The government's $700-billion bailout plan probably comes too late to help such faltering lenders as FirstFed Financial Corp. of Los Angeles and Downey Financial Corp. of Newport Beach, which stuffed their investment portfolios with multibillion-dollar helpings of now-troubled mortgages, analysts said Sunday.
But the plan contains a provision that could assist large and highly diversified banks that take over troubled institutions so the government doesn't have to deal with them.
That would include JPMorgan Chase & Co., which last week bought Washington Mutual Bank, the nation's largest savings and loan, immediately after regulators shut it down, a Treasury Department spokeswoman said.
The government isn't inclined to provide major help to lenders that wounded themselves by becoming overly concentrated on originating and investing in mortgages as their main business line, said one person who worked on the bailout plan and spoke on condition of anonymity because of confidentiality agreements.
The bailout is instead aimed mainly at reestablishing a market for complex bonds linked to mortgages, so that huge banks and Wall Street firms can unload them and start making other loans again.
"All mortgage-backed securities are difficult to sell in the current market," said Guy Cecala, editor of Inside Mortgage Finance.
Of the $6.9 trillion in these securities outstanding, bonds that are not from government-linked entities such as the Federal Housing Administration, Veterans Administration, Fannie Mae or Freddie Mac are "where the most relief is needed," he said.
There are about $2 trillion of these so-called non-agency securities, of which about $1.5 trillion currently have virtually no buyers because they are backed by subprime loans to the least creditworthy borrowers or Alt-A mortgages. The Alt-A category includes the "liar loans" that didn't require borrowers to verify their earnings or assets.
The government presumably would target these for purchase, Cecala said.
But the government was not immediately making clear what would be purchased and at what price, said Jennifer Zuccarelli, a spokeswoman for U.S. Treasury Secretary Henry M. Paulson.
FirstFed Financial and Downey Financial are not big holders of these mortgage-backed securities. They are the parents of First Federal Bank of California and Downey Savings -- S&Ls; that specialized in a kind of mortgage that got lenders in hot water when home prices plummeted.
These pay-option adjustable rate loans, or option ARMs for short, give borrowers several payment choices each month, including paying less than the interest that is due.
The borrowers most often have chosen that easy-money option. Now, their loan balances have risen far above the value of their homes, preventing them from refinancing. With little but option ARMs in their investment portfolios, Downey and FirstFed are struggling to find ways to modify the loans and still make money as delinquencies soar.
The thrifts' ratios of nonperforming assets, a dud loan indicator, illustrate the problem. As of Aug. 31, Downey had $10.74 billion in loans held as investments and a nonperforming asset ratio of 14.68%, up from 2.27% a year earlier. FirstFed, with $6.65 billion in loans, had a ratio of 7.86%, up from 1.16% at the end of August last year.
Both thrifts have established large reserves to cover these problems. But the reserves are not enough to cover the losses the thrifts would suffer on the mortgages if they were to sell them to the government at the price the Treasury is likely to pay, bank analyst Frederick Cannon of Keefe, Bruyette & Woods said in an interview Sunday.
Instead, Downey, FirstFed and other option ARM lenders such as Florida's BankUnited Financial Corp. probably will have to hope regulators give them time to try to work through their problems on their own, Cannon said.
On the other hand, an "unjust enrichment" provision in the proposed bailout could help banks that acquire troubled institutions.
The provision says an institution can't sell a troubled asset to the government for more than the institution paid for it.
But there is an exception: Troubled loans and mortgage bonds can be sold at a profit if the seller acquired them "in a merger or acquisition, or a purchase of assets from a financial institution in conservatorship or receivership, or that has initiated bankruptcy proceedings."
That provision would apply to banks like JPMorgan, which bought Washington Mutual last week in a federally assisted transaction, Zuccarelli said.
It also apparently would benefit Wells Fargo & Co. or Citigroup Inc. if one of them were to buy Wachovia Corp. Wachovia, a huge Charlotte, N.C., bank, inherited a giant portfolio of option ARMs in 2006, when it bought Golden West Financial Corp. of Oakland, the parent of World Savings.
New York-based Citigroup and San Francisco's Wells Fargo were "locked in a bidding war on Sunday over a possible emergency takeover" of Wachovia, the New York Times reported, citing people involved in the talks.
Citigroup and Wells Fargo are interested in acquiring Wachovia's powerful branch network in the East and Southeast. Wells Fargo, which until now has operated retail branches entirely west of the Mississippi River, would wind up with a nationwide franchise to compete with Bank of America Corp. and JPMorgan Chase.