Sub-prime hangover lingers over US banks

Sub-prime hangover lingers over US banks


Earnings results show woes may extend beyond Q2


(NEW YORK) Financial firms that had hoped to swallow their sub-prime mortgage pain and move on are finding the hangover is lasting longer than expected.


Bonds of banks and insurers that have been crushed as their sub-prime losses surged still may not be cheap enough to buy.


The conventional wisdom last year was that companies such as Citigroup and Merrill Lynch & Co , under new leadership, would use the last quarter of 2007 as a so-called ‘kitchen sink’ quarter, to report their worst write-downs and losses, and move on.


That didn’t happen.


Earnings results from banks, bond insurer MBIA Inc and American International Group Inc show the situation is worsening and may stretch beyond the second quarter or longer. As a result, investors are mostly avoiding their bonds and stocks for now.


‘To say we hit some speed bumps and now we’re ready to race again, is not the case,’ said David Hendler, an analyst at research firm CreditSights. ‘This is a prolonged problem and this is not going to get better next quarter and maybe even next year.’


Financial shares have dropped almost 11 per cent this year, the worst performing sector year-to- date, versus a 3.7 per cent decline in the Standard & Poor’s 500 Index. Bank and brokerage debt has lost 3 per cent year-to-date, versus a 0.3 per cent gain for overall high-grade corporate debt, according to Merrill Lynch data.


Finance firms continue to underestimate exposure to mortgage losses, missing their earnings targets as a result. At the same time, major revenue streams are drying up, such as those from building specialised bonds like collateralised debt obligations, or CDOs.


Fears of systemic meltdown of the financial system have eased after a slew of Federal Reserve actions to put more money into the banking system. Yet the aftershocks reverberating with each earnings season suggest the financial crisis that gripped global markets since last year may be entering a new phase – one that now reflects declines in US consumer debt markets.


Bond insurer MBIA recently posted a US$2.4 billion loss and AIG, the largest US insurer, reported a record quarterly loss due to exposure to derivatives, or investments which ‘derive’ their values from other underlying securities.


‘The financials are going to be under pressure, and it’s all coming from derivatives, ‘ said John Tierney, a credit analyst at Deutsche Bank AG in New York. ‘Prime residential mortgages and consumer debt portfolios may be the next shoe to drop.’


The deterioration seen in sub-prime mortgage debt is spreading to auto loans, credit cards and home equity lines of credit, all of which were bundled into bonds and other derivatives held by banks.


That will make it more difficult for financial companies such as Bank of America Corp to match earnings expectations.


Bank of America last month posted a 77 per cent decline in quarterly profit, and said the housing market will remain weak all year as problems shift to areas such as credit cards.


The fallout from mispriced mortgage assets is lasting longer than expected as both banks and rating agencies miscalculated the values of bonds underwritten by the shaky mortgage securities.


The new cracks in consumer debt follow years of sub-prime bond sales and then severe losses that devastated Wall Street, leading to at least US$400 billion in losses so far.


‘Housing declines combined with increases in energy prices may force consumers to appreciably slow spending,’ said Mirko Mikelic, a portfolio manager at Fifth Third Asset Management in Grand Rapids, Michigan. ‘Then you will see more write-downs as tightening standards are already having people stop using home equity lines and tap into credit cards.’


Indeed, Moody’s Investors Service last Tuesday said it underestimated losses for residential mortgage debt. Moody’s said bond insurers, including MBIA and Ambac Financial Group Inc, have ‘significant exposure’ to deteriorating second-lien mortgages.


That means the bond insurers’ top-tier ratings may be at risk, and further earnings hits may come.


To be sure, Fitch Ratings estimates that global banks already accounted for 80 per cent or more of their losses. Fitch said total market losses from sub-prime mortgage debt have climbed to US$400 billion, and some estimates may be as high as US$550 billion. — Reuters


Source: Business Times

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