The Foreclosure Mess

There’s no shortage of press on this issue.  The topics cover the spectrum:  who caused it, who profited, who was destroyed, etc., etc.  The dialog is endless. 

Because it affects everyone.  Foundationally, this is about housing.  One of the three fundamental necessities for every human being.  Food, clothing and shelter.  Thats it.  Lose just one and you won’t last very long. 

One obvious outcome of the Foreclosure Mess, which I’ll now refer to simply as the Mess, is an increase in renters.  And a decline in the number of home owners. 

But now a new group has made its way to the scene:  ‘home occupiers.’  Home occupiers are neither owners or renters.  They are transitional.   Most often, a home occupier was previously a home owner who, for whatever reason, stopped making their required monthly mortgage payment. 

Historically, this is a small group.   Let’s talk numbers.

First, for a more in-depth discussion of housing and housing values, check out this paper: http://www.liebmangroupadvisors.com/Sites/liebmangroup/static/EditorFiles/pdf/LGA_Housing_Theory_Paper.pdf

There are about 110 million occupied houses in the US.   Of this total, about 60 million have mortgages – the balance are loan-free.  

Historically, homeowners with loans made their payments.  Of course, the payment record was different for various segments:  ‘Prime’ loans have always performed best while ‘sub-prime’ and FHA guaranteed loans have the highest delinquency rates. 

But today, a large group of home occupiers are not paying.  Estimates for ‘serious delinquency’ (more than 90 days late) range up to about 5 million, or about 8% of all financed homes in the country.   That’s a ton by historical standards.

According to the Federal Reserve, at the end of Q-2, 2010, Americans owed about $10.15 trillion in mortgage debt.   Do the math and we see about $850 billion of this debt is seriously delinquent.  In other words, owners of these loans are paid nothing and the home occupiers pocket what would have been their monthly payment. 

How much are these home occupiers pocketing each month?  Lets estimate an average 6% interest rate.  This means these home occupiers have about $4 billion more – each month – to spend on something other than housing.   Seems like a lot, right?   Actually, not really.  In August of 2010 alone, consumer spending increased by over $40 billion. 

And while home lenders don’t like taking a $4 billion monthly haircut, this is not an unmanageable problem.  It’s irritating.  It’s political.  But it’s manageable. 

Take Bank of America, for example.  This behemoth has assets of over $2.3 trillion.  Their ‘non-performing’ assets total only $34 billion.  Barely 1.5% of total assets.   In the 3rd quarter of 2010, excluding a ‘non-cash goodwill impairment charge’ they earned $3.1 billion.  In one quarter. 

But they’re caught up in the Mess.  Rightfully so, they bought Countrywide – a huge contributor to the Mess – and so they’re right in the middle of it.  Politically and financially, they’re caught up in the muck.  So much that their common stock price is now below it’s tangible book value of $12.91.  And still falling. 

Again, excluding the non-cash item, Bank of America has earned $9.4 billion YTD in 2010.   With almost 10 billion shares outstanding, on annualized basis this is about $1.25 per share.  

So what’s this stock actually worth?  The industry group seems to hover between a 10 to 15 P/E ratio.  So, with earnings growth and a 10 P/E, the stock looks seriously undervalued. 

At $11.50 Bank of America common is a heck of a good buy.  Within 6 months, with growing earnings and the Mess – at least politically – a distant memory, this stock will easily eclipse $15 a share.  Let’s watch and see.