Some Banks (Yes, Banks) May Be Back in Favor

The New York Times

March 23, 2008 Sunday
Late Edition - Final

BYLINE: By NORM ALSTER
SECTION: Section BU; Column 0; Money and Business/Financial Desk; Pg. 5

THERE is blood in the water, but some long-term investors, defying danger, have begun wading into financial stocks.

In the eyes of these investors, some financial companies -- particularly those positioned to benefit from the flurry of recent Federal Reserve moves to cut interest rates and restore market liquidity -- have been battered beyond reason and now represent solid value.

That would be a very welcome turnaround for people whose portfolios have been shredded by seemingly endless bad news -- including the near collapse of Bear Stearns, a stream of enormous write-offs by banks and the freezing of large portions of the credit markets. Since early October, the Financial Select Sector SPDR, an exchange-traded fund, is down roughly 25 percent. Since the beginning of this year alone, the average mutual fund investing chiefly in financials has lost roughly 9 percent.

But some regional banks are now poised to benefit from plunging short-term rates, in the view of several money managers.

David Ellison, lead portfolio manager of the FBR Large Cap Financial and FBR Small Cap Financial funds, said he was buying shares of smaller banks that hew to what he calls an ''It's a Wonderful Life'' model.

Such banks, many of them in the Northeast, stuck to conservative standards that now position them to gather capital at low rates and lend it locally to the worthiest borrowers. Astoria Financial, which operates in metropolitan New York, and Hudson City Bancorp, with banks in New York, New Jersey and Connecticut, have the capital to lend ''on terms they feel comfortable with'' and to gain loan market share, Mr. Ellison said.

Anton Schutz, manager of the Burnham Financial Services and Burnham Financial Industries funds, two of the best-performing financial funds this year -- despite being down slightly -- says that repeated Fed rate cuts have helped banks that adhere to a traditional borrow-low, lend-high formula. ''The Fed is just throwing free money out there,'' he said. ''It's fantastic.''

Banks that do not have to raise capital to compensate for bleeding assets can lend to the worthiest mortgage borrowers at 6 percent after borrowing at rates of 2 percent or even less from their own depositors and federal home loan banks. Mr. Schutz holds Hudson City and Investors Bancorp, based in Short Hills, N.J., and has been adding to his position in People's United Financial. He said that People's, based in Bridgeport, Conn., has close to $3 billion in surplus capital above and beyond its operating needs and ''will see good lending opportunities.'' The bank can also take advantage of capital-constrained rivals, he said, by expanding market share or through outright acquisition.

Other attractive financial stocks have little to do with troubled mortgage markets, some investors say.

Peter Kovalski, portfolio manager for the Alpine Dynamic Financial Services fund, predicts that merger activity will ''begin picking up before the real estate market revives.'' One beneficiary, he said, would be Evercore Partners, which provides merger advice but, unlike the investment banks with huge buyout-related loans on their books, has ''no direct credit risk.''

But how safe are big investment banks that stand knee-deep in the securitized mortgage crisis? Determined to avert a bank failure that could reverberate through the economy, the Fed has made available hundreds of billions of dollars -- which may eventually come out of taxpayer pockets -- in low-interest loans. Many big banks also benefited last week from a capital infusion as a result of the shares they were able to sell in the $18 billion initial public offering of Visa. Can investors now safely assume that the fever has broken?

Not quite, Mr. Ellison said. ''The earnings prospects are still declining,'' he said. ''And loan growth won't be there.''

He and other skeptics wonder whether more nasty surprises are to emerge from balance sheets. ''Full disclosure only happens when things are good,'' Mr. Ellison said. ''Even now, we're still peeling back the onion.''

But Richard Bove, a financial strategist at Punk, Ziegel & Company who was among the first to lower ratings on the banks last summer, now says he thinks the selling has gone too far. '' I personally believe that investors should dramatically overweight their portfolios with bank stocks,'' he said.

Assets have been devalued and earnings reduced, but most banks -- even those like Citigroup and Bank of America that have taken large write-offs -- still have positive cash flow, he said.

Going strictly by the numbers, Derek Rollingson, manager of the quantitative ICON Financial fund, concludes that financial stocks are trading at 45 percent less than true value. ''We've priced in all the bad news,'' he said. ''Has the market overreacted to the news? In the case of the financials, we would say yes.''

Mr. Schutz, the Burnham manager, said he bought shares of JPMorgan Chase on Feb. 29, reasoning that the company had done ''a much better job'' than most large banks in risk management, and that it was better capitalized than many of its peers. While the company has said it would suffer wider-than-expected write-downs in home equity loans, Mr. Schutz described this problem as ''manageable.'' With its relatively strong balance sheet, JPMorgan stands to gain share in jumbo mortgages and other profitable loan categories, he said, adding that it made sense that the Fed chose JPMorgan to buy out Bear Stearns. ''They had the capital position to be the buyer of choice and of last resort,'' he said.

It takes strong nerves to buy when bad news keeps coming from new directions. But Mr. Bove, bear turned bull, says he believes that the danger has passed. ''The Bear Stearns event is the last event in the credit crisis,'' he said. ''The crisis is now over.''

The Wrong Questions About the Mortgage Market

The Washington Post

February 24, 2008 Sunday
Every Edition

BYLINE: Michelle Singletary

SECTION: FINANCIAL; Pg. F01

Daniel H. Mudd, chief executive of Fannie Mae, knows the feeling a physician gets when she attends a party and a guest wants a diagnosis for a rash or some other unexplained ailment.

In Mudd's case, people want to know about the housing market. Often they ask him whether it's a good time to refinance their mortgage loan.

Mudd may be the go-to guy at parties because he heads the Federal National Mortgage Association, or Fannie Mae and the Federal Home Loan Mortgage Corp., known as Freddie Mac, purchase mortgages from lenders. This in turn allows the lending institutions to provide more home loans.

People think Mudd, who runs the larger of the two government-chartered enterprises, would know the best time to get a mortgage because Fannie Mae is crucial to the mortgage industry.

But as Mudd points out, he's operating in the back end of the mortgage process after the loans have been originated.

"I'm not retail," he tells people.

Frequently, mortgage rates are the topic at parties, and just about anywhere else, because many homeowners are desperate to know the opportune time to get out of the loans they won't be able to afford once their teaser rates expire.

Of late, Mudd is fielding questions about a new law that has the potential to lower interest rates on jumbo mortgage loans. He certainly was pressed about it during a recent lunch meeting at The Washington Post.

First, some background.

A jumbo loan is a mortgage that exceeds $417,000, which is the limit on the size of mortgages that Fannie Mae and Freddie Mac can buy. Loans less than $417,000 are called conforming because financial institutions can easily sell them to Fannie Mae or Freddie Mac.

Jumbo loans are needed in areas where home prices exceed that $417,000 limit, such as high-priced housing markets on the West and East coasts. Because jumbo loans are not purchased by Fannie or Freddie, they typically carry higher interest rates.

As of Friday, the national average for a 30-year, fixed-rate jumbo loan was 6.90 percent, compared with 5.94 percent for a fixed-rate conforming loan, according to Bankrate.com. Many jumbo borrowers have adjustable-rate mortgages. A jumbo ARM that adjusts after five years was 5.82 percent, compared with 5.17 percent for a non-jumbo ARM with the same term.

In an effort to help lower rates for borrowers needing jumbo loans, the recent economic stimulus bill included a provision to allow Fannie Mae and Freddie Mac to buy mortgages above the $417,000 limit.

The new jumbo loan limits won't be the same for all areas. The limits will vary but can't be more than $729,750.

Many jumbo loan holders are certainly anxious to know if rates will fall soon. However, Mudd wasn't sure that many homeowners with jumbo loans would actually see lower rates anytime in the near future.

"There will be some benefit," Mudd said. "How much? I don't know."

Mudd questioned whether investors would buy bundles of jumbo loans. Given the current mortgage crisis, investors might fear that these larger loans would be more risky, he said.

With tighter lending standards, some borrowers won't qualify because their home values have dropped. Or they might not meet other stricter underwriting requirements.

Still, during our discussion about jumbo loans, I pushed Mudd to provide some idea of when jumbo loan borrowers might approach lenders to refinance.

"I don't know," he said.

Then Mudd added a very helpful tip that I thought I would pass along.

He said if you are worried about a 50 basis-point difference in your interest rate (that's half a percentage point), you might be living in the wrong place.

Mudd wasn't talking about bargain shoppers who negotiate hard for a good loan deal or who are calculating whether a refinancing would make sense long-term.

Let's say a jumbo rate of 7 percent for 30 years comes down half a percentage point as a result of the new loan limit. On a $500,000 mortgage, that's a savings of about $166 a month.

In other words, you shouldn't be buying a home or refinancing into a mortgage that leaves you with little cash cushion. That's what led so many to be in trouble now.

If you have a jumbo mortgage and a half-percentage-point difference is going to mean a great deal to you financially -- that is, it will free up money you need to pay for essentials -- you're in too much house.

It means you are living above your means. Cornering mortgage professionals or other real estate experts at parties to press them for the best time to refinance your huge mortgage is nonsensical. You need to be asking when you should sell.

US mortgage refinancing offers hope of stability

January 30, 2008 Wednesday
Asia Edition 1
BYLINE: By MICHAEL MACKENZIE and SASKIA SCHOLTES
SECTION: MARKETS & INVESTING; Pg. 23

Amid the steady drumbeat of bad news for the US housing market, there are hopes that a recent dramatic fall in mortgage rates could help struggling homeowners refinance into cheaper loans, offering the prospect of much needed stability.

But contrary to earlier periods when low mortgage rates prompted waves of refinancing activity, analysts say the silver lining could be tarnished by today's stricter lending standards, virtually closed securitisation markets and still high rates for non-conventional mortgages - all this while the dark cloud of falling house prices hovers over new buyers.

"Financing costs may have come down for some but it would take an extreme optimist to see any break in the price slide," says Alan Ruskin, strategist at RBS Greenwich Capital.

The decline in US home prices accelerated in November, with the Case-Shiller index for 20 major cities down 7.7 per cent year on year. It was the largest fall in prices since the index was created in 1988.

Nevertheless, interest rate cuts from the Federal Reserve and lower US government bond yields have helped drive mortgage rates for conventional 30-year mortgages - those that can be financed by government-chartered mortgage companies Fannie Mae and Freddie Mac - below 6 per cent for the first time since 2005.

This is because Treasury yields are the reference point for long-term fixed-rate home loans and, last week, the yield on the 30-year bond fell to a historic low of 4.10 per cent.

The average conventional borrower is currently paying an interest rate of 6.14 per cent on an existing 30-year mortgage, according to data from Bear Stearns.

For new mortgages, the average rate for a home loan of this type is 5.45 per cent. This means borrowers in more than 60 per cent of outstanding conventional mortgages, representing about Dollars 2,700bn, have an incentive to refinance into a cheaper home loan.

As a result, mortgage applications, especially for refinancing, have surged in recent weeks, say analysts at HSH Associates, a consumer loan research firm.

But the capacity for making new mortgages may be limited. Bank balance sheets remain constrained, and securitisation markets have ground to a halt for all but the highest quality mortgages.

"It's possible that an upsurge in demand for mortgage credit may run into a limited supply," HSH says.

Meanwhile, some borrowers may find that tighter lending standards and still high rates for non-conventional mortgages do not deliver the sort of relief for the household budget they hoped for.

"In principle, you can say lower interest rates deliver cost savings for owners of home loans but, in practice, (the savings) will be substantially lower this time," says Dominic Konstam, head of interest rate strategy at Credit Suisse.

This is because the refinancing opportunity is predominantly limited to borrowers who qualify for conventional mortgages.

For creditworthy borrowers with so-called "jumbo" mortgages, that is, for loans of more than Dollars 417,000, mortgage rates remain elevated at 6.56 per cent, still more than a full percentage point higher than conventional mortgages. Normally the difference is about 0.2 per cent.

The average jumbo borrower is paying an interest rate of 6 per cent on a current 30-year mortgage, according to Bear Stearns, so the only incentive to refinance is if they can somehow qualify for a conventional mortgage.

Borrowers could do this by reducing the size of their loan but they would need to meet the tighter lending standards and higher refinancing costs prevalent in today's mortgage market.

"Most of the refinance transactions will require reappraisal with borrowers in declining markets facing substantially higher costs," says Dale Westhoff, mortgage analyst at Bear Stearns.

This means mortgage rates may need to drop further still before borrowers are inclined to refinance their mortgages.

"Rates need to drop a lot more now than they did in the past in order to deliver the same kind of refi wave," Mr Konstam says. He points out that 10-year Treasury yields may need to fall closer to 3 per cent - against the current 3.68 per cent - to have the same effect in today's market conditions.

David Rosenberg, chief US economist at Merrill Lynch, says the recent proposed lifting of mortgage lending caps for Fannie and Freddie to Dollars 730,000 from Dollars 417,000 as part of the US administration's economic stimulus package "will probably help ease some of the pressure in the non-conforming mortgage market".

But "the overall impact is going to be pretty modest" because almost 60 per cent of the jumbo mortgages originated in the past three years were interest-only, which Fannie and Freddie are not allowed to guarantee.

Yet, the ability of lower credit quality borrowers to refinance into new mortgages remains uncertain, given the shutdown in bank lending and securitisation.

But the Federal Reserve's interest rate cuts and a sharp decline in money market rates have offered some subprime borrowers a ray of hope because adjustable-rate mortgages are benchmarked against interbank lending rates, or Libor.

Six-month Libor has eased to 3.18 per cent from about 5.15 per cent at its peak in October, meaning that subprime borrowers facing a interest rate reset will see their payments go up by about half what they could have faced in October.