quarter financial results. The loss of $393 million was significant less than the small profit Wall Street was expecting.. One of the main culprits in the loss was those pesky Pay Option ARMs, many of which came with the 2005 acquisition of Golden West (also known as World Savings) based in Oakland, California.

According to the HousingWire website, "The so-called "pick a payment" loans [Option ARMs] represented $119.6 billion of Wachovia's mortgage portfolio at year's end, by far the largest segment of the bank's mortgage loan holdings. Among these loans, $2.76 billion — or 2.31 percent — were classified as non-performing during Q4; Wachovia has seen NPAs in this loan category increase by $1 billion within one quarter."

Now, according to the just released earnings report, credit provisions for non-performing option ARMs increased by another $1.6 billion as the NPA percentage rose to 3.55%. Plus new credit modeling for this large asset pool leads Wachovia to suggest that credit reserves for Option ARMS in 2008 will be $3.2 - $3.8 billion and $2.4 - 2.8 billion for 2009. Ouch!! As the saying goes, a billion here, a billion there and pretty soon one is talking about some real serious money.