Tuesday, February 19, 2008

And more writedowns on the way

(Naked Capitalism) Ah, another quarter, another set of writedowns by financial firms, or so it goes these days.

There have been various sightings of new source of acute pain: leveraged loans, commercial real estate, auction rate securities. So far, analysts have been mainly talking about each problem separately, but as earnings season approaches, they are now considering them in aggregate, While the estimates vary considerably, the trajectory is not encouraging. There has even been talk that Goldman, so far seemingly immune to the credit crisis, may finally take a few lumps.

Note there are some quotes in the article that claim that commercial real estate loans aren't as bad as residential. While we will know sooner rather than later, the analysts at Fitch would probably beg to differ. Fitch started warning that commercial real estate lending was as lax as subprime in April of last year.

From the New York Times:

Wall Street banks are bracing for another wave of multibillion-dollar losses as the crisis that began with subprime mortgages spreads through the credit markets....

The losses keep piling up. Leading brokerage firms are likely to write down the value of $200 billion of loans they have made to corporate clients by $10 billion to $14 billion during the first quarter of this year, Meredith Whitney, an analyst at Oppenheimer, wrote in a research report last week.

Those institutions and global banks could suffer an additional $20 billion in losses this year on commercial mortgage-backed securities and other debt instruments tied to commercial mortgages, according to Goldman Sachs, which predicts commercial property prices will decline by as much as 26 percent.

Analysts at UBS go further, predicting the world’s largest banks could ultimately take $123 billion to $203 billion of additional write-downs on subprime-related securities, structured investment vehicles, leveraged loans and commercial mortgage lending. The higher estimate assumes that the troubled bond insurance companies fail, a possibility that, for now, is relatively remote....

One of the latest areas to come under pressure is the leveraged loan market. In recent weeks the market for these corporate loans plummeted, driven by fear that banks have too many loans to manage. Prices have fallen as low as 88 cents on the dollar, levels not seen since 2002, when default rates were more than 8 percent. Loans to some companies, like Univision Communications and Claire’s Stores, are trading in the high 70s, analysts say.

“Price declines of this magnitude — over 10 points — were not supposed to happen in the leveraged loan market,” Bank of America credit analysts wrote in a report on Feb. 11.....

Many analysts say the financial health of many companies has not deteriorated as much as loan prices suggest.

“People don’t know what’s out there, they haven’t sorted out what’s good and what’s bad, so they are throwing all credit assets out,” said Meredith Coffey, director of analysis at the Reuters Loan Pricing Corporation. Median loan prices were lower than those in 2002 when defaults peaked, even though very few defaults have actually occurred.

There has also been a marked deterioration in the market for commercial mortgage-backed securities, which are commercial mortgages packaged into bonds.

To some, the troubles plaguing commercial mortgage securities seem a logical extension of the turmoil in the residential real estate market. But some strategists argue that the commercial real estate market is not as vulnerable as the housing market. The pressure to package loans that was so evident in the residential market never materialized in the commercial market, these analysts say.

Also, commercial loans tend to be made at fixed, rather than adjustable, rates, and are not usually refinanced for long periods of time.

Nevertheless, the cost of insuring a basket of commercial mortgage-backed securities has soared. Last October, for example, it cost $39,000 to insure a $10 million basket of top rated 2007 commercial mortgages (super senior AAA, in Wall Street language) against default.

Today that price has increased to $214,000. For triple-B-rated commercial mortgage backed securities, those which are riskier, the cost of protection during the same time has soared from $672,000 to $1.5 million.

The deterioration of the CMBX, the benchmark index that tracks the cost of such credit protection, “started off as a fundamental repricing and then it escalated into something much more than that,” said Neil Barve, a research analyst at Lehman Brothers. “We think there is some downside in a challenging macroeconomic environment, but not nearly what has been priced in.”

Goldman Sachs seems to disagree, with analysts predicting commercial real estate loan losses to total $180 billion, with banks and brokers bearing $80 billion of that in total and about $20 billion this year.

Current index figures suggest that the banks will face significant pain. Brad Hintz, an analyst at Sanford C. Bernstein & Company, calculated that Lehman Brothers has the highest exposure to commercial real estate-backed securities, with $39.5 billion, followed by Morgan Stanley, with $31.5 billion. (These numbers do not include hedges that the banks may have but do not disclose).

To be sure, a crisis on Wall Street also spells opportunities for patient bargain hunters. After all, markets that were trading at all-time highs have been reduced to rubble, suggesting that those willing to search for value will find it.

And last week, some hedge funds began to wade into the troubled loan market. But prices do not yet reflect any widespread rallies, and Wall Street still has to absorb losses reflected in these markets.

“The fourth quarter was terrible, but you had strong investment banking revenues,” Mr. Hintz said. “Now you’ve had a bad December, a worse January and an even worse February.”

From the WSJ: Now, Lehman Gets Pelted

... credit markets have worsened, and Lehman believes it is now facing a write-down in the $1.3 billion range, according to people familiar with the matter.
...
Nearly $39 billion [of debt securities and loans that are potentially vulnerable to markdowns] are commercial real-estate loans. Even as it cut way back on making home loans, Lehman continued to lend to buyers of office buildings and other assets. In the fourth quarter of fiscal 2007, ended Nov. 30, Lehman originated $15 billion of commercial mortgages, in line with the average origination in the previous three quarters.

Yet, the firm only sold off $1.5 billion of those loans, compared with more than $10 billion in the third quarter. As a result, its commercial-mortgage holdings have swelled. Now, analysts wonder how much they will have to be marked down.

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