M&T Bank's Rude Alt-Awakening

For the last few weeks, conventional wisdom has held that problems in subprime lending would not spill over into the rest of the market. But the Alt-A lending market may prove that sentiment wrong.

Some investors consider Alt-A loans a separate class of loans above subprime, while others view them as the highest quality within subprime. Regardless of how investors choose to perceive them, after the market closed on Friday, M&T Bank (NYSE: MTB  ) issued a press release stating that multiple problems in Alt-A lending will pull down the company's earnings for the first quarter.

Yup, no problems in mortgage lending, folks. Everything's fine here!

All kidding aside, the content of M&T's press release is far more interesting than any perceived earnings miss. The two most interesting parts of the press release revolved around the company's ability to sell Alt-A loans it originated and the worse-than-expected performance of Alt-A loans already sold. Let's look at each part separately, because the consequences are different.

Normally, M&T originates Alt-A loans as part of its lending business, then sells these loans to third parties. When M&T recently tried to sell Alt-A loans it had recently originated, it found the bidding sparse, and the bids received below its estimate of the value of the loans involved. Rather than sell the loans for less than their value, M&T decided to hold onto them. Not a difficult economic decision to make, if you have the wherewithal to hold onto the loans.

The short-term pain for M&T is lower earnings, because its accounting treatment requires the company to recognize the current, lower market value. M&T is betting that the market will eventually improve, or that it will make out better by holding on than selling now. In the meantime, it'll take a $7 million hit to earnings, or $0.07 per share.

The second item of interest was that loans recently sold by M&T aren't performing as well as initially expected in the first 90 days after being sold. When this happens, M&T is required to repurchase the loan. More customers are requesting that M&T repurchase loans, which has required M&T to assume a higher level of repurchases than initially expected; a greater provision for these repurchases has pulled down earnings by $4 million, or $0.04 per share.

In fairness, M&T Bank is a very well-run financial institution. It didn't get to be one of the 20 largest banks in the country, or have consistently above-average financial metrics, by accident. This isn't good news for M&T, but in the big picture, M&T's total consumer real estate lending is less than 15% of total loans, and not all of the consumer real estate loans are likely to be Alt-A. The company still expects to report $1.50 to $1.60 in earnings per share in the first quarter, despite the two items above and slightly higher compensation expenses. In other words, M&T is not in any serious trouble, but it has some problems to address.

Given M&T's long history and strong track record, what does its difficulty with Alt-A loans imply for Impac Mortgage Holdings (NYSE: IMH  ) , which also focuses on Alt-A? And what about firms that focus on option ARM loans, such as Downey Financial (NYSE: DSL  ) or BankUnited Financial (Nasdaq: BKNUA  ) ?

The answer will be different for each. Impac sells or securitizes a number of its loans, and as a REIT that cannot retain capital, it'll likely need to continue securitizing, even if the overall market terms aren't as favorable. Impac also holds some loans for investment, but in a recent press release, it sounded positive that repurchase requests were declining.

Downey and BankUnited face a different situation, since they take in deposits and are able to retain capital. However, it's not as if option ARM loans offer particularly high quality. Since both banks are capitalizing more interest on loans -- recognizing income that isn't coming in as cash -- than they are reporting in net income, I won't be surprised if they issue an earnings warning or two.

At the time of publication Nathan Parmelee had no financial position in any of the companies mentioned. He was ranked 82nd out of 25,369 CAPS investors. The Motley Fool has an ironclad disclosure policy.


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