Another shaky line in the sand

The Baltimore Sun

Pay no attention to multimillion-dollar paper losses in our investments, says Provident Bankshares. The market doesn't value them correctly, and the losses are just temporary.

Maybe the market knows something Provident doesn't. It's not like Baltimore's biggest independent banking company has impressed anybody with its own analysis.

After writing down the value of bum securities by $47 million in January, Provident boss Gary N. Geisel told The Sun that was probably it. "We don't expect the value to go down further," he said.

Late Tuesday the bank announced another probable loss of up to $48 million on real estate bonds and preferred stock.

"This announcement is really Chapter 2" of the January stink bomb, Geisel said Wednesday.

Get ready for Chapter 3 - and there's no guarantee this book isn't War and Peace.

Provident owns mortgage bonds valued on its books at $116 million that aren't guaranteed by Fannie Mae and the like - on top of the at-risk securities it now says it will write down. More pain is possible, although Provident is in no danger of failure or losing depositors' money.

Like many banks, Provident loaded up on hard-to-understand paper backed by mortgages, homebuilders and real estate.

Also, like its peers, it has been painfully slow to admit that much of the paper was junk.

As early as Sept. 30, it was sitting on $62 million in "unrealized" losses on debt, based on market prices.

Like coupon clippers everywhere, Provident was happy to hold its paper to maturity, pocket the interest and not record the value change on its bottom line. Accounting rules allow this.

But sometimes bonds crater for reasons other than routine interest-rate increases, which depress the value of existing debt. Sometimes bonds hit the fan because it becomes apparent that the borrower won't pay back the money.

That's the message the market seemed to be sending last fall, but Provident wasn't getting it. Since then, of course, homeowners and homebuilders have continued to default. Provident has acknowledged as much as $95 million in investment losses and seen its stock price cut in half since October. Sometimes unrealized loss is painfully real.

Today we'll get an update. Provident's 10-K form, filed with the Securities and Exchange Commission, will show unrealized losses as of Dec. 31. If they're like most mortgage bonds, the securities Provident hasn't written down will have fallen in value from September to December.

Company officials explain why shareholders will be protected from further write-downs. Unfortunately, we've heard it before.

Nearly $50 million of the mortgage bonds are similar to a $14.9 million chunk that Provident plans to write off. Mortgages underlying another $9 million investment are 10 percent delinquent, although because of firewalls typical of mortgage bonds Provident hasn't yet lost any principal.

On a Wednesday conference call, analysts wanted to know why such delinquencies wouldn't spread to another $58 million in similarly-rated paper that Provident owns. Had the mortgages been issued in Florida, California or other housing disaster scenes?

Provident officials didn't have an answer. They talked about the "unstable" market, implying that mortgage securities are trading for less than they're worth.

Sure, numerous banking companies are wrestling with the same problems. Yes, Provident relied on bond-rating agencies, whose opinions turned out to be unreliable. True, bids for non-guaranteed mortgage bonds are scarce, which makes you wonder about the prices.

"Good information is the lifeblood of sound risk management," Federal Reserve Gov. Randall S. Kroszner said in a speech this week. Information breakdown has defined the housing mess, from fraud by brokers and borrowers to tardy disclosures by banks. In such a vacuum even flawed market prices are often the best information there is.

The size of the housing crash has shocked almost everybody. In November I noted Provident's unrealized losses but concluded that "so far it has navigated the housing storm better than many of its rivals."

That's not true now, and the unrealized losses, it's clear, were telling us it wasn't true then. If the market for mortgage paper is still "unstable," maybe so are the bonds themselves.

Unstable certainly describes the outlook for Provident. The stock sells for less than book value, and the indicated dividend yield is 8 percent. Geisel called that "acceptable." The market, by the mere fact of sending the yield to that level, calls it unsustainable.

I doubt the market has that wrong, either.

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