Monday, April 28, 2008

Sell the Rally in Financials

Morgan Stanley (MS) analysts on Monday told clients to "sell the rally" in financial stocks, slashing forecasts for big bank earnings and warning that the current credit crunch is only just beginning.

In aggregate, Morgan Stanley reduced its estimates for 2008 large bank earnings by $17 billion, or 26 percent, and reduced 2009 forecasts by $13 billion, or 15 percent. The analysts expect higher loan losses and expenses, offset by higher net interest income, though profits could fall further still if the Federal Reserve stops lowering interest rates.

"More capital hikes and dividend cuts (are) coming as our credit deteriorates and forward earnings decline," analysts led by Betsy Graseck wrote in a report. "We think we are only in the third inning of the credit cycle and expect this credit cycle will be worse than (the slump in) 1990-91."

Thursday, April 24, 2008

Can Ambac Raise More Capital After Reporting Loss?

Ambac's $1.66 billion loss for the three months ended March 31, announced yesterday, sent the shares tumbling 43 percent and sparked concerns that the company's AAA credit rating isn't as safe as investors thought. Goldman Sachs Group Inc. analyst James Fotheringham estimates Ambac and larger rival MBIA Inc. may need to raise $3.4 billion each to fill capital shortfalls.

Ambac in March sold stock after suffering more than $5 billion of charges on its guarantees of mortgage-liked debt. The offering was enough to persuade Moody's Investors Service and Standard & Poor's to take New York-based Ambac's AAA rating off review, averting a downgrade that would have crippled its ability to guarantee bonds and removing the broader threat of losses for the $524 billion of municipal and asset-backed debt the company insures.

The housing and credit-market slump pushed Ambac to three straight net losses after more than a decade of quarterly profit. The bond insurer posted a record loss in the fourth quarter of $3.3 billion, or $31.85 a share, largely on writedowns of $5.2 billion.

Ambac, which also cut its dividend to preserve capital, sold 171.1 million shares at $6.75 each on March 6. At the time, the sale more than doubled the stock outstanding. The shares soared 28 percent the next day on optimism the company had averted a downgrade.

Ambac slumped to $3.46 in New York trading yesterday, taking the company's market value to less than $1 billion. The shares closed up 30 cents to $3.76 in New York Stock Exchange trading. Ambac is down 96 percent in the past year.

Credit-default swaps that protect against the risk Ambac's AAA rated insurance unit won't make good on its debt payments soared to an upfront price of 11 percentage points and 5 percent a year for 5 years, up from about 7 percentage points a year yesterday, according to London-based CMA Datavision. Contracts tied to Armonk, New York-based MBIA's insurance unit climbed 87 basis points to 805 basis points.

Concern that bond insurers may be in for larger losses than previously thought sent MBIA shares down $4.49, or 34 percent, to $8.79 yesterday. MBIA spokesman Jim McCarthy declined to comment. The stock rose $1.01 to $9.80 today.

Goldman's Fotheringham, who is based in New York, reduced his share price target for Ambac to $2 from $7 and said MBIA probably will trade at $8 in 12 months, down from an estimate of $12. Ambac will likely have total pretax losses of $11.8 billion, Fotheringham wrote in a note to clients today, and MBIA's losses will probably reach $12.6 billion.

Fotheringham also reduced his estimates for Ambac in 2008 to a loss of $18.05 a share, from a profit of 95 cents. He cut his prediction for MBIA to a loss of $21.75 a share from a loss of $1.81.

Without the money from the March sale, Ambac's capital levels would have been ``materially impaired,'' Haines said. He didn't say how much the company may need to raise.

We question its ability to access the capital markets anytime soon, without which an outright downgrade from Moody's and S&P may be unavoidable,'' Haines said.
How, pray tell, and at what cost?

Despite these rather uncomfortable facts, Callen asserts that the ratings are "solid'. Fitch doesn't think so and already downgraded Ambac to AA. Rating agency Egan Jones doesn't think so and has been a long-time critic of the bond guarantors. The credit default swaps market doesn't think so. Even New York State insurance superintendent Eric Dinallo has doubts. And Bill Ackman at Pershing Square certainly doesn't agree.

And the last time I recall a company saying its liquidity was fine was Bear, and at least at the time of its crunch, Bear's long-term prospects looked better than Ambacs' do (there is still ample debate as to whether Bear was insolvent or not: the answer in most cases depends on one's view of the credit default swaps market). Source

Tuesday, April 22, 2008

The Credit Crunch is Dead? Don't bet on it!

Basically what's happened is that we've moved bad paper from the banks, where it needed to get marked to market, at least at some point, to the Fed, where that doesn't have to happen. It's a sort of out of sight out of mind phenomenon. But all those CDOs and MBS and CLOs are made up of individual mortgages, and of hung LBO loans [that were supposed to be bridges but now have become piers]. They will either be paid off in the end, or they'll go into default. Assuming, as I think seems right, that some of them default, the Fed will have another line item on its balance sheet, REO. So as I see it, it's absurd to say the credit risk has "disappeared"; it's just been moved from the banks to the public.

We still have the monolines almost destined to come apart at some point, the fact (as John Dizard pointed out) bigger GSEs are systemically destabilizing due to their pro-cyclical hedging, the not trivial problem that the housing market won't bottom till 2010 at the earliest, with more writedowns resulting, and my pet worry, CDS. As I understand it (and better informed readers can chide me if I am wrong), the CDS market basically has to keep growing to stand still. Again, perhaps I am too old school, but with inadequate margining/equity provisions, it seems guaranteed to go into crisis. You don't get happy endings with ever mushrooming bets on underlying equity that fails to show corresponding growth.

Today, we had the biggest bank fund raising announced to date, RBS's hugely dilutive £12 billion equity sale (and that's in addition to £4 billion of asset sales). Reader Steve pointed us to a key item from the press release: the Scottish bank's write downs are markedly deeper than those taken by US banks to date, suggesting that the worst is not over on this side of the Atlantic. They have marked their US subprime at 38%, Alt-As at 50% of face, and CMBS at 83%.

Monday, April 21, 2008

Draaisma: “The Bear Market Rally is Over”

Is Morgan Stanley’s equity strategist just unimpressed with the Bank of England’s efforts at a rescue package?

The second half of the bear market rally turned out to be rather shortlived, and Teun Draaisma is calling the top...

So the bank’s valuation indicator is saying its time to take profits, while its market timing indicator suggests that the rally has come to an end.

Sentiment has recovered somewhat. And of course, the authorities have made their drastic plays to avert the “financial end of the world.” But that still leaves us facing a big earnings recession, adds Draaisma.

Stand by then for “directionless but volatile markets until/when earnings trough and no new bull market till earnings rise again, possibly starting in 1H09.”

BofA $7.9 Credit & Investment Bank Losses

Bank of America Corp. ... provisions for credit losses quintupled to $6 billion and investment banking write-downs cost at least another $1.91 billion.

The big increase in credit costs was driven by weakness in home equity loans and credit extended to small businesses and home builders ...

Net charge-offs for loans the bank doesn't think are collectable jumped to 1.25% from 0.81% of total average loans and leases, reflecting deterioration in the housing market and a slowing economy. Nonperforming assets surged to 0.90% from 0.29%.
"We remain concerned about the health of the consumer given the prolonged housing slump, subprime issues, employment levels and higher fuel and food prices," Chief Executive Kenneth D. Lewis said ...

Saturday, April 19, 2008

Citigroup Capital Dwindles

Citigroup Inc.'s investors, cheered by a $5.1 billion first-quarter loss that wasn't as big as they feared, now must watch out for asset sales, a dividend cut and an infusion of outside investment as the bank's capital dwindles.

Citigroup's so-called Tier 1 capital ratio -- a measure of its ability to withstand loan losses -- fell to 7.7 percent at the end of March, the New York-based bank said yesterday. Citigroup says it needs a 7.5 percent ratio to provide a margin of safety and preserve its credit ratings.

The bank's shares surged 4.5 percent yesterday after it reported $16 billion of asset writedowns during the quarter, less than some analysts expected. The writedowns burned through much of the $30 billion of capital Citigroup has raised since late last year, leaving it vulnerable to further charges and loan-loss provisions.

Citigroup raised capital in December and January by selling stakes to investment funds controlled by foreign governments including Abu Dhabi, Korea and Kuwait. The infusion helped boost Citigroup's Tier 1 ratio to 8.8 percent by Jan. 22 from 7.1 percent at the end of the year.

The first-quarter loss was second in size in the bank's 196- year history only to the record $9.88 billion reported in the previous period. It wiped out so much capital that Citigroup may have to find outside investors or cut the dividend, Hendler said.

Standard & Poor's said it is reviewing Citigroup's rating for a possible downgrade, noting that earnings may be further depressed by loss reserves on the bank's loan portfolio. [Moody’s put them on negative watch.] Fitch Ratings lowered the company's rating one level to AA- from AA, with a negative outlook. Fitch cited deteriorating earnings in the consumer business and investment bank losses.

The market was giddy Friday, as if the bottom was in. News flash: The bottom is not in. A wave of pay option arms failures, walk aways, commercial real estate writedowns, corporate bankruptcies, and credit card writeoffs is coming. Unemployment is going to soar and an "L" shaped recession is upon us.

Nonetheless, this bounce was not unexpected. Stocks do not move in a straight line. The markets fell for six straight months so it is not unreasonable to expect a 2-3 month counter trend rally. In terms of price, this rally may be nearly over. In terms of time, another few weeks or longer of choppy waters may be in the cards. Source

Friday, April 18, 2008

Citigroup 1Q08

Citi posted a first quarter loss of $5.11 bln, or $1.02 per share (Bloomberg, WSJ). But take, for example, the headline write-down number of $6 billion. Nice headline, but if you look through all the numbers and add them up the total write-downs are actually $15 billion. Source

* Writedown of $6 bln on subprime securities.
* Writedown of $1.5 bln on leveraged loans (the WSJ says $3.1 bln).
* Writedown of $1.5 bln on auction rate securities.
* Wrote down the value of bond insurance contracts by $1.5 bln.
* Reserves for future losses on consumer loans increased by $3 bln.
Citi's share price is rising on the assumption the worst is behind the company. But Citigroup has lost close to $15 billion in the last two quarters, and has suffered more than $46 billion in write-downs and increased credit costs since the middle of 2007. Book value per share, which measures assets minus liabilities, fell to $20.73 from $22.74 at year end. Return on equity was negative 18.6 percent in the quarter. Book value per share, which measures assets minus liabilities, fell to $20.73 from $22.74 at year end. Return on equity was negative 18.6 percent in the quarter. But Meredith Whitney puts tangible book value closer to $10/share at year end before these huge losses. When Bear Stearns collapsed on March 17 Citigroup hit a low of $17.99/share.

Thursday, April 17, 2008

The Madness of Ben Bernanke

The dollar is in a tailspin, the trade deficit is growing and a recession is on the horizon. The American way of life is in serious danger. But the head of the Federal Reserve keeps on pumping easy credit into the system -- a crazy policy that will worsen the crisis.

Contrary to forecasts by both the Federal Reserve and the Treasury, the trade deficit has continued to grow, by 6 percent in February alone. America imported $62 billion worth of goods more than they exported in February, including a disturbingly large number of cars, computers and pharmaceutical products. Try as they might, most private households in America can't keep up this consumer miracle. The savings behavior of many Americans means that many of them now live from hand to mouth.

But Bernanke is doing nothing to dampen this hunger for credit. The former advisor to President George W. Bush is even trying to whip up credit-financed consumption by lowering interest rates. This is helping to fuel inflation because the monetary growth isn't being matched by growth in real economic output. Inflation in the US currently stands at 4 percent.

It's a paradox. The private commercial banks which have just had to make billions of dollars in write downs have become more cautious. They're scared of further risks. The management resignations at Citigroup and Bear Stearns have had a sobering impact

Meanwhile the Federal Reserve is urging the banks to go on taking risks. It has been injecting cash into the banking system for the past half-year while urging bank CEOs in confidential chats to offer more credit. The aim is to keep on financing consumer spending and even to stimulate it further -- for reasons of patriotism.

There's a word for this policy -- madness.


* The company's Q1 loss was $2.19 per share.
* The value of its portfolio of CDOs was written down by $1.5 bln.
* The company wrote down the value of Alt-A securities by $3.5 bln.
* Leveraged loans were written down by $925 mln.
* The company took a $3 bln loss on hedges with monoline insurers.
* The comapny's net loss excluded a $3.1 bln decline in the value of securities held in the firm's US bank which it intends to hold to maturity.
* Moody's said it may cut Merrill's rating again.
* Merrill indicated it might be open to raising more capital.
* The company announced it would cut another 3000 employees.

Sunday, April 13, 2008

A Long & Deep Recession by Professor Stiglitz (Columbia)

-Subprime problem just beginning, 2mil more foreclosures to come
-30%+ House price drop as a national average
-Real Estate brokers and industry experts too optimistic
-Zero consumer savings rate
-Banks don't know what is on there balance sheets
-States and localities tax revenues are dropping
-Very little the Fed can do, Bernanke is struggling
-US Financial system badly damaged
-The current stimulus package is couterproductive

1929 Once More? Winston Churchill Quote

"The year 1929 reached almost the end... under the promise and appearance of increasing prosperity, particularly in the United States. But in October a sudden and violent tempest swept over Wall Street......... The whole wealth so swiftly gathered in the paper values of previous years vanished. The prosperity of millions of American homes had grown up a gigantic structure of inflated credit, now suddenly proved phantom. Apart from the nation-wide speculation in shares which even the most famous banks had encouraged by easy loans, a vast system of purchase by installment of houses, furniture, cars and numberless kinds of household conveniences and indulgences had grown up. All now fell together."

Fed is Defending the Market instead of the Dollar

Not only is the Fed not doing its job, he said, but it is doing the wrong job: It is defending the economy and the market, instead of defending the dollar. And just to stick the knife in, Mr. Volcker added that this bad job now will make the real job - defending the greenback - much harder later. It'll cause even greater economic suffering.

In plain words, Mr. Volcker implied that the current Fed is not only incompetent, but that its actions are dangerous.

Friday, April 11, 2008

BoE's interest rate cut toothless in face of mortgage crisis

The credit crunch is now at its most severe since December, when the three month London inter-bank offered rate - the banks' cost of funding - was about 120 basis points above base rate.
Traders said they expect Libor to set today at 5.92375pc, 90 points above base and down just 2.75 basis points on yesterday.
Yesterday, the Bank confirmed it cut rates because "credit conditions have tightened and the availability of credit appears to be worsening". It also warned that "the disruption in financial markets could lead to a slowdown in the economy".

Thursday, April 10, 2008

Not Over Yet by Paul Krugman (Princeton)

Gurk. The TED spread is up again. So is the LIBOR-OIS spread. (One is the spread between Libor and Treasuries, the other the spread between Libor and the futures price of the Fed funds rate; I tend to prefer TED spread, because fears of bank defaults should affect Fed funds as well as Libor; but I know that Fed officials prefer OIS. Anyway, both pointing in the same direction.) And the flight to safety is back, with the interest rate on one-month Treasuries — which should be about the same as Fed funds — back down to 1%.

All of this involves fear of defaults by banks — despite what look from here (central New Jersey) like utterly clear signals from the Fed that bank debts will be socialized if necessary. I’m puzzled, and worried.

Wednesday, April 9, 2008

What will the FED do next?

Fundamentally, the Fed would have two options: It could increase the size of its balance sheet by issuing cash, which would require sacrificing its target Federal Funds rate target and letting that rate drop to zero. This option is referred to in the trade as "quantitative easing", but that's just a fancy term for printing money and tolerating any inflation that results. Alternatively, the Fed could expand its balance sheet by borrowing from someone else — from the US Treasury, from banks with excess cash, or from the public directly. This would permit the Fed to increase the scale of its asset swaps without sacrificing its ability to conduct ordinary monetary policy.   Source

The Fed is now considering borrowing from the Treasury (US taxpayers). Were the Fed to have to do this to remain whole, i.e., have the Treasury underwrite the Fed's balance sheet, the US central bank would be de facto insolvent, having insufficient assets to carry out its mandate. The perceived invincibility of the Fed's ability to reflate is now clearly in question. The Fed's own discussions prove it.  Source

Goldman Sachs Level 3 Assets Jump, Exceeding Rivals

Goldman's share of Level 3 assets surged 39 percent to $96.4 billion at the end of February from $69.2 billion in November, according to a filing with the U.S. Securities and Exchange Commission today. The ratio of Level 3 to total assets rose to 8.1 percent from 6.2 percent.

While many subprime-related stakes that lost almost 100 percent of their value since July were categorized in Level 3, other holdings such as private-equity stakes, real estate and rarely traded corporate debt are also included because market prices for them aren't available. More assets have become difficult to value in the last three months as investors shunned a wider array of credit, reducing trading.

Goldman Chief Financial Officer David Viniar said last month the Level 3-to-assets ratio had risen to about 8 percent mostly because some assets classified as Level 2, including commercial real estate loans, dropped to Level 3. The biggest increase in the hard-to-value category was a 59 percent jump in derivative contracts, according to today's filing. Mortgage and other asset-backed loans and securities increased 56 percent in the quarter.

Under accounting rules, Level 1 assets are those for which market prices are readily available. Level 2 holdings are valued based on ``observable inputs,'' or prices of similar assets traded in the market. Assets fall into the Level 3 category when there are hardly any observable inputs, and the firm has to rely on in-house models to calculate potential gains or losses.

Morgan Stanley's & Lehman's Ratio

Morgan Stanley's Level 3 assets rose 6.1 percent to $78.2 billion last quarter, the firm said today in an SEC filing. Lehman, which also filed a report with the agency today, said its Level 3 holdings rose 1.3 percent to $42.5 billion. All three firms are based in New York.

Tuesday, April 8, 2008

The U.S. Recession

We are experiencing the worst US housing recession since the Great Depression and this housing recession is nowhere near bottoming out. Housing starts have fallen 50% but new home sales have fallen more than 60% thus creating a glut of new –and existing homes- that is pushing home prices sharply down, already 10% so far and another 10% in 2008. With home prices down 10% $2 trillion of home wealth is already wiped out and 6 million households have negative equity and may walk away from their homes; with home prices falling by year end 20% $4 trillion of housing wealth will be destroyed and 16 million households will be in negative wealth territory. And by 2010 the cumulative fall in home prices will be close to 30% with $6 trillion of home equity destroyed and 21 million households being underwater (40% of the 51 million having a mortgage). Potential credit losses from households walking away from their homes (“jingle mail”) could be $1 trillion or more, thus wiping out most of the capital of the US financial system.

The US is experiencing its most severe financial crisis since the Great Depression. This is not just a subprime meltdown. Losses are spreading to near prime and prime mortgages; they are spreading to commercial real estate mortgages. They will spread to unsecured consumer credit in a recession (credit cards, auto loans, student loans). The losses are now increasing in the leveraged loans that financed reckless and excessively debt-burdened LBOs; they are spreading to muni bonds as default rates among municipalities will rise in a housing-led recession; they are spreading to industrial and commercial loans. And they will soon spread to corporate bonds – and thus to the CDS market – as default rates – close to 0% in 2006-2007 will spike above 10% during a recession. I estimate that financial losses outside residential mortgages (and related RMBS and CDOs) will be at least $700 billion (an estimate close to a similar one presented by Goldman Sachs). Thus, total financial losses – including possibly a $1 trillion in mortgages and related securitized products - could be as high as $1.7 trillion.

Rosner on the Prospects for the Credit Market

We have been talking about this for six months, but there seems to be a refusal on the part of many observers to accept that the losses reported to date have been primary trading book write downs vs. actual charge offs of loan losses. Citigroup (NYSE:C), for example, did just 120bp in aggregate charge offs in 2007.

There is a lack of appreciation or maybe a lack of understanding between these two issues, mark to market losses and actual credit losses, and we need to distinguish between these two issues. I continue to believe that we are going to see further downward pressure on home prices -- regardless of what the Congress believes or intends or manipulates. Unless we actually nationalize the housing industry, there is not much we can do to avoid the downward correction in home values.

Case for L Shaped Recession

Credit hedge funds are now the weakest link in the chain, Morris says. Their equity stands at some $750 billion and is so massively leveraged that "most funds could not survive even a 1 percent to 2 percent payoff demand on their default swap guarantees," he writes.

Morris sketches a scenario in which hedge fund counterparty defaults would ripple through default swap markets, triggering writedowns of insured portfolios, demands for collateral, and a rush to grab cash from defaulting guarantors. The credit system would suffer "an utter thrombosis," he says, making the subprime crisis "look like a walk in the park."

What he fears is that the U.S. will instead follow the Japanese precedent, seeking to "downplay and to conceal. Continuing on that course will be a path to disaster."

What's not debatable is what will happen if $1 trillion is written off. And that is the other "D" word: "deflation". A $1 trillion debt writeoff can hardly mean anything else. Furthermore, a $1 trillion writeoff will affect a whopping $10 trillion in future lending.

If the Fed and Congress drag this out, which at this point seems likely, we will see a severe "L" or "WW" shaped recession playing out over several (or more) years.

Monday, April 7, 2008

Central Banks Are Dangerous

As Herb Stein told us, what cannot go on forever won't. "When the music stops, in terms of liquidity, things will be complicated." Remember that? The music may have stopped already for Citibank, but it's still playing for the USA. The record is just beginning to skip.

Wednesday, April 2, 2008

The Trillion Dollar Meltdown

Either way we are only at the beginning of a process of realizing, acknowledging, writing down and accounting for the full variety of financial and real losses that the worst financial crisis since the Great Depression and the most serious recession in decades will entail. So the recent partial recovery of equity markets after the Bear Stearns is delusional; conditions in credit markets and money markets remain extremely strained and the onslaught of weak macro and financial news has not reached its peak yet. So the worst for the real economy and financial markets is ahead of us, not behind us.

Tuesday, April 1, 2008

Lehman raises $4 bln of capital to hush critics

Lehman Brothers Holdings Inc (LEH.N: Quote, Profile, Research) raised $4 billion of capital on Tuesday by selling convertible preferred stock in a deal designed to stop questions about the Wall Street investment bank's stability.

Shares of Lehman rose over 16 percent, as the offering met with strong demand, after rumors of looming write-downs left some investors worried that Lehman could face a drain on its cash resources similar to the run on the bank that triggered the collapse of Bear Stearns Cos Inc.

Investors are jittery about investment banks, and particularly Lehman, after Bear's demise and more than $200 billion of write-downs industrywide tied to subprime mortgages and other debt.

Some investors question whether Lehman has written down enough of its $73.4 billion of mortgage and real estate assets, but Lehman has said its valuation measures are fair.

Lehman has also said it suspects short sellers have spread false rumors about the company to profit from share declines. The company said last month that it has nearly $100 billion of assets at its holding company that could be easily sold or borrowed against.