In our investment policy meeting this morning the question was raised, what are the leading indicators of a bottoming in the real estate mess. Almost in unison, we all agreed that the best leading indicator of real estate in these bad times is the same leading indicator in the good times, the banks.
However you look at it, the banks are the biggest players in the mortgage market. They have the relationships with the homeowners, and they are the primary sellers of mortgage products to the average consumer. What is not well known, is that most banks then sell off their mortgage originations to Fannie Mae and Freddic Mac, the quasi-governemental agencies, thus minimizing their potential losses.
As a result of the almost incredible financial shenanigans practiced by Fannie Mae and Freddie Mac in recent years regulators have forced both firms to limit their rates of growth. This has opened the doors for big banks across the country to become more active in the mortgage holding business, as opposed to just the mortgage origination business. Wells Fargo, Bank of America, Wachovia, as well as Washington Mutual and Countrywide Credit have stepped into the gap left by Fannie and Freddie. As a reminder, this is the "traditional"(good credit with down payment) mortgage loan business, not the subprime loan busniess(nothing from nothing).
Even though most of these firms have continued to report fairly good earnings, with few alarming upticks in loan losses, investors are painting all of them with an ugly brush. The clear message is that investors believe that the subprime woes will spill over into the traditional mortage business and, at the least, surely these companies got greedy and have a slab of loans they wish they didn't.
We are believe that the majority of these firms were able to say no the real estate sirens who were claiming that no price was too high to pay for "that house down the street." They are all survivors, and they must have been aware of how anxious all the private pools of money were to take on these risks. We are betting most of these firms stepped aside and let the greater fools ply their trade, without holding on to too much foolish merchandise themselves.
Remember Wells Fargo -- WFC -- is due to report their dividend increase within the next few days. Our call is this:
1. A 5%-7% hike would be a negative sign that would mean that no end is in sight for the real estate troubles.
2. A 7%-9% hike would indicate that the real estate business is wounded, but the bottom is in sight.
3. A hike above 9% would mean that the bottom in real estate is not only in sight, but WFC is taking market share.
We will have an analysis of WFC's decision after their announcement. We will also run a number of banks through our Dividend Valuation Models over the next few weeks and share the results.
