Bank Downgrades Next

Here we are after S&P’s U.S. downgrade (here’s my take) and stocks are down again and the bond market is rallying. Markets set rates, not rating agencies, and it would seem that money is flowing into bullion and into the bond market, as many expected would happen. Perhaps the United States really is still viewed as a safe haven for money – after all, few markets match the depth and liquidity of the Treasury market, which has $9.3 trillion in debt outstanding. That being said, keep in mind other debt tied to Treasury rates, and risk quality, may be downgraded soon, which may lead to higher rates – a ripple effect.

For banks, the Fed already came out right after S&P’s downgrade announcement with: “For risk-based capital purposes, the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies and government- sponsored enterprises will not change.” So for banks this looks like a non-event although with bilateral ISDA contracts and collateral agreements at clearing houses (DTC, FICC, etc.) there could be problems when it comes to GSE debt – watch for potential downgrades early this week. [UPDATE: Fannie/Freddie downgraded]

Fannie Mae Loss
Fannie Mae reported a $2.9 billion second-quarter loss and said it would seek $5.1 billion in Treasury Department aid to balance its books since it has a net worth deficit of $5.1 billion for the three-month period that ended June 30. The loss, which compares with a $1.2 billion loss a year earlier, was mostly a result of credit-related expenses on home loans made before the 2008 financial collapse. Fannie Mae also made a $2.3 billion payment to the Treasury in the second quarter. As of the second quarter, Fannie Mae has drawn $104.8 billion in Treasury aid and paid $14.7 billion in dividends, the company reported. Fannie Mae and Freddie Mac together have drawn about $170 billion in taxpayer aid.

BofA Bad Loan Trouble
Bank of America’s stock was hit late last week after telling investors that claims from Fannie Mae and Freddie Mac may cost more than previously forecast. The buyback claims have analysts saying that the $30 billion of expenses booked may not be enough to clean up the faulty mortgages. F&F can request a buyback from a seller if a mortgage insurer denies coverage for a loan, even when the lender disputes the insurer’s decision, and companies currently have three months after being denied coverage to appeal the repurchase demand and will have just 30 days starting in July 2012.

Home Affordability Returning
At some point it comes back to our economy, and continued worries about jobs and housing. Feeble job growth and rising unemployment don’t help the housing market, and in turn construction or distributing distressed properties. For example, California has significantly reduced its backlog of foreclosures, while Florida has not. This will dictate the speed with which these housing markets return to normal. The home price-to-rent ratio has slipped just below one, which means rents are now slightly expensive to home prices on a national basis.