Last year's Wachovia acquisition contributed 39% of the Wells Fargo’s (WFC: 29.60 +1.89%) record Q209 profits of $3.17bn.

Wells posted the record profit even as its mortgage-related write-offs rose to $758m. The Q209 profit brings Wells’ profits for the first six months of 2009 to $6.22bn, up 66% from the first half of 2008.

Earnings per share broke down to $0.57, up 8% from last year, which comes after a $700m credit reserve build, a $565m Federal Deposit Insurance Corporation special assessment and $244m in merger and restructuring-related expenses.

Wells’ mortgage banking business saw a more than 8% annualized linked-quarter increase in revenue. The bank reported mortgage applications worth $194bn, up from $190bn in Q109. It originated $129bn home mortgages, up from $101bn the previous quarter.

Wells Fargo reported it provided mortgage relief to nearly 1m customers through the Home Affordable Refinance Program (HARP) and other standard refinance programs (750,000 customers) and the Home Affordable Modification Program (HAMP) and bank’s own programs (200,00 modifications completed or in HAMP trial stage).

Wells reported a combined $758m in write-off losses among single-family mortgages between its Wells Fargo and Wachovia banking entities, up $367m in the linked quarter.

“The loss levels in our 1-4 family first mortgage portfolio increased as expected, in part due to increased loan modifications and the lifting of the foreclosure moratorium,” chief credit officer Mike Loughlin said in the quarterly report. “While we are seeing some encouraging signs of home sales in California, housing prices need to stabilize broadly before credit results in the mortgage portfolio will improve.”

Wells has yet to apply to repay the $25bn it received as part of the government’s Troubled Asset Relief Program (TARP), but president and CEO John Stumpf addressed it in the report.

“We intend to pay back the government’s investment in Wells Fargo on behalf of US taxpayers in a shareholder-friendly way,” he said in the report. “We will work closely with our regulators to determine the appropriate time to repay the funds while maintaining strong capital levels.”

On the heels of the quarterly report, Fitch Ratings downgraded Wells’ long-term issuer default rating to double-A minus from double-A and moved the bank from rating watch negative to outlook stable.

"On a consolidated basis, approximately 40% of [Wells'] loan portfolio is secured by residential first or second lien mortgages," Fitch said in a statement on the ratings action. "Together with other consumer lending, approximately half of [Wells'] loan portfolio is exposed to US consumers, a borrower group that has been very negatively impacted by reduced home prices and high unemployment."

Write to Austin Kilgore.

[Update 2: Corrects statements made by CMSA on proposed regulatory reforms; an earlier story had incorrectly stated that the CMSA was supporting a Treasury proposal for 5% risk retention requirements, when the CMSA is not supporting such a requirement.]

The commercial real estate market — and specifically the commercial mortgage-backed securities (CMBS) market — is experiencing its worst liquidity crisis since the early '90s, according to the Commercial Mortgage Securities Association (CMSA).

The association hosted a Webcast late Tuesday to discuss a "looming" crisis in the commercial real estate and mortgage market and to discuss the administration's regulatory reform plan.

The CMSA addressed five "utmost" concerns in the plan.

The first issue deals with risk retention, which "is an important component regardless of who ultimately retains the risk: the broker/originator, the issuer or the first-loss buyer," CMSA said in its paper on regulatory reform–but the group stopped short of endorsing a risk retention proposal being floated by Administration officials. The Treasury Department is urging a 5% risk retention ratio, with the idea that this would encourage originators to make loans of the highest quality.

Under any 5% risk retention requirement by the Treasury, the CMSA said an exception authority should be crafted to allow certain structured finance vehicles to qualify for an exception to the requirement, "subject to the appropriate transfer of such risk."

But if originators are required to retain a portion of risk, they should be allowed to hedge certain risks, the CMSA said, as leaving such positions unhedged places the financial stability of the originator at risk.

"Since there is no way to ensure that any hedge protects 100% of an investment from loss," CMSA's reform plan reads, "loan originators and sponsors will continue to carry significant credit risk exposure that reinforces the economic tie between the originator and the issued CMBS."

The CMSA also addressed the Treasury Department's proposed changes to certain rules that allow originators to immediately recognize "gain on sale" and instead require such gains to be realized over a longer time period.

"[W]hile aligning compensation with long-term performance of securitized assets would appear to be appropriate," the CMSA's plan reads, in part, "it is very difficult to determine if a future loan default is due to poor underwriting at origination, changes in market conditions, or poor business practices by the borrower and/or tenants."

Another issue generating discussion — a ratings differentiation for structured finance products — would be unhelpful, the CMSA claims, confusing some investors and prohibiting others from buying bonds until their investment policies are revised for the new ratings system.

"This could significantly delay the positive impact of government initiatives to reinvigorate commercial mortgage lending," CMSA said.

In a Webcast late Tuesday, a CMSA panel discussed current government initiatives, including the Federal Reserve's Term Asset-Backed Loan Facility (TALF).

Panel member Lisa Pendergast, who serves as managing director of Jeffries & Co., said commercial mortgage lending remains challenged along with the TALF's slow start among CMBS. She noted the delinquency rate among commercial mortgages, currently around 3%, may top as much as 9% in a worst-case scenario.

Another panel member, Chris Hoeffel — managing director of Investcorp International — noted the government's expansion of TALF in May to consider certain CMBS as eligible collateral under the program. The deadlines within the program, however, must be extended if the CMBS side of TALF is to have any significant effect, Hoeffel said.

Rick Jones, a partner at Dechert and fellow panel member, called the current time frames "relatively ludicrous." It might be why the Fed received no bids at all for its first CMBS facility in June. It did receive almost $669m in applications for its July legacy CMBS facility.

"The Fed's heart is in the right place" as it tries to help bring liquidity to the market, Jones said. The legacy CMBS side of TALF is likely to have a positive impact on the business, and Jones expects the Fed to see more subscriptions for its next CMBS facility in August.

Write to Diana Golobay.

SilverLeaf Financial will sell 321 single-family mortgages it acquired from a private investor last week, according to a corporate release.

The notes range in value from $60,000 to $100,000. Interested investors can buy as many or as few notes from the portfolio as they require – directly from SilverLeaf, according to their release. The properties are located primarily in Indiana and Ohio, and all are non-performing.

Before these for-sale signs went up, SilverLeaf worked with larger investors that required a minimum payment of $500,000, but these will be sold for around $0.20 to $0.30 on the dollar, attracting the attention of “Average Joe” investors, according to the release.

“It would be too time-intensive for us to do 321 separate work outs on all these notes,” said CEO Shain Baldwin. "Each one takes time, and would have to be dealt with individually. We are selling them or 're-trading' them to create some liquidity on our side."

SilverLeaf acquired more than $150m in face value notes and “worked out” 65% of them. The Utah-based private equity firm will continue to purchase performing and non-performing notes from the FDIC and other financial institutions using income-producing commercial properties as collateral.

Write to Jon Prior.

The Federal Reserve and Treasury Department's responses to the liquidity crisis in the asset-backed security market and the lending system in general largely avoided a systemic catastrophe, but came with their own consequences.

They also failed to address the real risk posed by US credit market instruments, according to Mark Zandi, chief economist at Moody's Economy.com.

The worst may be yet to come with total losses on housing bubble-related lending estimated at $2.6trn, despite the Fed's and Treasury's efforts to calm financial markets.

The Fed has revived commercial paper market while Treasury has done a fair job of forcing bank holding companies to shore up their balance sheets by conducting stress tests. The financial system is stabilizing, Zandi said, but unprecedented policy will be difficult to unwind.

"The government's vast intrusion into the financial system… poses a range of threats. There are legitimate worries that with the Federal Reserve pumping so much liquidity into the system, it will eventually ignite undesirably high, if not runaway, inflation," Zandi told the House Financial Services Committee on Tuesday, according to prepared testimony.

"Moreover," Zandi added, "it is not clear whether the government will be able to gracefully exit its large ownership stakes in Fannie and Freddie, banks, and other financial firms. Fortunately, calls to nationalize major financial institutions, which would make such an exit significantly more complicated, have not been heeded."

But neither were the warning signs of the housing bubble, according to Zandi, who chided regulators' failure to save Lehman Brothers from bankruptcy shortly after placing Fannie Mae (FNM: 0.00 N/A) and Freddie Mac (FRE: 0.00 N/A) into conservatorship. The real systemic risk present in major financial institutions and government agencies, according to his testimony, are the loans left over from the housing boom.

Moody's Economy.com calculated the ultimate cost of bad lending associated with the takeoff of subprime, alt-A and jumbo residential mortgages during the housing boom at around $2.6trn. These losses translate into a lifetime loss rate well over 10% on the approximately $24trn in US credit market instruments now outstanding, Zandi told the House Committee.

Of expected credit losses, Zandi estimates that $1.2trn will be suffered by depository institutions, nearly $1trn by pension funds, insurance companies, hedge funds and mutual funds, and $350bn by government mortgage agencies Fannie, Freddie and the Federal Housing Administration.

As the fallout from bubble lending continues to unwind in these institutions, Zandi recommended posting the Federal Reserve as a systemic risk regulator to avoid these risks from building up in the future.

"As a systemic risk regulator, the Fed would be able to address an age-old problem: Namely, that banking regulation tends to be procyclical," Zandi said. "When credit quality is good and lenders are aggressive, regulators have difficulty imposing discipline; when quality is poor and lending is tightening, the disciplinary screws are tightened. This procyclicality tends to exacerbate swings in lending standards and credit availability."

The House Committee, in hearing economic commentary on systemic risk and institutions that may be too big to fail, also considered testimony from Alice Rivlin, senior fellow at the Brookings Institute, who pointed out systemic risk as seen in the securitization market.

According to Rivlin, securitization disconnects lenders from borrowers and creates incentives for lenders to ignore repayment risk. The consensus, particularly during the housing boom, was that originating lenders were in the clear as long as the loan remained current as it was sold to an investor to be bundled into a security and sliced and diced into various tranches.

The rest of the story is history: Loans throughout these securities began defaulting at an alarming rate, and the security structure itself and the interest of the security investors made modifications a tricky task. Rivlin recommended clearing up the legal responsibilities of originators, servicers, packagers and owners of mortgage-backed securities (MBS).

"We need to ask whether the social utility of slicing up MBS into risk tranches to be sold to investors with different appetites for risk is worth the confusion that ensues when the loan has to be renegotiated," Rivlin said, according to prepared testimony. "I would favor giving bankruptcy judges the power to adjust mortgages as they do can do with other debts, but it also has to be clear who is on the other side of the mortgage transaction."

Write to Diana Golobay.

Proposed regulations for credit rating agencies would promote transparency, resolve conflicts of interest and empower the Securities and Exchange Commission (SEC) to better monitor the tools investors use to evaluate financial products, according to legislation the Obama Administration presented to Congress Tuesday.

Ratings agencies have faced criticism for over-rating mortgage-backed and other asset-backed securities created by their clients but that were comprised of assets that turned out to be toxic. Since the subprime mortgage fallout, critics have called for regulation of the firms.

The administration’s proposal would require nationally recognized statistical rating organizations (NRSRO), like Fitch Ratings, Moody’s Investor Services and Standard & Poor’s, to register with the SEC.

In turn, the SEC would establish an office dedicated to NRSRO oversight, and the agencies would be required to submit regular reports on internal controls, due diligence ratings methodologies to that office.

“In recent years, investors were overly reliant on credit rating agencies that often failed to accurately describe the risk of rated products,” according to an unsigned Treasury Department statement issued Tuesday. “This lack of transparency prevented investors from understanding the full nature of the risks they were taking.”

The ratings agencies would also be required to designate dedicated compliance officers who would report to their firm’s board and CEO. This compliance officer would be responsible for ensuring the legislation’s new initiatives are implemented. These new rules would prevent agencies from consulting for companies they rate, a restriction similar to one placed on accountants.

The agencies would also have increased disclosure responsibilities, including fees paid for rating reports and potential business conflicts of interest.

The proposed legislation comes after last week’s testimony from SEC chair Mary Schapiro to a House Financial Services subcommittee, which called for, among other things, an end to “ratings shopping,” — the practice of soliciting “preliminary ratings” from multiple agencies and then purchasing and reporting the highest rating.

The administration’s proposed legislation would require issuers disclose all preliminary ratings it requested.

The regulations would even go so far as to require NRSROs to use different rating symbols for different types of structured products. Under the proposal, asset-backed securities would have a different ratings scale than corporate bonds.

Write to Austin Kilgore.