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davelj
ParticipantOK, there were a couple of questions/comments addressed to me above, so I’ll try to address them below:
HereWeGo – “Who are the good customers?” The short answer is that most customers are good. A better way of answering your question would be to explain what we are avoiding, which are as follows:
– Construction loans of greater than 8 units at greater than 70% LTV with no personal guarantee from the borrower
– Commercial real estate loans at cap rates below 7%, debt coverage above 1.25x, at interest rates below 8%
– SFR loans above 75% LTV with FICOs below 700
– C&I loans without personal guarantees and a first lien on the collateralUnfortunately, once you eliminate the above groups you find yourself with a pretty small group of potential borrowers. But if you’re a small bank, that’s o.k. If you’re a large bank you simply can’t grow with the above restrictions. My banks are small so we can be very selective about the credits we underwrite. The trick is not to get caught up in a race for growth. Sometimes you just don’t grow. Nothing wrong with that.
An important thing to remember is that even in a severe recession, 95% of all commercial and related loans will still pay off. If you go back to the early-90s the problems were in SFR loans and CRE in certain locations. The vast majority of the banks nationwide had very few asset quality problems. The coming recession will be no different. The vast majority of banks will make money in ’08 and ’09 despite a slowdown as the vast majority of their customers will continue to pay. But some banks will crater and these will be in the headlines. The problems will be concentrated in the large banks with MBS and subprime SFR exposure (Citigroup, Wells, Wachovia, WAMU, etc.), thrifts like Downey, and small banks with a lot of construction exposure in CERTAIN areas like CA, FL, NV and AZ. But, again, the vast majority of banks will be just fine. The trick is to avoid the implosions.
4plex – Regarding whether the banking industry is outraged or rejoicing regarding the “bailouts” (really so far all we’ve seen is pseudo-bailouts – with moral suasion and lower rates, as opposed to real taxpayer dollars at work) I’ll paraphrase: “Where you stand depends upon where you sit.” If you’re managing a bank with a lot of construction or SFR exposure (or a lot of exotic mortgage-related instruments on your balance sheet), you support any kind of bailout. If you’ve avoided these things and been a fairly prudent lender over the last few years you probably don’t really care one way or the other. I will say that I haven’t run across anyone in the industry thus far that thinks the current Paulson-led proposals are anything other than disasters in the making at worst or completely ineffective at best.
TheBreeze – Exactly. One of the main problems with the MBS out there that are rotting in valuation hell is that a lack of information regarding the actual borrowers (no doc, etc.) leads to a lack of transparency regarding the entire security. This lack of transparency is (obviously) an additional source of considerable risk. The greater the risk the lower the price, all else being equal. It ain’t rocket surgery.
ParticipantOK, there were a couple of questions/comments addressed to me above, so I’ll try to address them below:
HereWeGo – “Who are the good customers?” The short answer is that most customers are good. A better way of answering your question would be to explain what we are avoiding, which are as follows:
– Construction loans of greater than 8 units at greater than 70% LTV with no personal guarantee from the borrower
– Commercial real estate loans at cap rates below 7%, debt coverage above 1.25x, at interest rates below 8%
– SFR loans above 75% LTV with FICOs below 700
– C&I loans without personal guarantees and a first lien on the collateralUnfortunately, once you eliminate the above groups you find yourself with a pretty small group of potential borrowers. But if you’re a small bank, that’s o.k. If you’re a large bank you simply can’t grow with the above restrictions. My banks are small so we can be very selective about the credits we underwrite. The trick is not to get caught up in a race for growth. Sometimes you just don’t grow. Nothing wrong with that.
An important thing to remember is that even in a severe recession, 95% of all commercial and related loans will still pay off. If you go back to the early-90s the problems were in SFR loans and CRE in certain locations. The vast majority of the banks nationwide had very few asset quality problems. The coming recession will be no different. The vast majority of banks will make money in ’08 and ’09 despite a slowdown as the vast majority of their customers will continue to pay. But some banks will crater and these will be in the headlines. The problems will be concentrated in the large banks with MBS and subprime SFR exposure (Citigroup, Wells, Wachovia, WAMU, etc.), thrifts like Downey, and small banks with a lot of construction exposure in CERTAIN areas like CA, FL, NV and AZ. But, again, the vast majority of banks will be just fine. The trick is to avoid the implosions.
4plex – Regarding whether the banking industry is outraged or rejoicing regarding the “bailouts” (really so far all we’ve seen is pseudo-bailouts – with moral suasion and lower rates, as opposed to real taxpayer dollars at work) I’ll paraphrase: “Where you stand depends upon where you sit.” If you’re managing a bank with a lot of construction or SFR exposure (or a lot of exotic mortgage-related instruments on your balance sheet), you support any kind of bailout. If you’ve avoided these things and been a fairly prudent lender over the last few years you probably don’t really care one way or the other. I will say that I haven’t run across anyone in the industry thus far that thinks the current Paulson-led proposals are anything other than disasters in the making at worst or completely ineffective at best.
TheBreeze – Exactly. One of the main problems with the MBS out there that are rotting in valuation hell is that a lack of information regarding the actual borrowers (no doc, etc.) leads to a lack of transparency regarding the entire security. This lack of transparency is (obviously) an additional source of considerable risk. The greater the risk the lower the price, all else being equal. It ain’t rocket surgery.
ParticipantOK, there were a couple of questions/comments addressed to me above, so I’ll try to address them below:
HereWeGo – “Who are the good customers?” The short answer is that most customers are good. A better way of answering your question would be to explain what we are avoiding, which are as follows:
– Construction loans of greater than 8 units at greater than 70% LTV with no personal guarantee from the borrower
– Commercial real estate loans at cap rates below 7%, debt coverage above 1.25x, at interest rates below 8%
– SFR loans above 75% LTV with FICOs below 700
– C&I loans without personal guarantees and a first lien on the collateralUnfortunately, once you eliminate the above groups you find yourself with a pretty small group of potential borrowers. But if you’re a small bank, that’s o.k. If you’re a large bank you simply can’t grow with the above restrictions. My banks are small so we can be very selective about the credits we underwrite. The trick is not to get caught up in a race for growth. Sometimes you just don’t grow. Nothing wrong with that.
An important thing to remember is that even in a severe recession, 95% of all commercial and related loans will still pay off. If you go back to the early-90s the problems were in SFR loans and CRE in certain locations. The vast majority of the banks nationwide had very few asset quality problems. The coming recession will be no different. The vast majority of banks will make money in ’08 and ’09 despite a slowdown as the vast majority of their customers will continue to pay. But some banks will crater and these will be in the headlines. The problems will be concentrated in the large banks with MBS and subprime SFR exposure (Citigroup, Wells, Wachovia, WAMU, etc.), thrifts like Downey, and small banks with a lot of construction exposure in CERTAIN areas like CA, FL, NV and AZ. But, again, the vast majority of banks will be just fine. The trick is to avoid the implosions.
4plex – Regarding whether the banking industry is outraged or rejoicing regarding the “bailouts” (really so far all we’ve seen is pseudo-bailouts – with moral suasion and lower rates, as opposed to real taxpayer dollars at work) I’ll paraphrase: “Where you stand depends upon where you sit.” If you’re managing a bank with a lot of construction or SFR exposure (or a lot of exotic mortgage-related instruments on your balance sheet), you support any kind of bailout. If you’ve avoided these things and been a fairly prudent lender over the last few years you probably don’t really care one way or the other. I will say that I haven’t run across anyone in the industry thus far that thinks the current Paulson-led proposals are anything other than disasters in the making at worst or completely ineffective at best.
TheBreeze – Exactly. One of the main problems with the MBS out there that are rotting in valuation hell is that a lack of information regarding the actual borrowers (no doc, etc.) leads to a lack of transparency regarding the entire security. This lack of transparency is (obviously) an additional source of considerable risk. The greater the risk the lower the price, all else being equal. It ain’t rocket surgery.
ParticipantJosh,
No, bad assets do not necessarily imply widespread liquidity problems; just liquidity problems related to those bad assets. Let me compare two separate financial events to make a distinction between a Liquidity Crisis and a Bad Asset Crisis.
When Long Term Capital Management imploded back in the Fall of 1998 we saw a true Liquidity Crisis. LTCM had a bunch of illiquid assets that were being marked down as hedge funds ganged up on the positions they were trying to unwind. When the Fed lowered rates and put together a plan with the major investment banks to organize an “orderly liquidation” of LTCM’s assets the Liquidity Crisis slowly disippated. LTCM’s investors lost a bunch of money but the markets returned to normal functioning in a relatively short period of time. That’s because LTCM’s assets were being undervalued in large measure BECAUSE OF the lack of liquidity as opposed to a problem with their underlying fundamental values. LTCM’s trading strategies were seriously flawed but the underlying values of the assets weren’t imperiled. Even companies with good credit were having problems rolling over their credit lines during the Fall of ’98. That’s not the case right now.
Flash forward to today. Most of these mortgage-related assets whether they are MBS’s, CDOs, CDO-squareds, etc. etc. have VALUES that are materially impaired because people aren’t paying their mortgages as originally expected. Furthermore, prices are deteriorating because the underlying assets were overvalued to begin with. So, even if you improve “liquidity” it isn’t going to improve the intrinsic value of the underlying assets that are causing the problem right now, as much as some would like to believe the contrary.
A Liquidity Crisis is a “pricing” issue. A Bad Asset Crisis is a “value” issue. Now, yes, you could argue that we have liquidity issues right now. But that’s not the root of the issue. The root of the problem is plain and simple bad assets. The two problems are related, but there’s a distinction between them.
ParticipantJosh,
No, bad assets do not necessarily imply widespread liquidity problems; just liquidity problems related to those bad assets. Let me compare two separate financial events to make a distinction between a Liquidity Crisis and a Bad Asset Crisis.
When Long Term Capital Management imploded back in the Fall of 1998 we saw a true Liquidity Crisis. LTCM had a bunch of illiquid assets that were being marked down as hedge funds ganged up on the positions they were trying to unwind. When the Fed lowered rates and put together a plan with the major investment banks to organize an “orderly liquidation” of LTCM’s assets the Liquidity Crisis slowly disippated. LTCM’s investors lost a bunch of money but the markets returned to normal functioning in a relatively short period of time. That’s because LTCM’s assets were being undervalued in large measure BECAUSE OF the lack of liquidity as opposed to a problem with their underlying fundamental values. LTCM’s trading strategies were seriously flawed but the underlying values of the assets weren’t imperiled. Even companies with good credit were having problems rolling over their credit lines during the Fall of ’98. That’s not the case right now.
Flash forward to today. Most of these mortgage-related assets whether they are MBS’s, CDOs, CDO-squareds, etc. etc. have VALUES that are materially impaired because people aren’t paying their mortgages as originally expected. Furthermore, prices are deteriorating because the underlying assets were overvalued to begin with. So, even if you improve “liquidity” it isn’t going to improve the intrinsic value of the underlying assets that are causing the problem right now, as much as some would like to believe the contrary.
A Liquidity Crisis is a “pricing” issue. A Bad Asset Crisis is a “value” issue. Now, yes, you could argue that we have liquidity issues right now. But that’s not the root of the issue. The root of the problem is plain and simple bad assets. The two problems are related, but there’s a distinction between them.
ParticipantJosh,
No, bad assets do not necessarily imply widespread liquidity problems; just liquidity problems related to those bad assets. Let me compare two separate financial events to make a distinction between a Liquidity Crisis and a Bad Asset Crisis.
When Long Term Capital Management imploded back in the Fall of 1998 we saw a true Liquidity Crisis. LTCM had a bunch of illiquid assets that were being marked down as hedge funds ganged up on the positions they were trying to unwind. When the Fed lowered rates and put together a plan with the major investment banks to organize an “orderly liquidation” of LTCM’s assets the Liquidity Crisis slowly disippated. LTCM’s investors lost a bunch of money but the markets returned to normal functioning in a relatively short period of time. That’s because LTCM’s assets were being undervalued in large measure BECAUSE OF the lack of liquidity as opposed to a problem with their underlying fundamental values. LTCM’s trading strategies were seriously flawed but the underlying values of the assets weren’t imperiled. Even companies with good credit were having problems rolling over their credit lines during the Fall of ’98. That’s not the case right now.
Flash forward to today. Most of these mortgage-related assets whether they are MBS’s, CDOs, CDO-squareds, etc. etc. have VALUES that are materially impaired because people aren’t paying their mortgages as originally expected. Furthermore, prices are deteriorating because the underlying assets were overvalued to begin with. So, even if you improve “liquidity” it isn’t going to improve the intrinsic value of the underlying assets that are causing the problem right now, as much as some would like to believe the contrary.
A Liquidity Crisis is a “pricing” issue. A Bad Asset Crisis is a “value” issue. Now, yes, you could argue that we have liquidity issues right now. But that’s not the root of the issue. The root of the problem is plain and simple bad assets. The two problems are related, but there’s a distinction between them.
ParticipantJosh,
No, bad assets do not necessarily imply widespread liquidity problems; just liquidity problems related to those bad assets. Let me compare two separate financial events to make a distinction between a Liquidity Crisis and a Bad Asset Crisis.
When Long Term Capital Management imploded back in the Fall of 1998 we saw a true Liquidity Crisis. LTCM had a bunch of illiquid assets that were being marked down as hedge funds ganged up on the positions they were trying to unwind. When the Fed lowered rates and put together a plan with the major investment banks to organize an “orderly liquidation” of LTCM’s assets the Liquidity Crisis slowly disippated. LTCM’s investors lost a bunch of money but the markets returned to normal functioning in a relatively short period of time. That’s because LTCM’s assets were being undervalued in large measure BECAUSE OF the lack of liquidity as opposed to a problem with their underlying fundamental values. LTCM’s trading strategies were seriously flawed but the underlying values of the assets weren’t imperiled. Even companies with good credit were having problems rolling over their credit lines during the Fall of ’98. That’s not the case right now.
Flash forward to today. Most of these mortgage-related assets whether they are MBS’s, CDOs, CDO-squareds, etc. etc. have VALUES that are materially impaired because people aren’t paying their mortgages as originally expected. Furthermore, prices are deteriorating because the underlying assets were overvalued to begin with. So, even if you improve “liquidity” it isn’t going to improve the intrinsic value of the underlying assets that are causing the problem right now, as much as some would like to believe the contrary.
A Liquidity Crisis is a “pricing” issue. A Bad Asset Crisis is a “value” issue. Now, yes, you could argue that we have liquidity issues right now. But that’s not the root of the issue. The root of the problem is plain and simple bad assets. The two problems are related, but there’s a distinction between them.
ParticipantJosh,
No, bad assets do not necessarily imply widespread liquidity problems; just liquidity problems related to those bad assets. Let me compare two separate financial events to make a distinction between a Liquidity Crisis and a Bad Asset Crisis.
When Long Term Capital Management imploded back in the Fall of 1998 we saw a true Liquidity Crisis. LTCM had a bunch of illiquid assets that were being marked down as hedge funds ganged up on the positions they were trying to unwind. When the Fed lowered rates and put together a plan with the major investment banks to organize an “orderly liquidation” of LTCM’s assets the Liquidity Crisis slowly disippated. LTCM’s investors lost a bunch of money but the markets returned to normal functioning in a relatively short period of time. That’s because LTCM’s assets were being undervalued in large measure BECAUSE OF the lack of liquidity as opposed to a problem with their underlying fundamental values. LTCM’s trading strategies were seriously flawed but the underlying values of the assets weren’t imperiled. Even companies with good credit were having problems rolling over their credit lines during the Fall of ’98. That’s not the case right now.
Flash forward to today. Most of these mortgage-related assets whether they are MBS’s, CDOs, CDO-squareds, etc. etc. have VALUES that are materially impaired because people aren’t paying their mortgages as originally expected. Furthermore, prices are deteriorating because the underlying assets were overvalued to begin with. So, even if you improve “liquidity” it isn’t going to improve the intrinsic value of the underlying assets that are causing the problem right now, as much as some would like to believe the contrary.
A Liquidity Crisis is a “pricing” issue. A Bad Asset Crisis is a “value” issue. Now, yes, you could argue that we have liquidity issues right now. But that’s not the root of the issue. The root of the problem is plain and simple bad assets. The two problems are related, but there’s a distinction between them.
ParticipantThis is fairly recent.
http://bespokeinvest.typepad.com/bespoke/2007/12/a-look-at-the-t.html
I’m not sure where you chart the TED Spread for free. I have a subscription service where I pull it up occasionally. It’s possible that on Yahoo you can chart these spreads.
ParticipantThis is fairly recent.
http://bespokeinvest.typepad.com/bespoke/2007/12/a-look-at-the-t.html
I’m not sure where you chart the TED Spread for free. I have a subscription service where I pull it up occasionally. It’s possible that on Yahoo you can chart these spreads.
ParticipantThis is fairly recent.
http://bespokeinvest.typepad.com/bespoke/2007/12/a-look-at-the-t.html
I’m not sure where you chart the TED Spread for free. I have a subscription service where I pull it up occasionally. It’s possible that on Yahoo you can chart these spreads.
ParticipantThis is fairly recent.
http://bespokeinvest.typepad.com/bespoke/2007/12/a-look-at-the-t.html
I’m not sure where you chart the TED Spread for free. I have a subscription service where I pull it up occasionally. It’s possible that on Yahoo you can chart these spreads.
ParticipantThis is fairly recent.
http://bespokeinvest.typepad.com/bespoke/2007/12/a-look-at-the-t.html
I’m not sure where you chart the TED Spread for free. I have a subscription service where I pull it up occasionally. It’s possible that on Yahoo you can chart these spreads.
Participantpublicdefender,
So true. People forget that humans have been “civilized” for less than 1% of our existence on this planet. 99% of our genetic wiring still remains from our hunting and gathering days. We’re just beasts with computers in nicer clothes and cars. Many people like to convince themselves that they are “above the (inherited evolutionary) fray.” Personally, I have no illusions regarding the true (inherited evolutionary) nature of humanity – which is neither good nor bad, but rather just “is.” I find it liberating to accept and embrace human flaws – life’s a lot more fun and far less disappointing.
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