Wednesday, April 09, 2008

Rescap: Why are you still here?

In the last couple days, two particularly troubled mortgage originators got some good news on the capital front. Yesterday, Washington Mutual announced they will receive a $7 billion cash infusion with private equity firm TPG as the lead investor. To put the size of the capital infusion in perspective, WaMu's market cap was only about $9 billion as of Friday.

Along with announcing the new cash, WaMu also announced they were increasing their loss provision to $3.5 billion and expect 1Q net charge-offs of approximately $1.4 billion. Note that as of 12/31, WaMu's loan loss provision was $1.5 billion. So they have in essence charged off their entire previous loan loss provision and on top of that, have found another $3.5 billion in expected losses. Is it just me or does something not ring true here? Do we really believe that WaMu only saw $1.5 billion in losses on their loan portfolio in December, but then suddenly see $3.5 billion now? If I recall, the outlook for home prices was pretty negative in December as well, so it seems curious that the bank would see such a surge in expected losses now but not then.

In other news, Residential Capital, of "Lost another loan to Ditech" fame, got help from erstwhile parent GMAC in retiring $1.2 billion of debt. It was a very unusual transaction, where GMAC apparently bought the debt in the open market, at approximately 50 cents on the dollar. GMAC then traded the newly purchased debt to Rescap in exchange for preferred shares paying 13%. Rescap then retired the debt.

Monday, as news of the WaMu infusion was reported, Washington Mutual bonds tightened 100bps. WaMu's 7.25% issue due in 2017 is now bid at 575bps over Treasuries, about 250bps tighter than its recent wides. Rescap saw their 6.125% notes due this November rise 9 points to $85.

Given the disconnect between their words (i.e., their previous loss reserve) and their actions (raising $7 billion in cash), I can't get involved in the bond or the stock. But as skeptical as I might be about Washington Mutual's mortgage loan portfolio, the fact is that WaMu has a viable retail banking franchise which, if they have enough capital to withstand the onslaught of mortgage-related losses, should allow the bank to survive.

Rescap, on the other hand, has an obsolete business model. Its a non-bank mortgage origination firm. Is that a viable business model going forward? I really don't think so. To see what I mean, consider the following analogy. Forget about the legacy losses on poorly underwritten loans during the bubble years. Imagine you have the opportunity to start a new company, and your two choices are a retail bank covering high-growth areas in the west and northwest. Or you could start a mortgage originator with effectively no access to bank-type liquidity. Its obvious which you'd choose. So for my money, even forgetting about the loan losses which will inevitably hit Rescap, there just is no light at the end of the tunnel for them. No franchise worth saving.

As far as I'm concerned, this $7 billion may well save Washington Mutual. But GMAC is just throwing good money after bad with Rescap. Investors should avoid Rescap bonds, and watch out for high-yield mutual funds with significant Rescap exposure.


Anonymous said...

Regarding the loan loss provision, loans held in a portfolio ( not for sale) are valued at amortized cost less impairment and not market to market. The idea is that if a loan isn't impaired, there is no reason to revalue for every 1/8 % change in the interest rate. However, there is obviously a lot of subjectivity in the timing and amount of loan losses.

As far as WM, one could argue that they waited until they had acquired capital before they recognized the losses. Or just the opposite -- they revised their estimate and then immediately found capital.

It's $7 billion that the FDIC won't have to spend. However, they totally diluted the shareholders. When you see massive dilution, it tends to be done for the survival of management rather then the stockholders. Management should get 86'ed for the mess. And no golden handshake. In another world, perhaps.

Anonymous said...

Another question -- where did you get the cool excel version of their financials?

Anonymous said...

Okay, investors, rise and shine.

The yen is strengthening this morning. Could that possibly mean a bad day on Wall Street?

Tune in later for the latest news.

Anonymous said...

I would note that the dollar is also losing ground against the euro.

The strategy of the Bush Administration?

Borrow a shitload of money overseas with debt denominated in dollars and then cut the legs from under the dollar. So long suckers!

I like it. It restores the industrial base. The only problem is that borrowing money gets really, really tough in the old US of A. Really tough.

AI how will that play out?

Anonymous said...

AI, do you know of a way to look into the assets of Rescap? Like how much sub-prime they have.

Anonymous said...

I believe you confuse loan loss provisions with allowances for loan losses. One is a flow (joining one period to the next) and one is a stock (a balance sheet item at the end of the period). One would not say 'as of "X" date, the loss provision was "Y."'

The loan loss allowance as of 12/31/07 was $2,571M, not $1.5B. The provision for Q4 was $1,534M and the beginning allowance as of 9/30/07 was $1,889M, implying Q4 net charge-offs of $852M. The provision was thus 180% of net charge-offs for the quarter.

Anonymous said...

How large is GMAC Bank? Does anyone know its relationship with the rest of the GMAC subsidiaries?

Anonymous said...

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