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Banks Underestimate Home Price Declines

Oppenheimer report analyzes bank estimates

July 16, 2008

By MortgageDaily.com staff

Some big financial institutions vary widely on how much they estimate real estate prices will drop and, consequently, how much their mortgage-related losses will be. A new study indicates some banks can expect further declines in the price of their stocks until they "get real" about the market.

The report, Bank Stocks Headed Lower Until Asset Valuations "Get Real", was prepared by Oppenheimer analysts Meredith Whitney, Joseph Mack and Kaimon Chung.

"We believe that banks' carrying valuations on mortgage related assets are still too high, but it varies by degree," the report, released Tuesday, said. "For the financial markets to stabilize, we believe banks need to swiftly address true asset values and adjust their books accordingly."

Driven by a decline in loan securitizations beginning with falling subprime issuance, home prices began falling.

Subprime loan originations grew from $124 billion in 2001 to $222 billion in 2005. As subprime volume flattened in 2006 at $222 billion, home prices went from double-digit increases to no appreciation. By 2007, when subprime originations fell to $201 billion, home prices fell 10 percent.

Global asset- and mortgage-backed securitizations peaked in the fourth quarter 2006 at $804 billion. The next quarter, when volume fell to $770 billion, home prices fell and the decline accelerated. By the first quarter of this year, home prices were down 15 percent from a year earlier and securitization volume had fallen to $142 billion.

While the securitization boom created more homebuyers, the subsequent contraction took 5 million buyers out of the market.

The authors noted that the futures market currently indicates that home prices, based on the Case-Shiller 10-city index, will ultimately drop 33 percent from their highs. So far, prices have already tumbled more than 15 percent.

But some banks are still utilizing an unrealistic assumption from the Office of Federal Housing Enterprise Oversight of just 12.9 percent from peak to trough.

Even Fannie Mae and Freddie Mac, which are regulated by OFHEO, no longer use the regulator's index because it has proven unreliable.

Among the worst prepared is Wachovia Corp. The Charlotte, N.C.-based bank uses OFHEO's assumption of 12.9 percent.

But cross-town rival Bank of America Corp. is among the most realistic, the report said. BoA assumes home prices will eventually fall 30 percent from their peak.

In between the two banks are Citigroup, which estimates a 20 percent decline; Fannie, which forecasts 20 to 25 percent; Freddie, at 20 percent; and JPMorgan Chase & Co., which expects prices to fall between 14 and 16 percent this year alone.

Oppenheimer rated BoA and JPMorgan as perform, while Citigroup, Wachovia and Wells Fargo & Co. were rated as underperform.

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