"The economic spiral starts and ends with housing. If we do not slow and stop the erosion of the ad valorem tax base in this country, we are going to have really serious problems. If you put the mortgage credit relationship and the servicing back into the hands of the local bankers who know the market and the people, we can save millions of home owners from foreclosure and dozens of banks from failure. We may never be able to resurrect the asset securitization market as it was, but we can stabilize the housing market and the local tax base by getting these assets back into the hands of bankers who understand how to manage credit. I've had transient customers along the Mexican border who would disappear for months at a time and then reappear at my office with six months of mortgage payments in cash. Only local bankers have these kind of relationships. You cannot manage a credit or really service a loan over the telephone. Give America's community bankers these toxic assets and we'll make the most of these credits."

First a housekeeping note. Our CEO and chief system designer Dennis Santiago discusses in our new blog, Picking Nits, the arrival of the final 2008 data for all FDIC insured banks, which will be released in about two weeks around the date for the FDIC press conference.

For those IRA Bank Monitor users dying to see their bank's latest, Q4 2008 data, you may manually look up the individual bank call on the FFIEC web site, but you must grind the numbers manually to come up with the relevant risk benchmarks. It's pretty simple balance sheet/income stuff, but lots of detail, hundreds of data elements per bank. Read through the instructions and glossary at the bottom of the FDIC call report PDF for any questions about the terms.

All registered users for the IRA Bank Monitor and related tools, such as the "Benchmark My Bank" tool on the American Banker web site, and will receive an email notice when the Q4 data and new IRA ratings are online. We've added a new feature for users of the professional version of The IRA Bank Monitor, with links to the facsimile of the current FDIC period call reports and also a new tool that let's to ping the FDIC server to see if the latest call report is available. Note that the automated BHC links in the IRA Bank Monitor to the NIC reports prepared using the Fed Y-9C/Y-9LP data will be updated around the end of the month.

BTW, if your organization wants its own maintenance-free widget driven by FDIC, EDGAR and/or other structured financial data and hosted by IRA displayed on your web site, please contact us. For example, portals which are members of IRA's affiliate program like HousingWire, RiskCenter and SeekingAlpha, have the option to include various types of content in our turnkey displays, all enabled through the wonder of web services and IRA's proprietary data management architecture.

We don't make your web site. We make it better.

Changing Places: Is BAC now Behind C on the Problem Bank List?

In the NY Times on Sunday, the saga of Bank of America (NYSE:BAC) CEO Ken Lewis is documented. All we can say about BAC and Ken Lewis is that this bank has gone from arguably the most stable large money center to one of the most unstable, just behind Citigroup (NYSE:C). We attribute this remarkable transformation to the ill-advised Countrywide and Merrill Lynch transactions, both of which were done without a receivership to restructure the target companies.

As one banker told The IRA Friday: "We can still save Bank of America if we just put Merrill into bankruptcy. But the Fed does not want to see the last significant primary dealer fail. For many people, Merrill really is the only dealer left. Morgan Stanley (NYSE:MS) does not seem committed to the markets and Goldman Sachs (NYSE:GS) does not seem to care either."

Forgive our broken record, but just compare the Countrywide and Merrill transactions to the way in which Jamie Dimon, CEO of JPMorganChase (NYSE:JPM) bought WaMu, cleansed through an FDIC receivership. As we describe in further detail for our advisory clients this week, we don't think JPM will outrun the economic tsunami, but hats off to Dimon and his operating team for buying his organization valuable time to restructure and change their risk profile. That may be the difference in terms of outcome for creditors of JPM and BAC.

Frankly, the more we look at the mess at BAC, the more we wonder if BAC should not put ahead of Robert Rubin and the directors of C on the bank director incompetence index. We'll be coming back to our view of the failure of Lewis and the BAC board to exercise sufficient oversight of the bank's M&A activity in a future comment focusing on the duties and responsibilities of the directors of bank holding companies.

But we spend overmuch much time on dead zombie banks. Let's switch gears now and talk about how strong, well-managed banks are helping the FDIC and state regulators create what we've called the Prime Solution, putting troubled assets and deposits in strong hands, and how this ongoing process is the example members of Congress should be taking in developing responses to the crisis.

The Prime Solution in Action: Westamerica Bancorp

The FDIC closed and/or merged several more banks on Friday, adding to the list of resolutions to date. For example, after the close Friday, County Bank, Merced, California, was closed by the California Department of Financial Institutions, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with the sole bank unit of Westamerica Bancorp. (NASDAQ:WABC), San Rafael, California, to assume all of the deposits of the $1.8 billion asset County Bank. At the end of Q3 2008, County was rated "F" by the IRA Bank Monitor with a overall stress score of 21.6 vs. the 1.5 industry averaged stress or more than one order of magnitude above the industry mean for Q3.

This resolution fits the pattern of past FDIC actions, with high stress scores for ROE degradation and charge-offs, but County's efficiency and capital stress scores were also above average. County had been rated an A as of Q1 2008, but slipped to "F" in Q2 2008 due to a large surge in charge-offs and operating losses. The bank had FHLB advances equal to 8% of total assets at the end of Q3 2008. The estimated loss rate to the FDIC from the County transaction will be $135 million or less than 10% of the failed banks total assets, not a terrible outcome if the actual resolution tracks the projections.

All 39 branches of County Bank will reopen as branches of WABC's subsidiary bank today and FDIC personnel will be on hand to facilitate the handoff to WABC managers. Americans should be very proud of the thousands of FDIC, other federal and state regulatory personnel, government contractors, legal and financial advisers, and employees of the federal bankruptcy courts, who worked all weekend to make this and other resolutions possible. Notice how the FDIC and other regulators are managing this resolution process, scheduling the closures of several institutions on Friday and thereby minimizing public stress and anxiety. And the list of banks, funds and investors actively participating in the shelf facilities established to help FDIC to quickly move failed bank assets into strong hands is growing.

By the way, WABC was rated "A+" by the IRA Bank Monitor as of Q3 2008, with an aggregate level of stress of 0.7 vs. 1.5 for the entire industry. At Q3 2008, WABC was 30% below below the 1995 stress baseline in the IRA Bank Stress Index for the entire industry. WABC's bank unit boasts an efficiency stress rating of 0.6 vs. 1.2 for the entire industry. The efficiency ratio for the sole bank unit of WABC was an amazing 39% at the end of Q3 2008. We call that righteous.

WABC's bank unit had "only" 6.35% leverage at end of Q3 and about the same in Q4, putting them slightly below peer in terms of capital, but with an ROE of 13% at the end of Q3 and 14.9% at the end of Q4 2008, equity capital is not an issue. Charge-offs for WABC bank unit increased from 31bp in Q3 to 52bp at year-end 2008, well below peer loss rates for both periods. But analysts note the two key positives on WABC as it ends 2008: strong earnings and excellent operating efficiency.

With the branches of County Bank, WABC will be a $5 billion asset regional player in CA and well positioned to take advantage of opportunities as 2009 proceeds. Did we mention that WABC closed over $48 on Friday, up 10% for the day? The 90-day equity volatility on WABC is 167% based in the EOD pricing from our friends at Morningstar, which is less than half the implied volatility of larger bank names. For all of you stock pickers out there who are users of the IRA Bank Monitor, consider that a hint.

If members of Congress and the Obama Administration take one lesson from us this week, then they ought to look at the growing crowd of investors - several who are working with IRA - forming to purchase assets cleansed through the process of insolvency. Banks, branches and individual loans are being bought and sold by investors with capital and the ability to manage credit. These are the beginnings of economic recovery and are an early indicator that the bull case is reappearing for financials - if not yet ripe.

Fix Housing, Fix the Banks and the Securitization Markets Both

As this issue of The IRA goes out, in Washington the Obama Administration is wrestling with three basic issues: dealing with troubled banks, restoring illiquid securities markets and restarting economic growth - though not necessarily in that order of priority. The political issue of "helping homeowners" is significant as well. But perhaps it is time to consider whether the Wall Street-centric priority of restoring function to the existing securities markets for "toxic assets" is not independent of these other very real priorities. Reports that Treasury Secretary Geithner is focusing additional spending on spurring new market activity and not remediation of existing securities is, to us, good news.

This does not mean that private label securitization is dead or that the toxic cannot be cleansed. Indeed, we've heard from a number of practitioners in the channel on the state of the securitization markets in recent weeks, partly as we have been working to organize an all-day event in Washington on May 4, 2009 sponsored by PRMIA, "Market & Liquidity Risk Management In Post-Bubble Markets."

One confirmed participant in that event, Sylvain Raynes of RR Consulting, told The IRA last week:

"The securitization market will come back because the next generation will not remember what happened here, in the same way this one forgot the depression, the 1929 Crash, and even the S&L crisis. Is that ancient history? As far as how this "come back" will emerge, that's easy. What we will see is an accelerated version of the first cycle, i.e. the one that took 25 years to unfold first time around. First, prime RMBS will start-up again with simpler and more meaningful underwriting criteria (that's already happening) then the prime credit card and auto sectors will be brought back to life. Maybe US medical receivables will be the next big, 'exotic' asset class to take off."

So the good news seems to be that the private securitization markets are beginning to fix themselves, albeit without a vital federal leadership role in terms of setting standards for the future. Raynes lists three areas where such leadership and perhaps legislation is needed:

* First, define a meaningful template for data disclosure regarding all securitizations and OTC contracts, and enforce it. This is already largely done in the form of Regulation AB for securitizations. Enforce it.

* Second, mandate monthly valuation-feedback via a monitoring system that uses remittance reports and publicly published models from the rating agencies. That's much harder to do, but will soon happen.

* Third, mandate educational standards in the area of structuring and primary market valuation for securitizations and OTC contracts.

With those positive thoughts on the private securitization market in mind, we come back to the central task facing the Obama Administration, namely to help the banks, help homeowners and also the broad economy. One interesting idea we heard from a veteran banker in South Texas might provide food for thought in terms of how to deal with the existing body of toxic assets on the balance sheets on banks, the key issue that must be resolved if banks are to start lending again.

As part of the Obama Administration's efforts to support the primary market for new mortgage securitizations and also provide new capital to banks, below we describe an approach that harkens back to the market maker model The IRA described last year when we first started talking about the need for more bank capital ("More Bank, Less Bucks: A Four Point Plan for the Rescue," October 6, 2008).

Here's the basic approach:

* The US Treasury would tender for all of the private label CDO/MBS extending between a range of dates, say 2004 forward to year-end 2007, representing trillions of dollars in assets held by investors and banks globally. The pricing on this paper will reflect current market prices, but say the average price was 50% of face value. Only issues that actually have an enforcable legal claim to collateral will be eligible. Derivative structures without collateral will not be eligible.

* Treasury then transfers all of the purchased toxic paper to the FDIC Deposit Insurance Fund, which acting as receiver under 12 USC restructures the trusts that are the legal issuers of the bonds and recovers legal ownership of the underlying collateral. The FDIC arguably has the power to call in all bonds and related investment contracts, and extinguish the claims of those parties which do not respond to the Treasury tender. The legal finality of an FDIC-managed receivership under 12 USC is what is required to end the toxic asset issue once and for all. The bankruptcy courts could be used in a similar fashion, but the unique legal authority of the FDIC suggests to us that this agency should run the process as part of its larger asset sale operations.

* This now "clean" whole loan collateral will then be re-sold to solvent banks in the localities where the property is located, using zip codes and other means to identify eligible buyers, priced at say 90 cents on the dollar, with a full recourse guarantee from the FDIC and financing from the Federal Reserve Bank in the relevant district. The banks will initially be guaranteed a minimum net interest margin and servicing income, and immediately begin to service the loan and manage the credit locally. Indeed, the participating bank must agree to retain and service the loan so long as government financing is used. The bank has the option to repay the financing from Treasury and take full, non-recourse possession of the loan.

We don't pretend that this simple outline is sufficient treatment of this proposal, but we have heard several permutations of this approach from veteran bankers in the loan origination channel all over the US. We see several advantages to this "community bank" approach to the crisis, which might be combined with modest additional capital infusions to solvent community and regional banks like WABC, if they even need it.

* First, it puts the trillions of dollars in now illiquid mortgage loan collateral trapped inside thousands of securitization deals back into strong local hands, who are responsible and incentivized to both manage and service the loan.

* Second, it re-liquefies the balance sheets of the US banking industry and it will vastly improve the prospects for home owners and housing markets around the country. If we are going to further lever the balance sheets of the Treasury and Fed, let's do it for a real reason and with a clear purpose.

* Third, the approach outlined above provides the Obama Administration and the US Treasury with maximum bang for the buck in terms of both addressing the solvency problems facing the banks and also helping the economy and the housing industry.

One downside: This new market paradigm suggests that loan servicing as a standalone business may be at risk. Once community banks begin to accumulate significant local servicing portfolios, they may rediscover the benefits of keeping the credits that they originate. Sorry Wilbur!

And what about valuation? Well, as our friend Kyle Bass of Hayman Capital likes to remind us, all of these assets are valued and traded every day. It's just a matter of organizing the purchase process in a transparent and competent fashion. Starting with our friends at shops like Hayman, Black Rock and RW Pressprich, we know people who know how to trade illiquid assets.

Of interest, securitization experts like Raynes believe that servicing will remain a viable business model, but only time will tell. We notice that nobody seems to want the Lehman Brothers servicing portfolio that is still sitting in the NY bankruptcy of the parent. We'll be exploring these and related issues regarding securitization at the May 4 PRMIA event in DC.

AEI Event: Everything You Wanted to Know about Credit Default Swaps

On Monday, February 23, 2009, American Enterprise Institute in Washington is hosting an event entitled "Everything You Wanted to Know about Credit Default Swaps." IRA co-founder Christopher Whalen and Mark Brickell, the former chairman of the International Swaps and Derivatives Association (ISDA) and founder of Blackbird Holdings, will discuss and debate the market for credit default swaps and proposals in the Congress to reform this over-the-counter market.

Click here for more information

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