Tuesday, 30 October 2007

Repeat after me: This Is Not A One Quarter Event

Despite record write-downs from large banks and brokerage firms in the third quarter the market cheerily expects earnings to rise by about 10% in the fourth quarter. That figure assumes that business for the banking and brokerage industry will be largely back to normal. However if you care to look there is enough evidence to seriously doubt such assumptions.

Just as a couple of examples, today UBS warned that more write-downs may be on the way due to their exposure to the U.S. housing and mortgage markets. Also there are rumors that Merrill Lynch is not done with it's writedowns and will need to take more in 4Q07. This is even more likely now that a new CEO will be coming in and will probably be bringing a large broom to sweep away the mess created by the previous inhabitant.

Then there is the much mooted 'Super SIV' bailout plan being sold by Wall Street's own government employed shill Hank Paulson which is little more than a desperate attempt to keep more forced writedowns of dubious quality assets off bank balance sheets.

Gretchen Morgenson of the New York Times summed things up well yesterday:

Guesstimates Won’t Cut It Anymore

The props holding up the values of risky mortgage securities finally started to give way last week. And that means the $30 billion in losses and write-downs taken by big brokerage firms in the third quarter are not likely to be the last....

The executives on Merrill’s dismal conference call conceded that even after they decided to value their C.D.O. holdings more conservatively — resulting in losses — much of their methodology was based on “quantitative evaluation.” (For the rest of us, that means that Merrill was in the unfortunate position of still having to guesstimate its exposure to losses.)

ANALYSTS quickly responded by forecasting an additional $4 billion in write-downs on Merrill’s portfolio. Marking positions to model — a favorite reality dodge on Wall Street — just doesn’t cut it anymore....

...Merrill’s decision to write down its holdings as it did gives a clear signal to other banks and brokerage firms that valuing similar assets at lofty levels is no longer acceptable or credible....

“We’ll definitely see a lot more write-downs,” said Josh Rosner, an expert on asset-backed securities at Graham-Fisher, an independent research firm in New York. “I think that the exposures that we are seeing and the announcement out of Merrill are the leading edge, not the end.”

Also today from Bloomberg:

Fitch May Cut Credit Ratings on $36.8 Billion of CDOs

Fitch Ratings said it may cut rankings on $36.8 billion of collateralized debt obligations linked to residential mortgage securities.

The company placed $32.6 billion of debt on review for a possible downgrade, according to a statement today. The remaining $4.2 billion had already been under review. Almost $24 billion of the debt had AAA ratings, New York-based Fitch said.

Fitch, a unit of Paris-based Fimalac, follows Moody's Investors Service, which last week cut ratings of CDOs linked to $33 billion of subprime mortgage securities. Lower ratings may force owners to either mark down the value of their holdings, or sell the securities. Moody's, Fitch and Standard & Poor's in July began lowering ratings on hundreds of mortgage-linked securities after their value tumbled as much as 80 cents on the dollar.

"The market at this point no longer believes the rating agencies when it comes to mortgage-related products," said David Castillo, who trades CDOs in San Francisco at Further Lane Securities. "It's merely forcing the hand of investors who are ratings-driven from an investment-criteria perspective."

How are the ABX indices doing? As of yesterday 17 of the 20 ABX indices fell to all time lows.

There will inevitably more writedowns to come in 4Q07 which is going to put significant pressure on double digit earnings growth expectations.