Cramer on BloggingStocks: Five steps to find bad loan answers

Posted Dec 3rd 2007 9:04AM by Jim Cramer
Filed under: General Motors (GM), Countrywide Financial (CFC), Washington Mutual (WM), Wells Fargo (WFC), NovaStar Financial (NFI), Housing, Cramer on BloggingStocks

TheStreet.com's Jim Cramer gives you the questions you have to answer about this major issue affecting the market and the economy.

We never talk about "purchased loans," yet those are at the crux of what's wrong with the system. The big losses that E*Trade (NASDAQ: ETFC) (Cramer's Take) and Wells Fargo (NYSE: WFC) (Cramer's Take) had were all loans that were purchased that were originated by others.

I have long held that there are specific parts of these bad loan amalgams that have made them so elusive to get your arms around, although we should be forever thankful to Citadel for placing a dollar value of 27 cents on this gunk.

Put simply there are five items on any check list of the purchased loans that are awful:

1. Who originated the loan? We know that the sloppiest lenders included NovaStar (NYSE: NFI) (Cramer's Take), New Century Financial, American Home Mortgage, Fremont General (NYSE: FMT) (Cramer's Take) and Ditech (NASDAQ: GM). If your collateralized debt obligation (CDO) has a lot of origination by them, you are in trouble. (I am excluding Washington Mutual (NYSE: WM) (Cramer's Take) and Countrywide (NYSE: CFC) (Cramer's Take) loans as we don't know enough about how much was packaged and sent and how much was bad.)

2. Home Equity lines of credit. If the stuff contains HELOC from 2005-2007 from virtually anywhere with any credit ratings, it is questionable to worthless.

3. Florida and California. You get rid of the mortgage debt of those two states from 2005 to 2007 and you have a very manageable problem.

4. FICO scores are meaningless. Unless they are in the mid-700s, forget it; you have no protection from default. These are particularly worthless if after a primary loan was made, a secondary loan -- HELOC -- was added on top of it, which would make anyone in the FICO low 700s and high 600s a candidate for failure.

5. Loan-to-value ratio higher than 70%, meaning that the value of the loan pretty much depended upon the property rising in value.

I am sure Citadel used this five-pronged test to try to value E*Trade's portfolio. What's amazing to me is that after all of this handwringing and crying I get the sense that most institutions have not run these held CDOs through this process. If they did, we wouldn't have much less to worry about, but we could just accelerate the process of the disposal and crunching of the roughly $500 billion in debt that fails to pass these tests.

Why isn't everything bad? Because we have excellent stats from Wells Fargo about non-purchased loans. Mitch Caplan told me that most of the bad loans were purchased loans originated by these bad actors.

When everyone has this drill down pat we will be at the end of the problem.

Jim Cramer is a director and co-founder of TheStreet.com. He contributes daily market commentary for TheStreet.com's sites and serves as an adviser to the company's CEO. At the time of publication, Cramer had no positions in any of the stocks mentioned in this post. Please note that due to factors including low market capitalization and/or insufficient public float, we consider NovaStar and Fremont General to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Reader Comments (Page 1 of 1)

12-03-2007 @ 11:12AM

Roger said...

Jim,
You are once again right in the groove!
I'm hearing that P/E ratios right now should send investors up the wall!
What's your take on that?
Typical P/E ratios in a recession are a known factor. The fact that that major indices show P/E ratios which has benefited from so many years of back-to-back growth leads many to believe that a major correction is ahead. Your thoughts?
Take care,
Roger