Real Estate Disaster Story: BankUnited Financial

I love 10-Ks. You know those annual filings that public companies are required to make with the SEC? BankUnited Financial (stock ticker: BKUNA) published theirs last week and it makes for some fascinating reading. BKUNA’s loan book is clearly a real estate disaster story worthy of an optionARMageddon post. And, according to the 10-K, they claim not to have been involved in subprime. That is an interesting theme developing of late: plenty of lenders that avoided subprime debt entirely are still in deep trouble. American Home Mortgage? Bankrupt. Fannie and Freddie? Cutting their dividends and “hurrying” to raise capital. Even “prudent” lenders are getting hammered by real estate’s implosion. Did BKUNA lend “prudently?” Check out the 10-K for yourself. Forthwith: my favorite nuggets.

[By the way, this post should not be construed as offering any sort of investment advice.]

To start off, a little background on the company. BKUNA is a Florida bank that takes deposits and borrows money which it uses to fund mortgage loans. In 2007, 61% of their loans were for properties, primarily one-to-four family residential properties, in bubbly Florida. 7% of their loans were in California, another bubble state and 5% were in Arizona, yet another.

“Non-Performing Assets”

So how have their loans been performing? Well, uh, worse. Non-performing assets is a way to look at it. These include past due and delinquent loans as well as “owned” real estate–i.e. foreclosed homes now owned by the bank.

I would say the trend is up. But the $209 million of BKUNA’s so-called “non-performing assets” at the end of FY 2007 represent only 1.4% of the bank’s total assets. That’s up 9x from 0.16% last year, but why worry about 1.4% of the loan book?

Negative Amortization–why more than 1.4% of BKUNA’s loan book is at risk.

NegAm is an ugly term that refers to a pretty simple concept. Loans with “options” (an option ARM, e.g.) give the borrower the “option” to pay back less than the full interest and principal payment in a given month. Any unpaid interest and principal is added to the total outstanding loan balance. The concept is similar to making the minimum payment on your credit card. Whatever you don’t pay gets added to your balance. And as your balance grows, so does the amount of interest you owe. Now imagine if the interest rate on your credit card was going to jump after a couple years. Not only do you have a higher balance, the interest rate charged on the higher balance is higher. Now we get to the ARM in option ARM….it stands for, of course, adjustable rate mortgage.

To sum up, NegAm option ARMs are loans where the borrower is making a minimum principal and interest payment on his mortgage, consequently the total mortgage balance is INCREASING and to make matters worse the interest rate on that mortgage balance is set to explode upward in a couple years time. Not a big deal if home values are increasing and you can refinance. But what if home values are falling and you can’t? You get a real estate disaster.

So what percentage of loans are “negatively amortizing” at BKUNA?

Would you believe 55%?

Yup. According to the footnotes of the 10-K, page 49, $6.7 billion worth of mortgages (out of a total loan book of $12.2 billion) are “negatively amortizing.” So you have to ask yourself, doesn’t it seem like 55% of the loan book is at risk, not just the 1.4% labeled “non-performing?”

It’s one thing to skip a payment on a $10,000 credit card balance, quite another to skip a payment on a $400,000 mortgage. Over time the loan balance can grow to as much as 125% of the original amount, $500,000 in our example. In the meantime, housing prices are falling and your home isn’t worth $400,000 anymore. It’s worth $300,000 (if you can sell it at all). So now you owe $500,000 on a home that’s worth $300,000. What happens to the bank? Well they foreclose on the home and write down the loan.

I’m oversimplifying things here, but obviously it’s a bigger deal to skip a payment on a $400,000 mortgage balance than a $10,000 credit card balance.

NoDoc/LowDoc loans

BKUNA says they weren’t involved in subprime lending, presumably b/c none of its loans were granted to borrowers with credit scores in the “subprime” zone below 620. In fact nearly 50% of BKUNA’s borrowers have scores above 700. Yet how valuable is a high credit score for a borrower who isn’t paying back the full cost of his loan?

Indeed, you have to question whether these loans weren’t indeed subprime. Of BKUNA’s
$10.2 billion of one-to-four family residence loans outstanding at the end of FY 2007, only 18% were classified as “full doc, employment verified.” 42% were classified as “stated income/employment verified.” How DO you verify someone is employed without having them produce a pay stub or other proof of income?

Anyway, another 31% of loans were to borrowers for “low doc employment verified” loans. And 9%, or $1.0 billion were for “no doc” loans.

That’s right: BKUNA has $1.0 billion loaned out to folks they know virtually nothing about.

The Stock Price

BKUNA may be reporting that only 1.5% of its loan book is “non-performing,” but investors seem skeptical:

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