The problems at M&T Bank….

M&T bank happens to be a bank that we in the Ethereal Land have some familiarity with. So it was of great interest to me to come across this post from Calculated Risk(be sure to read the comments). The post by CR called to my attention this Reuter’s news story…..

M&T Bank Corp. said on Friday that problems with mortgages that have limited income documentation will hurt first quarter profit.

As far as that goes, no big deal. Everyone has down quarters. It is the reason for down turn in profits and the way that M&T is handling the down turn that bothers me. From the M&T press release….

Recent, well-publicized problems in the subprime residential mortgage lending market have had a negative effect on the rest of the residential mortgage marketplace, specifically with regard to alternative (“Alt-A”) residential mortgage loans that M&T actively originates for sale in the secondary market. Alt-A loans originated by M&T typically include some form of limited documentation requirements, as compared with more traditional residential mortgage loans. Unfavorable market conditions and lack of market liquidity impacted M&T’s willingness to sell Alt-A loans in the first quarter. At a recent auction of such loans fewer bids than normal were received and the pricing of those bids was lower than expected. In accordance with generally accepted accounting principles, loans held for sale must be recorded at the lower of cost or market value. As a result, the carrying value of M&T’s Alt- A portfolio that had been held for sale was reduced by $12 million in the first quarter of 2007, which M&T estimates will result in an after-tax reduction of net income of $7 million in the quarter, or $.07 per diluted share.

Management of M&T believes that the value of the Alt-A residential mortgage loans it holds is greater than the amount implied by the few bidders presently active in the market. As a result, $883 million of Alt-A loans previously held for sale (including $808 million of first mortgage loans and $75 million of second mortgage loans) were transferred in March to M&T’s held- for-investment residential mortgage loan portfolio.

In addition, M&T is contractually obligated to repurchase previously sold Alt-A loans that do not ultimately meet investor sale criteria, including instances when mortgagors fail to make timely payments during the first 90 days subsequent to the sale date. Requests from investors for M&T to repurchase Alt-A loans have recently increased. As a result, during the first quarter of 2007, M&T accrued $6 million to provide for declines in market value of previously sold Alt-A mortgage loans that are expected to be repurchased. That loss will reduce M&T’s net income by $4 million or $.03 per diluted share.

The big question here is whether M&T is correct in thinking that their portfolio of Alt-A loans is worth more than the market is willing to pay for or are they throwing good money after bad and hoping that things will get better?

If most of M&T losses stemmed from market panic in the secondary market, I would be inclined to give them the benefit of the doubt. But given that a lot of M&T losses stem from a very real failure of their Alt-A loans to pay according to contract, I would guess that they are throwing good money after bad.

Another reason for thinking that it is going to get worse is this….

M&T has initiated changes in its origination and sales practices as they relate to Alt-A lending that will likely result in lower originations of Alt-A mortgage loans in future quarters.

In one sense, this is good thing. They should tighten up their standards. But in the short term, this is only going to increase their losses. After all, tightening their standards means that there is going to be less people approved for mortgages. Less people approved for mortgages means less buyers on the market. Less buyers on the market means that M&T is going to see even more defaults (because distressed borrowers will not be able to unload their property on the market) and bigger losses on those properties that do default (because M&T will have a hard time finding buyers for the property that they repossess).

What we are seeing at M&T and at other banks is the reversal of the virtuous cyclical. For the last decade or so, low interests rates made it cheaper to borrow money to buy housing. This increased the value of housing overall at a faster rate than the economy as a whole. This gave people a lot of housing “equity” that they could borrow against to pay off their credit cards and send their kids to college. It also gave bankers the confidence to make risky loans because they felt that rising home values would cover them in the event of a default.

For a while, this all worked out. Housing prices kept going up and up, and credit kept on getting easier and easier to get for the average American. This enabled American consumers to spend far beyond their means and still not decrease their debt-to-equity ratios by any significant margin.

But now we are going to see the reversal of that cycle. Credit is going to get harder and harder to get and housing prices are going to keep going down.

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