Thursday, October 11, 2007

It's a Subprime Crisis, Not a Banking Crisis.

After Countrywide Financial warned in July that they were experiencing delinquencies across all credit quality classes of mortgages, the stock market went into a tailspin, assuming that all banks were either deep into subprimes or that prime mortgages were beginning to default.

We were watching the chart at the right, which shows the % of delinquencies of subprime (blue line) and prime (orange line). It has been clear that subprimes have been in big trouble for the last two years, with delinquencies now running at over 15% of subprime loans oustanding. So if the big banks are deep into subprimes, they will, indeed, be taking big write offs. However, if they have managed to sell off or avoid their low quality loans, the prime sector of mortgaes would appear to be in very good shape, with only 2.7% of prime loans currently delinquent.

Our analysis of Bank of America, Wells Fargo, and Wachovia, tells us that these three major US banks have only modest amounts of subprime loans and that they are well secured and manageable.

Wachovia said in their July earnings meeting that they did not have any subprime loans. Since then they have announced that they are going to commit $15 million to the lower quality market. We think this is a smart move, since almost everybody else is exiting the sector. There are probably some great bargains.

The evidence is growing steadily that the big banks in the country sold off their high risk mortgages to the big pools of money that Wall Street was throwing their way.

The market is on pins and needles awaiting the big banks to announce their earnings, or lack of them. We are firmly in the camp that believes the news will be better than Wall Street now believes, and for this reason, we believe the aforementioned banks represent very good values.