Monday, 31 December 2007

Santa Takes a Holiday in December

Last month I threw caution to the wind and speculated that the All Ords would finish down in the month of December and low and behold it did falling -2.6%. Santa failed to show in November or December and I believe he'll stay home in January. In fact over the last 24 years (yes that's right I discovered more data on Yahoo Finance, I'm a bit slow you see) the month of December has only produced negative returns on 6 occasions as shown below.

So what will January bring? Probably the first economic data point of note will be the US nonfarm payroll report next Friday. With the steady rise in initial unemployment claims in recent weeks the number could come in to the low side. If that happens, no doubt the stockmarket will go into schizophrenic mode between 'this is bad news because it might mean recession' and 'this is good news because it means the Fed will have to continue to cut the Fed funds rate'.

Also in the US, 4th quarter earnings season will get underway in earnest. Earnigns are forecast to come in negative. Expect some more large writedowns from Merrill Lynch and Citibank and no doubt some more equity injections. Also the ratings agencies may be forced to end the charade surrounding the AAA ratings of the large bond insurers like Ambac and MBIA. That event could have some serious repercussions.

However at the end of month the Fed may ride to the rescue and save the day. Although their last rescue attempt didn't fare too well. Stockmarkets usually have a decent correction before recessions get underway and thus if the US is moving into recession we could see some rather large moves downward. That said stockmarket corrections are characterized by a series of sharp upward movements that fail to move the market higher over the medium term (sucker rallies).

So as always the choice is not an easy one but being the glass is half empty kind of guy I am when it comes to the current economic environment I'm betting the All Ords will continue to slide in January. incidentally the last time the All Ords fell for 3 consecutive months was Dec 2002 - Feb 2003.

Saturday, 29 December 2007

DeKaser Calls Bottom For US Home Sales in 4Q07

Richard DeKaser, chief economist at National City Corp., believes that US Home Sales will bottom in the current quarter. Let's be clear here, he is talking about sales, he sees construction activity picking up 3 - 6 months after that.

(click image to play interview)

DeKaser is not some kind of permabull in denial, he makes a coherent argument as to why he thinks sales have bottomed in 4Q07. The basis of his argument is that previous housing downturns which were more severe from peak to trough such as the one from 1978 - 1982 were driven by an economic environment with double digit unemployment and double digit interest rates.

This time round Dekaser notes it is due to developments in the mortgage market rather than economic conditions. More specifically he means the development of exotic mortgage products such as subprime and Alt-A loans. Once this part of the origination industry is gone,which DeKaser argues it largely is, that should be it.

Whilst I disagree a bottom in sales will happen this quarter it is a compelling argument and sounds much better when DeKaser makes it so I urge you to watch the interview by clicking in the image above rather than read my waffle.

US New Home Sales Plunge in November

Inspired by the great work of Calculated Risk I've tried to come up with some pretty graphs of my own for Housing related posts. Sales of New Homes in the US plunged in November falling -9% from the previous month. Also as expected downward revisions were made to August, September and October.

(click on any of the charts below for a sharper image)

From the US Census Bureau:

Sales of new one-family houses in November 2007 were at a seasonally adjusted annual rate of 647,000... This is 9.0 percent below the revised October rate of 711,000 and is 34.4 percent below the November 2006 estimate of 987,000.

The SAAR for November Sales has not been this low since 1994 (646k) and subsequent revisions could send it considerably lower.

The seasonally adjusted estimate of new houses for sale at the end of November was 505,000.

As Calculated risk has pointed out numerous times in the past Inventory numbers do not include cancellations - and cancellations are at record levels meaning inventories are probably significantly higher than reported. Calculated Risk's estimate is about 100K higher.

This represents a supply of 9.3 months at the current sales rate.

Whilst the number of new homes for sale has declined, the months of supply ticked up as the sales rate continues to fall. How about those revisions? November Revisions were as follows:
  • August 717k - 701k -2.2%
  • September 716k - 699k -2.3%
  • October 728k - 711k -2.4%
Now remember the original estimate for August's was for a seasonally adjusted annual rate of 795k which means subsequent revisions have sent that estimate -11.8% lower. September's estimate was originally 770k, so that estimate has been revised a further -9.2%. Thus New Home Sales have been consistently overestimated in the downward leg of this cycle.

The chart below tracks New Home Sales and Recessions over the past 40 years. As you can see a significant housing downturn is not a pre-requisite for a recession (1969-70 and 2001) , however every time there has been a significant housing downturn a recession soon follows.

Whilst this single data point is not conclusive evidence of an impending recession, the magnitude of this housing downturn (the biggest in US history) makes the argument all the more compelling.

Friday, 28 December 2007

UK House Prices Fall for 2nd Consecutive Month

UK House prices fell -0.5% in December after a -0.8% decline in November. The first time house prices have fallen for 2 consecutive months since August 2000. From Nationwide:

House prices fall by 0.5% in December

* House prices fell by 0.5% in November, the second consecutive monthly decline
* The average price of a UK property is £8,334 higher than a year ago
* Rate cuts will help but are unlikely to reignite the housing market as in 2005

Commenting on the figures Fionnuala Earley, Nationwide's Chief Economist, said:

UK house prices fell by a seasonally adjusted 0.5% in December, recording their second consecutive month-on-month fall. The annual rate of house price inflation fell to 4.8%, compared to 6.9% in November and10.5% in December 2006.

The average price of a UK property rose by £8,334 over the last 12 months, leaving it at £182,080 at the end of 2007. The three-month on three-month rate of growth – a smoother indicator of house price trends – fell from 1.4% in November to 0.9% in December, the lowest since November 2005.

ABCP market continues to slide

Asset backed Commercial Paper outstanding declined $15.9 billion in the week to December 26th. As you can see from the chart above ABCP outstanding has declined to it's lowest point in a little over 2 years, which is all the data the Fed provides on it's website.

From it's high in August the ABCP market has shed -37.4%. So what? I hear you say, you report this every week. Well, just in case you've forgotten here is a good article from the Financial Times written over a month ago that reminds us why the decline in ABCP is important, from the FT:

Banks bear the strain of short-term debt market troubles

There is a big reason why the asset-backed commercial paper market has garnered so much interest in recent weeks.

It is not simply because the volume of this short-term debt in issue has shrunk so dramatically, nor is it because millions of ordinary savers have put their trust in supposedly safe money market funds, which turned out to have large exposure to this riskier paper.

The real importance of this market is that since the end of 2004, it has been the ultimate source of the flood of cheap money that has gushed through global debt markets and helped to drive growth in asset prices and the economy.

It has been a major contributing factor to the volume of new lending business that banks around the world have been able to generate over the past three years.

But now that it has so spectacularly gone into reverse it is causing significant balance sheet discomfort to many of those same banks, because it amounts to a sudden and totally unexpected growth in lending.

Along with subprime mortgage-related write-offs and the backlog loans to private equity buy-outs, it is also helping to cause significant capital constraints, which limit the amount of planned new lending that banks can make to help keep western economies growing.

According to Kit Juckes, head of debt markets research at Royal Bank of Scotland, the impact of this is already visible in evidence such as the recent European Central Bank loan officers survey, where the general feedback was an intention to tighten lending conditions across the board.

The reason is that banks provide lending facilities to their conduits and offbalance sheet entities such as structured investment vehicles, both of which use cheap, short-term funding to finance investments in longer-term higher yielding securities or lending activities. These facilities can be called on at very short notice to fund SIVs and conduits when investors no longer want ABCP.

The ABCP market has shrunk by more than $330bn, or about 30 per cent, since its peak of about $1,190bn in July, according to the Federal Reserve and, to a great degree, banks have had to step into the breach.

"Banks have replaced ABCP and seen committed lending facilities drawn down," Mr Juckes says. "The result is astonishingly strong lending growth for the banks - lending that was unplanned."

The easiest place to see the real effects of the impact on banks is in the US, where quarterly reporting and the demands to file detailed financial statements with the Securities and Exchange Commission brings a level of transparency that European and UK banks are able to avoid.

Citigroup, for example, saw a third quarter increase in funding commitments for its conduits and SIVs of $16bn to $72bn, though it will not disclose how much of this is actually drawn.

Such an amount may be tiny compared with the total size of the bank's balance sheet, which is almost $2,300bn, but is far more significant in the context of Citi's net new lending to consumers worldwide from its balance sheet over the same quarter, which was about $20bn.

JPMorgan Chase, another big US player in the world of conduits, saw the amounts drawn on its liquidity facilities jump $12bn to $65bn in the same period.

Bank of America saw its exposure to off-balance sheet vehicles jump from $47bn to $71bn during the first nine months of the year.

However, BoA also provides an example of another route by which banks have been forced to tackle the ABCP problem, having pledged $600m to support money market funds it controls. The funds face potential losses due to their investments in ABCP. ...

The resulting strain on banks' balance sheets has also contributed to elevated money market rates. Yesterday, the two-month and three-month dollar London interbank offered rate set above 4.90 per cent, the highest level since late October.

The implications for financial companies is clear, stretched balance sheets, tighter lending standards and a higher cost of funding mean lower margins and reduced profits. Expect earnings revisions to continue well into 2008.

Thursday, 27 December 2007

US Intial Jobless Claims

Initial Jobless Claims are one of the more timely indicators of the health of the labor market and are attracting more attention as they have moved to more elevated levels in recent weeks. From the US Department of Labor:



In the week ending Dec. 22, the advance figure for seasonally adjusted initial claims was 349,000, an increase of 1,000 from the previous week's revised figure of 348,000. The 4-week moving average was 342,500, a decrease of 1,000 from the previous week's revised average of 343,500.

The advance seasonally adjusted insured unemployment rate was 2.0 percent for the week ending Dec. 15, unchanged from the prior week's unrevised rate of 2.0 percent.

The advance number for seasonally adjusted insured unemployment during the week ending Dec. 15 was 2,713,000, an increase of 75,000 from the preceding week's revised level of 2,638,000. The 4-week moving average was 2,644,500, an increase of 13,500 from the preceding week's revised average of 2,631,000.

The the 4 week moving average dropped by 1,000 however that was because the 353,000 initial claims number for the week to November 24th fell out of the calculations. As noted previously claims are far from recessionary levels however it is only a matter of time before they start to set off alarm bells.

Wednesday, 26 December 2007

Case-Shiller Home Price Declines Accelerate

Noone expected House Prices to be good in October, however they may not have expected them to be quite as bad as the latest Case-Shiller Home Price Index reading suggests. From Standard & Poors:

Data through October 2007, released today by Standard & Poor’s for its S&P/Case-Shiller® Home Price Indices, the leading measure of U.S. home prices, show broadbased declines in the prices of existing single family homes across the United States, marking the 10th consecutive month of negative annual returns and the 23rd consecutive month of decelerating returns.

The chart above depicts the annual returns of the 10-City Composite and the 20-City Composite Indices. The 10-City Composite’s annual decline of 6.7% is a record low. The previous largest decline on record was 6.3% recorded in April 1991. In October, the 20-City Composite recorded an annual decline of 6.1%.

“No matter how you look at these data, it is obvious that the current state of the single-family housing market remains grim,” says Robert J. Shiller, Chief Economist at MacroMarkets LLC. “Not only did the 10-City Composite post a record low in its annual growth rate, but 11 of the 20 metro areas did the same.

If you look at the monthly figures, every MSA went down in both October and September. Eleven of the 20 MSAs, in addition to the two composites, recorded their single largest monthly decline on record in October. For both the 10-City and 20-City composites this was a decline of 1.4% over September”

The decline in the 10 city composite index is the worst ever recorded. November represents the second month on month decline for every single city in the index. Year over year price declines bottomed out at -6.3% in1991. I suspect they are not near a bottom in year over year declines just yet as the biggest housing bubble in history continues to unwind.

How good were US holiday retail sales?

So after all the fanfare surrounding last week's supposedly strong November Retail sales and consumer spending numbers, how good were US holiday retail sales really? .From

MasterCard says holiday retail spending up 3.6% vs year ago

Holiday retail spending rose 3.6% from a year earlier, led by luxury goods and electronic-commerce purchases, MasterCard Advisors LLC said on Wednesday...

...Sales "came in just above the lower end of the range we were expecting, maintaining the slower, modest growth we've been seeing throughout the year," said Michael McNamara, vice president of research and analysis for MasterCard Advisors, in a statement. Apparel lagged and electronics sales rose "a very moderate 2.7%," the firm said. Gasoline prices were 30% to 35% higher than they were a year earlier, while the e-commerce segment may have been boosted by inclement weather, the firm said.

At the lower end of expectations but 3.6% doesn't sound too bad. Or is it? Barry Ritholtz of the BIG PICTURE is saying that Real Holiday Spending Was Negative in 2007:

Excluding just the gas purchases, holiday sales rose a lackluster 2.4%. If we back out restaurants (and their price increases), then I ballpark sales at approximately 2% -- or a bit below the core rate of inflation. In other words, Real Sales may have reflected an actual loss over last year. This was despite the longer holiday shopping season.

Now the chatter has turned to how much shoppers will spend in the final week of the year as they cash in their gift cards and take advantage of huge post Christmas discounts. The final week of the year typically accounts for around 15 - 18% of total holiday sales.

At best you could say sales results look mixed with the likes of Costco and Best Buy doing well whilst the 2nd largest US retailer Target, has warned that they may post negative same store sales growth. At worst you would say they are lacklustre and a warning of things to come.

As noted before the US consumer is a resilient beast but the headwinds of falling home prices and higher fuel prices are starting to take a toll. This is showing up more recently in surging credit card delinquencies as consumers turn to plastic now that the home equity ATM has been shut off.

Consumer confidence has fallen to levels usually seen just before recessions and employment looks vulnerable. Next Friday's ever unreliable and subject to huge revisions payroll report will be watched anxiously as the goldilocks soft landing scenario is contingent on the continuation of a robust employment market that will continue to fuel consumer spending.

Tuesday, 25 December 2007

Merrills Turn For Cash Injection

In what is fast becoming a trend for Wall Street firms, Merrill Lynch went hat in hand to Asia to get some sorely needed cash. From

Merrill raising up to $6.2 billion via equity placement

Merrill Lynch & Co. will raise up to $6.2 billion to be invested by Singapore-based investment firm Temasek Holdings Pte. Ltd. and U.S.-based Davis Selected Advisers L.P., the investment bank said Monday.

Along with the private placement of common stock, Merrill (MER) said it's selling its middle-market commercial finance business for an undisclosed amount.

Temasek will invest $4.4 billion in Merrill common stock, with the option to buy an additional $600 million in stock by March 2008. Its ownership position in Merrill won't exceed 10%, Merrill said.

Davis, meanwhile, will make a "long-term investment" of $1.2 billion, Merrill said. Neither Temasek nor Davis will have any "role in the governance" of Merrill, the firm

Meanwhile, Fitch Ratings maintained a negative outlook on Merrill following news of the investment, saying in a statement that it believes "there is a high probability that additional losses will be recognized in fourth-quarter 2007 fiscal year which collectively may result in [the firm] posting a loss for its 2007 fiscal year."

Fitch had lowered Merrill's long-term issuer default rating in October. Following an initial rise early in Monday's abbreviated trading session, Merrill shares closed nearly 3% lower, ending at $53.90.

Also Monday, Merrill said it is selling Merrill Lynch Capital, the firm's middle-market commercial finance business, to GE Capital (GE). Financial terms were not disclosed.

MER is widely tipped to record a similar writedown to the -$8.4 billion taken in the third quarter which led to a -$2.2 billion loss. The sale of Merrill Lynch Capital is estimated to free up $1.3 billion in capital. Will that be enough to offset the potential losses for the 4Q07? You would have to think it comes close so or else Temasek's shareholding could wind up being more than 10%. The only way to avoid that is to raise more capital or do more asset sales.

Preventing Temasek from owning more than 10% is probably also the reason why they must wait until the end of March to exercise their right to purchase another $600 million worth of MER common stock.

At the end of the day this move raises much needed equity capital for MER, however it is heavily dilutionary for current shareholders. Current estimates for MER earnings per share for 2008 stand at $7.13. That's only 6% lower than their record earnings of 2006. Analysts are still behind the eight ball with their earnings forecasts for Wall Street firms, expect significant revisions to MER's 2008 earnings going forward.

Monday, 24 December 2007

UK Real Estate prices slide

Watching your home lose value is not just a US phenomenon. UK homeowners have seen the price of their homes fall for the last 3 months in a row. Whilst prices on a year over year basis are still up, it seems that trend is set to change in the next 6 - 12months. From Bloomberg:

U.K. House Prices Fall the Most in Three Years

U.K. house prices fell the most in three years in December, and the threat of more declines may cause the property market to seize up in 2008, Hometrack Ltd. said.

The average cost of a home in England and Wales slipped for a third month, dropping 0.3 percent to 175,200 pounds ($348,350), the London-based research group said today. The number of property transactions will fall 17 percent and prices will rise just 1 percent next year, Hometrack forecast.

Bank of England policy makers said this month that a drop in house prices seemed ``more pronounced'' than expected as they cut their benchmark interest rate for the first time in two years. Record debt, higher mortgage costs and the property market's worst performance since 1995 have discouraged homebuyers.

Prices increased 3 percent from a year earlier, the least in 18 months, Hometrack said. The average selling time for a home rose to 8.3 weeks, the most since the survey of real-estate agents and surveyors began in 2001...

...Mortgage lender HBOS Plc said Dec. 5 that home values fell for a third month in November, the worst streak in 12 years. Estate agents and surveyors became the most pessimistic about house prices since at least 1998 last month, the Royal Institution of Chartered Surveyors said Dec. 13.

Sunday, 23 December 2007

Ding Dong the SIV is dead

Kudos to naked capitalism, who from the get go said the super SIV idea would most probably fail. So it's only fitting to give them the last word on the death of the Super SIV:

SIV Rescue Plan: RIP

The SV rescue plan touted by the Treasury Department and sponsored by Citigroup, JP Morgan, and Bank of America, has finally, officially, had a stake put through its heart today. It dies unmourned and unloved.

It wasn't hard to see that this concept was unlikely to get off the drawing board. But with the Treasury's prestige at stake, Paulson (and even Bernanke) flogging the idea and garnering front page coverage, the plan kept moving ahead, zombie-like, based on momentum rather than merit, demand, or utlility.

The sponsors nevertheless put a brave face on this move, saying the banks would "reactivate" the program if conditions warranted. I guess that's Wall Street for "peace with honor."

While the Vietnam comparison may seem strained consider: the US government, in this case a Treasury secretary, was unable to win the hearts and minds of a reluctant population, in this case both the supposed beneficiaries, the SIV sponsors, and the investors who would ultimately bear the risks. We witnessed the astonishing precedent of a Treasury secretary lobbying top bankers at a G7 meeting to promote what had consistently been depicted as a private sector initiative. There was also more that a bit of boosterism in lieu of reporting in evidence on this story at the Wall Street Journal.

A fitting epitaph comes via Bloomberg:

"The market is in surgery and they can't even get the Band- Aids to work,'' said Thomas Flaherty, who manages $25 billion in corporate debt at Aberdeen Asset Management in Philadelphia.

But in the denouement, BlackRock, engaged to act as manager of the program, doth protest too much, complaining that this exercise kept them from taking on other, presumably better-paying, assignments. Yet, but here the firm got tons of profile without having to put its reputation at risk by delivering an outcome. Sounds like awfully good PR to me. And the three sponsors, who incurred real expenses (a hundred lawyers were reported to be working on the deal) aren't whining.

Click on the link above for the entire post.

Saturday, 22 December 2007

DJIA and US GDP Forecasts for 2008

Yesterday on CNBC's Kudlow & Company 5 regular participants spelled out their predictions for the Dow Jones Industrial Average, the fed funds rate and the 10 year treasury:

2008 DJIA forecasts:

Jerry Bowyer, Benchmark Financial Network chief economist - 15,000

Mark Skousen, "Investing in One Lesson" author - 15,000

Stefan Abrams, "Bryden-Abrams Investment Mgmt - 14,555

Joseph Battipaglia, Stifel Nicolaus market strategist - 14,500

Michael Metz, Oppenheimer chief investment strategist - 11,896

I just wrote down their stockmarket predictions but if you want to listen to all the forecasts click on the image above.

On Thursday Nouriel Roubini appeared on Kudlow and Co with Brian Westbury and they gave their predictions for US GDP growth. It was an interesting match up as these two guys are on opposite ends of the spectrum in terms of their views.

Roubini thinks that a recession is "inevitable in 2008," Westbury's view is, and I quote from an earlier interview on CNBC on Dec 14th "This whole recession is a figment of people’s imagination." So the divergence in their forecasts should come as no surprise:

2008 US GDP growth forecasts:

Brian Westbury 3.0%

Nouriel Roubini -1.5%

Click on the image above to see the entire segment.

Friday, 21 December 2007

S&P Earnings Forecasts Continue To Tumble

As repeated here ad nauseam earnings forecasts have been too high and are now coming down. The table above shows the sharp revision made to 4Q07 S&P500 Operating earnings going from a positive 2.9% just 5 weeks ago to negative -5.4% as of Wednesday this week.

Earnings growth for the 1H08 looks tepid at under 5% whilst the FY08 number still looks healthy at 15.4% down just over 1% from 5 weeks ago. The week earnings figure for 3Q07 and 4Q07 make the comparable quarter's growth in 2008 look good. However I suspect they will come in for revision as we get further into 2008.

I'd hate to be accused of ignoring good news so I think it's only fair to acknowledge the strong results coming from the tech sector this week via Oracle (ORCL) and Research In Motion (RIMM). Can they continue to deliver in 2008? With P/E of 70 RIMM will need to.

ABCP Market Loses $27.5 Billion in Latest Week

The great disappearing act involving Asset Backed Commercial Paper was particularly impressive this week as another $27.5 billion vanished. That brings the grand total of ABCP to disappear since August to $432 billion or a decline of 36%.

Also of interest was the $28.5 billion of Financial Paper that got wiped away. Financial paper outstanding had been steadily growing since bottoming out in late September. Maybe just a one off. No ABCP update next week as I think (not sure) the Fed takes a rest over Christmas.

Bond Insurer's House Of Cards Set To Tumble

The house of cards made up of credit derivatives backed by crap that isn't worth the paper it's written on moved a step closer to tumbling yesterday with a revelation from MBIA. From Bloomberg:

MBIA Tumbles on $8.1 Billion of CDOs, Fitch Warning

MBIA Inc. fell the most since 1987 in New York trading after the world's biggest bond insurer disclosed that it guarantees $8.1 billion of collateralized debt obligations that investors say have a greater chance of losses.

"We are shocked management withheld this information for as long as it did,'' Ken Zerbe, an analyst with Morgan Stanley in New York, wrote in a report yesterday. "MBIA simply did not disclose arguably the riskiest parts of its CDO portfolio to investors.''

MBIA, Ambac Financial Group Inc., and other insurers are being reviewed by credit-rating companies on concern they don't have enough capital to cover potential losses stemming from mounting downgrades of the securities they guarantee. Fitch Ratings ratcheted up the pressure on MBIA today, saying it would reassess its AAA insurance rating for a possible downgrade and gave the company four to six weeks to raise at least $1 billion.

More than $2 trillion of insured securities would lose their AAA ratings amid mass downgrades of bond guarantors. MBIA fell $7.07, or 26 percent, to $19.95 at the close of regular New York Stock Exchange trading....

Will it take the company being delisted as happened with ACA Capital last week before the already behind the curve ratings agencies downgrade MBIA?

....In five CDOs-squared MBIA insured, the majority of collateral was CDOs of corporate loans, according to the statement. Between 12 percent and 38 percent of the collateral was CDOs of asset- backed securities including mortgage bonds, the company said.

Yesterday, Standard & Poor's lowered its outlook to negative for the AAA ratings of the bond insurance units of Armonk, New York-based MBIA and Ambac.

The $30 billion of exposure for MBIA Insurance to CDOs linked to residential mortgage-backed securities that S&P listed in its report yesterday includes the CDOs-squared disclosed by MBIA, S&P said today in response to investor inquiries. A Dec. 14 analysis by Moody's also included the exposures, Jack Dorer, an analyst at the New York-based ratings company, said in an e-mail message.

There is no credibility left with these rating agencies. The patient has malignant cancer and the doctor's diagnosis is that they look a little tired.

...Credit-default swaps for MBIA soared as much as 145 basis points to 625 basis points, the widest ever, before narrowing to 568 basis points, according to prices from CMA Datavision in London. That means it costs $568,000 a year for an investor to protect $10 million in MBIA bonds from default for five years.

One-year contracts surged to 1,050 basis points, prices from broker Phoenix Partners Group show. That implies investors are pricing in a 20 percent chance of default by March 2009, according to a JPMorgan Chase & Co. valuation tool used by Bloomberg.

Contracts on MBIA's bond insurer, MBIA Insurance, climbed 55 basis points to 300 basis points after reaching 340 basis points earlier today, CMA prices show. Contracts tied to Ambac rose 17 basis points to 582 basis points, according to CMA.

"How is confidence expected to return to the capital markets when htese types of surprises continue to pop up?'' said Peter Plaut, an analyst at New York-based hedge fund manager Sanno Point Capital Management...

Good question Peter, the answer is not until everybody owns up to the junk they hold, mark it down to what it's really worth and the rating agencies follow accordingly.

Initial Jobless Claims tick higher

Whilst not reaching alarming levels yet the 4 week moving average of jobless claims continues to creep higher suggesting the labour market is not as healthy as the pollyannas would have us believe. From the Department of Labor:

In the week ending Dec. 15, the advance figure for seasonally adjusted initial claims was 346,000, an increase of 12,000 from the previous week's revised figure of 334,000. The 4-week moving average was 343,000, an increase of 4,250 from the previous week's unrevised average of 338,750.

The advance seasonally adjusted insured unemployment rate was 2.0 percent for the week ending Dec. 8, unchanged from the prior week's unrevised rate of 2.0 percent.

The advance number for seasonally adjusted insured unemployment during the week ending Dec. 8 was 2,646,000, an increase of 12,000 from the preceding week's revised level of 2,634,000. The 4-week moving average was 2,633,000, an increase of 23,000 from the preceding week's revised average of 2,610,000.

The 4 week moving average of initial claims is at it's highest since October 2005, but it is still far from recessionary levels. However I don't want to sound like one of those economists who won't admit the house is on fire until the blaze is in full swing. Remember employment growth usually does not turn consistently negative until well into a recession and by that time you would have been late to the party. The upward trend over the last couple of months is sending a smoke signal that not all is well in the US labour market.

Thursday, 20 December 2007

Morgan Stanley's 4th Quarter Shocker

An absolute shocker from Morgan Stanley. From Bloomberg:

Morgan Stanley Posts Loss, Sells Stake to China

Morgan Stanley wrote down its subprime-infected mortgage holdings by a greater-than-expected $9.4 billion and received a $5 billion cash infusion from state- controlled China Investment Corp...

...The loss of $3.61 a share in the three months ended Nov. 30 compares with net income of $1.98 billion, or $1.87, a year earlier. Analysts were estimating a loss of 39 cents, according to a survey by Bloomberg. The company, which went public in 1986, has never reported a loss...

...China Investment, the nation's sovereign wealth fund, will acquire as much as 9.9 percent of Morgan Stanley, making it the company's second-largest shareholder after Boston-based State Street Corp., according to data compiled by Bloomberg.

The fund, advised by New York-based investment bank Lazard Ltd., is buying securities that convert into Morgan Stanley shares and pay annual interest of 9 percent. China Investment won't get a seat on the board or play a role in management, Morgan Stanley said in the statement...

Incidentally the stock rallied $2.01 or 4.2% to close at $50.08. So here we have a company that posted it's biggest loss in history. have just diluted their balance their existing shareholders by 10% and added $450m in interest payments to their expense line for the next 3 years.

The only thing missing is the CEO's head served up on a platter Chuck Prince and Stan O'Neal style. But apparently what saved Morgan Stanley's CEO John Mac is that he is a nice guy and well liked, after all he did graciously decide to forgo his multi-million dollar bonus this year.

In addition to the above platitudes as to why Mac will keep his job CNBC said that there is a dearth of talent out there for such a role. How much talent does it take to lose almost $4 billion in a quarter? I'm sure there is any number of people out there who could lose such amounts if given the opportunity. Mac should go but it sounds like he probably won't. The stock price should tank and of this I am more certain. MS shares will see $40 before they see $60.

More Bailout's?

The New York Times printed an interesting article yesterday about the possibility of some major banks bailing out troubled bond Insurer ACA Capital Holdings. From the NYT:

Banks Study Bailing Out Struggling Bond Insurer

Officials from Merrill Lynch, Bear Stearns and other major banks are in talks to bail out a struggling bond insurance company that has guaranteed $26 billion in mortgage securities, according to two people briefed on the situation, because the insurer’s woes could force the banks to take on billions in losses they had insured against.

The insurer, ACA Capital Holdings, which lost $1 billion in the most recent quarter, has been warned by Standard & Poor’s that its financial guarantor subsidiary may soon lose its crucial A rating. If it did, the banks that insured securities with the ACA Financial Guaranty Corporation would have to take back billions in losses from the insurer under the terms of the credit protection they bought from the company.

News Flash, ACA Financial Guaranty Corp was cut to junk by S&P today, from Rueters:

S&P cuts ACA to "CCC" junk, acts on 6 bond insurers

NEW YORK, Dec 19 (Reuters) - Standard & Poor's cut its ratings on ACA Financial Guaranty Corp to junk as part of actions on six bond insurers on Wednesday.

S&P cut ACA's rating to "CCC," or eight levels below investment grade, from "A," the sixth-highest investment-grade rating. It also said it may cut Financial Guaranty Insurance Co's 'AAA' rating.

Well this is not good news considering the balance sheets of Merrill and Bear are already stretched.

The troubles at ACA could also serve as the first real test for credit default swaps, the tradable insurance contracts used by investors to protect, or hedge, against default on bonds. In June, the value of bonds underlying credit default swaps rose to $42.6 trillion, up from just $6.4 trillion at the end of 2004, according to the Bank for International Settlements.

“The hedge is only as good as the counterparty, or the other party, to the hedge,” said Joseph R. Mason, a finance professor at Drexel University and the Wharton School of the University of Pennsylvania. “This is part and parcel of the financial innovation that has grown very rapidly in recent years.”

....Banks that insured securities with ACA have another reason to keep the company afloat — if it fails they may have to restate earnings they have already booked as a result of their dealings with the company.

That doesn't sound good, the last thing Merrill needs after billions in writedowns is to restate earnings. What's the bet Merrill will be lining up to get equity injections just like Morgan Stanley's hugely dilutionary injection from China Investment Corp. announced today.

Wednesday, 19 December 2007

How Good Were Goldman's Results Really?

Yesterday Wall Street's darling Goldman Sachs reported better than expected earnings. The media muppets looked bemused as the stock price fell whilst they lauded praise on the company. From

Goldman scores but shows strains

....As in the previous quarter, the Wall Street firm reported earnings that beat forecasts. Net income at the bank climbed to $3.22 billion, or $7.01 a share, from $3.15 billion, or $6.59 a share a year ago. Analysts were expecting earnings of $6.61 a share. Net revenue also came in slightly ahead of expectations, climbing 14 percent to $10.7 billion.

Last quarter I speculated that Goldman would be lucky to post earnings growth of any kind in 4Q07. They managed 6.4% eps growth, not bad given the operating environment. However whilst the media was busy fawning I couldn't get enthusiastic. The environment for a lot of Goldman's, and by implication the other major brokers, core businesses deteriorated sharply in the fourth quarter however that was disguised in Goldman's case by $800m in asset sales.

Net revenue in Goldman's trading business, by far its biggest division, dropped 16 percent in the past three months, even though it climbed 47 percent from a year ago. The company's investment banking and asset-management divisions also experienced declines from the previous quarter.

"If you look back in the third quarter, the difference is you are getting a slowdown in some of the core businesses," said Brad Hintz, who covers the Wall Street firm for Sanford Bernstein & Co.

Offsetting some of those declines was the sale of assets including an $800 million sale of more than a dozen power plants.

That the broker's core businesses are under pressure shouldn't be surprising given the credit crunch. What I found disturbing about the reporting yesterday was the lack of attention the asset sales got. Since when are asset sales a core business? Analysts usually exclude such items so they can compare like for like.

However most articles on Goldman yesterday didn't even mention it and the ones that did like the one quoted above, barely mentioned it. Excluding asset sales, Goldman's profit would have been 25% lower than the $7.01 eps reported. It would have been more like $5.35. That assumes the asset sales were after tax numbers which we don't know either from the report.

So what's my point? Well I have two really, firstly Goldman's results excluding asset sales was not impressive at all and secondly the outlook for brokers earnings into 2008 is not encouraging as many of their core businesses are under pressure.

Whilst the market seems obsessed with the size of writedowns they should be looking beyond that to the effect that a deteriorating business environment will have on these firms earnings in 2008.

Nov. Housing Starts, Permits, Completions Fall

Starts and Completions fell sharply in November as did permits for single family units. From the Census Bureau:


Privately-owned housing units authorized by building permits in November were at a seasonally adjusted annual rate of 1,152,000. This is 1.5 percent below the revised October rate of 1,170,000 and is 24.6 percent below the revised November 2006 estimate of 1,527,000.

Single-family authorizations in November were at a rate of 764,000; this is 5.6 percent below the October figure of 809,000.


Privately-owned housing starts in November were at a seasonally adjusted annual rate of 1,187,000. This is 3.7 percent below the revised October estimate of 1,232,000, and is 24.2 percent below the revised November 2006 rate of 1,565,000.

Single-family housing starts in November were at a rate of 829,000; this is 5.4 percent below the October figure of 876,000.


Privately-owned housing completions in November were at a seasonally adjusted annual rate of 1,344,000. This is 4.1 percent below the revised October estimate of 1,402,000 and is 28.7 percent below the revised November 2006 rate of

Single-family housing completions in November were at a rate of 1,088,000; this is 4.1 percent below the October figure of 1,135,000.

The bottom callers were notably absent today. Still a ways to go I suspect.

Tuesday, 18 December 2007

ECB Lends Half A Trillion For Year End Squeeze

Desperate times call for desperate measures. From

ECB Lends 348.6 Billion Euros, Easing Year-End Cash Drought

Dec. 18 (Bloomberg) -- The European Central Bank loaned 348.6 billion euros ($501.5 billion) for two weeks to banks to bring down the cost of money at year-end.

The reluctance to lend money after the collapse of the U.S. subprime market pushed interbank euro rates for two weeks to the highest level at least six years earlier this week. The rate banks charge each other for two-week euros fell to 4.45 percent from 4.94 percent, the European Banking Federation said today.

``It won't fix the actual problem of banks not lending,'' said Michael Schubert, an economist at Commerzbank AG in Frankfurt. ``It also raises the moral hazard question for the ECB, whereby banks could start relying on getting cheap cash....''

....The ECB said 390 banks bid for the two-week loans at a marginal rate of 4.21 percent. Bids ranged from 4 percent to 4.45 percent.

Half a trillion dollars just to tie the banking system over for a couple of weeks. Hmmm does this sound like a healthy credit environment? Will banks be more willing to lend to each other in 2 weeks time? I doubt it.

Monday, 17 December 2007

Credit crunch 2.0 comes down under

Another timely reminder that Australia is not immune from the effects of the global credit crunch. From the Sydney Morning Herald:

Centro securities plunge 70%

Centro Properties Group has become the biggest local victim of the US sub-prime mortgage crisis after higher funding costs forced it to downgrade of its distribution guidance, causing its shares to plunge by more than 70 per cent.

Australia's second largest shopping centre owner has downgraded its full year distribution guidance by 14 per cent to 40.6 cents, from 47 cents.

It also announced it would not pay a distribution for the first half of the 2008 financial year as it revealed it had failed to refinance $1.3 billion of maturing debt although.

Centra has obtained an extension until February 15 to refinance the debt.

The market was already expecting bad news from Centro, which went into a trading halt last Thursday, citing the need for "revised earnings guidance.

But Monday's announcement was far worse than investors expected.

By 14332 AEDT, Centro stapled securities had fallen $4.11, or 71.93 per cent, to $1.60. They closed trading at $10.02 on May 7 and have gradually slid since then on concerns about the level of debt used to fuel the company's rapid United States expansion.

Centro told the stock exchange its 2007/08 earnings would be hurt specifically by the increased costs associated with the extension of the debt facilities until February, and the expected costs of the refinancing.

"In addition, restrictions imposed on Centro's capital expenditure under the terms of the financing extension will restrict Centro from carrying out some of its growth plans in the United States which had been expected to generate higher earnings," the firm said....

....Centro said it hadn't warned the market of any potential trouble earlier than Monday because in August, when the sub-prime crisis started to push up borrowing costs and drain liquidity in debt markets, it believed that long-term refinancing would be available when it needed it.

"We never expected, nor could reasonably anticipate, that the sources of funding that have historically been available to us and many other companies would shut for business," chairman Brian Healey said.

Centro said that in August it completed a $US300 million, 10 year commercial mortgage-backed security issue "on reasonable terms", despite the fall-out in global credit markets.

This had given it confidence that it could wait for debt markets to settle before returning.

"Up until late last week, we were of the view that our short term debt obligations could be refinanced on a long term basis," Mr Healey said.

No sympathy for these guys they are leveraged up to the eyeballs. Healy must have been living under a rock if he thought his short-term funding requirements were not in doubt. Has he heard of RAMS? The obvious question now becomes; Who's next?

Roubini on Deflation

In an interesting post on why the US Federal Reserve should cut interest rates aggressively despite not being able to prevent a recession, Nouriel Roubini touched on the topic of deflation. I put forward yesterday the case that deflationary pressures will overwhelm inflationary pressures in 2008. Below is Roubini's take, click on the title link below for the full article. From RGE monitor:

Why monetary policy easing is warranted even in the current insolvency crisis

Third issue: would monetary policy easing cause a much higher inflation rate and undermine the anti-inflation policy credibility of the central banks? After all inflation rates are now rising around the world thanks to high and rising oil, energy, food and oher commodity prices. My answer to the question above is no as a US hard landing followed by a global slowdown will seriously reduce those inflationary force and would – like in 2001-2003 – rather induce serious deflationary risks.

Inflationary pressures may be elevated now but they will fizzle away in short order once the US hard landing is in full swing. Thus, the central banks current concerns with a rise in inflation are misplaced as a US recession will lead to global disinflation (and concerns about deflation as in 2002-2003). There are at least four reasons why these global inflationary forces will abate once this US hard landing occurs:

a) a fall in US aggregate demand relative to supply;

b) a slack in labor market conditions and slowdown in wage growth as the unemployment rates sharply increases;

c) a fall in global aggregate demand as the glut of output from overinvestment in China and some other emerging market economie will face a fall in global demand as the world re-couples with the US hard landing;

d) a sharp fall in oil, energy, food and other commodities prices as a global slowdown emerges.

We are thus set for the repeat of the 2000-2003 cycle when the Fed and other central banks underestimated the downside risks to growth and overestimated the upward risks to inflation and ended up having to aggressively cut rates to deal with the fall in economic activity and the deflation risks that such a US and global recession triggered.

Sunday, 16 December 2007

Inflation Or Deflation?

So US PPI and CPI was through the roof last week stoking inflation fears and sending investors running for cover as they mulled the possibility that the Federal Reserve may be done cutting rates for the time being. However should we really be worried about inflation?

No doubt there are inflationary pressures and have been for some time, the Federal Reserve has belatedly recognized that, by paying more attention to the headline number in addition to the core. However, was last month's inflation reading really a surprise to anyone considering oil reached $99 a barrel?

But it's not just oil, we know that certain agricultural commodities have been shooting up over the past 12 months. Anecdotal evidence has shown up in some company outlooks such as Starbucks comments on rising milk prices. OK so we know there is inflation out there.

However lets put that aside and turn to deflationary pressures in the US economy. Firstly what is deflation? Typically it is a decrease in the money supply or amount of credit in the system and a decrease in the demand for goods related to the inability to access credit. Sounds like the opposite of inflation doesn't it? Funny that. What evidence do we have to support a deflationary environment? We have:

  • Tighter access to credit both for individuals and corporations , and unwillingness to lend as evidenced by widening credit spreads.
  • $400 billion of Asset Backed Commercial Paper wiped out of existence in 4 months.
  • Falling housing prices across the country.
  • markets for LBO's, asset backed securities and bond issuance have all but dried up.
  • Banks and other financial institutions' balance sheets continue to shrink as they mark down asset prices.

However asset prices as measured by the US stock market are not far from all time highs. The S&P500 is up 3.5% year to date however the US dollar is down -11.8% against the Euro. In Euro terms the S&P500 is down more than -8.0% for the year. Asset deflation is pervasive and is set to continue in home prices, corporate balance sheets and ultimately stock prices.

What of the US dollar? In a deflationary environment you would expect it to appreciate and that's what you've seen over recent weeks. The Dollar has firmed up against the Euro from about 149 to 145. That's not to say it won't go back down again. No doubt it's in for a volatile ride but if the supply of dollars decreases the currency will eventually go in the opposite direction.

Now the Fed is supposedly busy pumping money into the economy however as stated repeatedly the vast majority is of short term duration via repos. There is not a lot of new money out there. Also the velocity of money (the rate at which it is turned over) has decreased sharply which means people are hoarding cash.

Asset prices got out of control due to the easy money environment fostered by the Fed in the early part of this decade. Now it's time to deflate and there is little the Fed can do about it.

On the inflationary side, if global economic growth slows next year then I would expect energy prices to recede, that still leaves food inflation. I'm not smart enough to know how that will play out next year but from where I sit deflationary pressures appear to outweigh inflationary pressures. Anyone else care to take a stab at the inflation/deflation debate? Any comments are welcome.

Saturday, 15 December 2007

How silly will the NAR look in 2008?

It would be difficult to make the NAR look much sillier than they did this year with 9 consecutive downgrades to their existing home sales forecasts but I'm betting they can top that effort in 2008 with their current prediction for existing home sales.

Calculated Risk had a post yesterday on more housing forecasts. In that post the NAR's forecasts were compared with that of Goldman Sachs, Moody's and Global Insights which I decided to put it in a graph. Note that Golman has become somewhat more bearish on the US economy since this forecast was made back in August.

Hands up if you think the NAR is too optimistic? Whilst Moody's forecasts may look too low, I'm willing to bet that the final number for existing home sales in 2008 will be closer to Moody's forecast than the NAR's.

Friday, 14 December 2007

Citi's Moves May Signal End of the Super SIV

Vikram Pandit, the new CEO has dashed into the fray and decided to bring Citi's $49 billion worth of SIV;s back on balance sheet. Pandit has the luxury of claiming that the SIV debacle didn't happen on his watch so why not kitchen sink the results in the next quarters and start fresh. From CNBC Money:

Citi plugs $49B in leaky SIVs
Citigroup Inc. said Thursday it plans to assume control of the seven "structured investment vehicles" the bank advises to help them repay their debts.

Citigroup will provide a "support facility" for its seven SIVs with investments totaling $49 billion and incorporate them onto its balance sheet. The bank previously said it had no plans to bring the SIVs onto its books....

....Citigroup will bring the SIVs onto its balance sheet in order to protect their credit ratings and give them time to sell their assets, the bank said.

After Citi's announcement, Moody's downgraded Citigroup's long-term credit rating to "Aa3" from "Aa2," and lowered Citibank's Bank Financial Strength Rating to "B" from "A-," citing the view that Citigroup's capital ratios will remain low.

The company's Tier 1 capital ratio - its ratio of cash to debt for regulatory purposes - was about 7.3 percent as of Sept. 30. Citi said adding the SIVs to the company's balance sheet would reduce the ratio by 0.16 percentage point but it still expects to return to its targeted ration of 7.5 percent in the first half of 2008.

The bank said it expects its SIVs to be able to meet their liquidity needs, which total $35 billion, through the end of next year. Citigroup expects to provide "little or no" financing.

"After considering a full range of funding options, this commitment is the best outcome for Citi and the SIVs," said Vikram Pandit, who was named Citigroup's chief executive officer Tuesday.

Pandit is demonstrating he is a man of action which can only be good news, however I have just one question, how will Citi raise it's capital ratio back up to it's target of 7.5%? Cut dividends, capital injections, both?

ABCP loss exceeds $400 billion

The amount of Asset Backed Commercial Paper wiped from existence since early August pushed through the $400 billion mark in the week to December 12th. This represents a -34% decline in the ABCP market over the same period. Total ABCP outstanding now stands at $791 billion down from $1,194 billion on August 8th.

Thursday, 13 December 2007

PWK Upgrades Guidance, Project Runway Update

Pipe Networks (PWK) today upgraded guidance for the FY08 and in addition provided guidance for FY09. At its financial results announcement in September PWK announced that they expected FY08 NPAT growth of 45 - 50% and revenue in excess of $30m.

Today they gave a revenue range of between $33m - $35m and NPAT of $7.0m - $7.4m for FY08 which effectively lifts the upper end of the range given earlier to 55%.

Also for the first time the company gave guidance for FY09 of revenue between $44m - $46m and NPAT to 'eclipse' $10m. Encouragingly this is all organic growth and more to the point the numbers given reflect improved margins and profitability as the table below demonstrates.

Of course all these forecasts are off the table if Project Runway gets up and running. That is looking more and more likely given what the company said today:

PIPE Networs' Board has today provided its formal approval for the legal and financial structure of Project Runway. PIPE Networks is now in a position to execute a number of outstanding sales agreements. With these agreements in addition to commitments being finalised, the Board believes it will shortly have sufficient customer commitments to proceed with Project Runway.

Cutting through the formality PWK is basically saying that now that all the legal and financial requirements are squared away, they can concentrate on getting customers signed up. Remember PIPE management have said all along they will not proceed with the project unless they have sufficient revenue generating contracts in place.

Another failed deal

Another one bites the dust, JC is no longer offering flowers for Sallie Mae and who would want to quite frankly after the company slashed earnings forecasts yesterday by -17%.

Sallie Mae buyout fails as J.C. Flowers group walks

SLM Corp. on Wednesday announced it failed to renegotiate a leveraged buyout worth $25 billion and also cut its 2008 profit forecast, the latest sign of this year's credit crisis derailing the recent private-equity boom.

The group that offered to buy SLM Corp., or Sallie Mae, earlier this year, led by private-equity firm J.C. Flowers, Bank of America (BAC) and J.P. Morgan Chase (JPM), turned down an offer by the company to make a new bid, Sallie Mae said.

The original offer had run into problems because of new legislation curbing federal subsidies to student lenders like Sallie Mae.

"The company offered to consider an alternative transaction with the Flowers group, and to give them the opportunity to update their due diligence and submit a new proposal to acquire the company with no pre-conditions," Sallie Mae said in a statement. "The buyer's group has indicated to Sallie Mae that it does not wish to pursue these opportunities."

Sallie Mae also cut its forecast for 2008 core earnings per share to a range of $2.60 to $2.80 from $3.25, mainly due to increased costs from replacing an interim funding facility the company had set up during its preparations for the leveraged buyout.
Fourth-quarter core earnings will also be hit by funding costs and increased reserves for one of the company's loan portfolios, Sallie Mae said.

More financial confessions

On Monday it was Washington Mutual, yesterday it was Freddie Mac and today 3 more large financial companies visited the confessional. From

Banks raise loss estimates

Some of the nation's largest banks on Wednesday warned of higher losses in the fourth quarter as the turmoil in the credit and mortgage markets continues to weigh on the financials sector.

Bank of America (BAC) Chief Executive Ken Lewis said the firm would have to write down a larger amount of its investment in some debt securities than previously planned.

"Based on conditions today, we expect those write-downs will be larger than have already been reported -- although obviously we won't know our final numbers until we close the fourth quarter," Lewis said in remarks prepared for delivery at a Goldman Sachs conference.

The company had previously expected to report a write-down of $3 billion. Lewis also said that while fourth-quarter results will be "disappointing," the company will still report a profit.

"While we do not make a practice of forecasting quarterly earnings, I think you certainly can assume results will again be quite disappointing. At this point, the final write-downs of CDOs are unknowable, but we expect to be profitable in the fourth quarter," Lewis concluded....

He said the firm now expects provision expense at $3.3 billion in the fourth quarter, reflecting increased reserves of about $1.3 billion. Bank of America is also looking to rebuild it capital ratio, like all its rivals.

Lewis said he's planning to get the bank's Tier 1 capital ratio to 8%; that means there won't be any share buybacks until at least 2009.

It also means they will be raising capital or cutting dividends or both.

Also Wednesday, Wachovia Corp., (WB) in a Securities and Exchange Commission filing, said it now estimates its loan-loss provision for the fourth quarter will be about $1 billion in excess of charge-offs.

Its previous forecast was between $500 million and $600 million due to slowing loan growth and ongoing deterioration in its loan portfolio.

Surprise, surprise, losses are now larger than were expected, who would have thought?

In a separate regulatory filing Wednesday, PNC Financial Services Group Inc. (PNC) said it expects to report fourth-quarter earnings in the range of 60 cents to 75 cents a share, and adjusted earnings between $1 and $1.15 a share. Analysts polled by Thomson Financial are looking for profit of $1.39 a share, on average.

The revised expectation is due to write-downs on its $1.5 billion of commercial mortgage loans held for sale and lower trading revenue as a result of "unprecedented market price volatility," PNC said in the filing. It also expects to take a charge of $141 million before taxes on its stake in money manager BlackRock Inc. (BLK).

Did someone say Commercial real Estate? Interesting, forget about dropping shoes it's raining shoes and the storm is not about to let up for some time.

So what you say? More bad news from a sector that has already been beaten down severely. That's just the point, the bottom callers (and there have been a lot of them) and the analysts that think it's time to buy financials have been and are still now dead wrong.

Not only that, as has been written here repeatedly over the last 6 months earnings estimates for 2008 are far too high and need to come down. Some brokers have already started downgrading for 2008. The most recent from Merrill Lynch yesterday who cut their 2008 estimates for BofA by -6.7%, for JP Morgan by -7.5% and Wachovia by -2.5%.

Economist David Malpass of Bear Stearns, a fairly smart guy said a couple of days ago it's a bit early to be calling an earnings recession because we need to see 3 - 4 quarters of year over year earnings declines before you can make that call. The

4th quarter is going to be the second consecutive quarter and whilst 2008 forecasts look rosy (currently expected to be 15.6% higher according to S&P500 operating earnings forecasts) expect them to come down substantially in the next few months.

Wednesday, 12 December 2007

Freddie Mac to take another whack in 4Q07

Is anyone really surprised given WaMu's revelations that Freddie Mac (FRE) would be taking substantially bigger losses on their mortgage portfoilo? Well it seems the market was more than a bit surprised smacking FRE shares down more than -10% on Tuesday. From Bloomberg:

Freddie Expects 4th-Quarter Loss, Record Default Rate

Freddie Mac, the second-largest source of money for U.S. home loans, said it doesn't expect a ``quick fix'' for a mortgage market buffeted by record defaults, and may have a second straight quarterly loss of about $2 billion.

Freddie Mac didn't get any help today from the Federal Reserve, whose quarter-point cut in its benchmark interest rate failed to reassure investors that a recession could be avoided. Freddie Mac shares, down 52 cents before the announcement, fell $3.73, or 11 percent, to $31.31 on the New York Stock Exchange.

The housing market ``will get tougher before it gets better,'' Chief Executive Officer Richard Syron told investors at a conference in New York sponsored by Goldman Sachs Group Inc. ``We are not promising a silver bullet, a short-term quick fix.''

Fourth-quarter results ``are not going to be effectively better than'' the third-quarter net loss of $2.02 billion, or $3.29 a share, Syron said. Freddie Mac expects a 3 percent to 3.5 percent default rate in its mortgages, the worst since 1991, and reiterated a forecast for $10 billion to $12 billion in credit losses, according to slides accompanying Syron's speech.

...and while we are on the subject of failed government backed institutions, Fannie Mae (FNM) offered this somber outlook for the housing market:

The U.S. mortgage and housing markets are unlikely to fully recover until at least 2010, Fannie Mae Chief Executive Officer Daniel Mudd said today.

Finally someone is getting realistic about the housing market, although 2010 could turn out to be a bit early.

``The correction will begin to turn into recovery in late '09, when we start to see credit clear and liquidity restored,'' Mudd told investors at a conference sponsored by Goldman Sachs Group Inc. He cautioned that ``forecasting right now is fraught with peril.''

Fannie Mae, which last week sold $7 billion in preferred stock and cut its dividend by 30 percent, has enough capital for any of the ``scenarios'' it's expecting for 2008, Mudd said.

This is funny stuff, given that FNM did not expect the current scenario they now inhabit, should we really be concerned with them being able to handle any of the scenarios that they expect or should we be more worried about the scenarios they don't expect?

More Evidence of CRE slowdown

The slowdown in Commercial Real Estate has started to show up in corporate earnings, from Forbes:

Weak Construction Blasts NCI

The weak housing market has taken a heavy toll on builders and their suppliers. NCI Building Systems' quarterly earnings showed that the non-residential building market is now causing problems too.

Shares of NCI Building Systems (NCS) fell $7.18, or 20.1%, to $28.60, after the company reported its fourth-quarter profits fell to $25.4 million, or $1.27 per share, from $28.0 million, or $1.33 per share, a year ago. Analysts polled by Thomson Financial expected a profit of $1.59 per share.

NCI (nasdaq: NCIT - news - people ), which is headquartered in Houston, makes metal building materials used in non-residential construction. Its products include roofs and roll-up doors.

A slowdown in non-residential construction pressured NCI's fourth-quarter results. According to McGraw Hill, low-rise nonresidential construction fell by 4.4% during NCI's fiscal 2007. It gained 5.7% during the previous year.

Tuesday, 11 December 2007

WaMu To Bleed Red Ink In 2008

Just over a month ago when Washington Mutual announced they were upping their loan loss provisions, I noted that they would likely make a small loss in 4Q08 and be lucky to make a profit at all in 2008. After yesterday's announcement it is no longer likely but a certainty: From

WaMu subprime exit results in over 3,000 job cuts

Washington Mutual Inc. said late Monday it will leave the subprime lending business, eliminating 3,150 jobs, while it shores up an increasingly shaky financial position by slashing its dividend by over two-thirds and selling preferred stock.

WaMu (WM) said it will stop lending through its subprime mortgage channel; close roughly 190 of its 336 home loan centers and sales offices; shut down nine home loan processing and call centers and cut about 2,600 home loan positions and 550 corporate and support employees.

The reductions will cost $140 million in the fourth quarter, but will lower non-interest expenses by about $500 million next year, WaMu said. It will now focus on offering home loans directly to more creditworthy customers through its retail branch network.

WaMu said it would cut its quarterly dividend to 15 cents a share from 56 cents a share, while the sale of convertible preferred stock will raise $2.5 billion, the lender said....

.... Mortgage losses will also likely remain high, WaMu said. Fourth-quarter provisions for loan losses will be $1.5 billion to $1.6 billion. Provisions will rise to a range of $1.8 billion to $2 billion in the first quarter of 2008.

"The first quarter range reflects the company's current view that prevailing adverse conditions in the credit and housing markets will persist through 2008," WaMu said. "The company also currently expects quarterly loan loss provisions through the end of 2008 to remain elevated."

So much for the argument put forth by a number of analysts of what good value WaMu was since it had such a high dividend yield. Today's announcement should put investors on notice that those kind of yields cannot be relied upon for distressed companies such as WaMu.

Back in November I estimated that WM would make about a -$100m loss based on a provision for loan losses of $1.3 billion in the 4th quarter. If we take the middle of the new range of between $1.5 - $1.6 billion and add the $140 billion of costs related to restructuring WM is likely to make a loss of about -$500m for 4Q07. That would put WaMu's FY07 profit in the region of $1.3 billion, less than half of the $3.6 billion they made in 2006.

Now if you think that is a miserable result check out the implications for FY08. WaMu now says provision for loan losses will be in the region of $1.8 - $2.0 billion for 1Q08 and "The company also currently expects quarterly loan loss provisions through the end of 2008 to remain elevated."

The graph above takes the lower of the 1Q08 range of $1.8 billion and multiplies it by 4 to get a $7.2 billion loan loss provision for 2008. That would mean a loss of at least -$2.0 billion taking into account the $500m expected costs savings and based on a year comparable to 2006. That is probably being generous since the mortgage market is expected to shrink by more than half to less than $1.5 trillion next year and the fact that WaMu will be a much smaller entity.

Granted that the word 'elevated' does not mean that the 1Q08 loan loss provisions will be as high for the entirety of 2008 however even a loan loss provision of $5 billion in FY08 would mean a modest loss for WaMu.

This is a lesson in the dangers of bottom fishing. As the market rallied yesterday like a druggie on the verge of his next hit the financial landscape continues to deteriorate. How long this suckers rally lasts will depend on how much the Fed cuts interest rates in the US today. However that doesn't make it any less of a sucker's rally.

NAR Chuckleheads at it again

Yesterday in the US, the National Association of Realtors (NAR) released pending home sales data along with some totally unrealistic forecasts for next year. From the NAR:

Existing-Home Sales to Trend Up in 2008

Lawrence Yun, NAR chief economist, said the worst part of the credit crunch has already worked its way through the data. “The unusual mortgage disruptions that peaked in August were clearly seen in lower home sales that were finalized in September and October, so the market was underperforming,” he said. “Now that mortgage conditions have improved, some postponed activity should turn up in existing-home sales over the next couple of months, and I expect sales at fairly stable to slightly higher levels.”

Unfortunately for Yun, the worst part of the credit crunch is yet to come. The statement is all the more ludicrous when you consider Alt-A and ARM resets have not even peaked yet.

The Pending Home Sales Index,* a forward-looking indicator based on contracts signed in October, increased 0.6 percent to an index of 87.2 from an upwardly revised reading of 86.7 in September. It was the second consecutive monthly gain, but remained 18.4 percent below the October 2006 index of 106.8. “The broad trend over the coming year will be a gradual rise in existing-home sales, but because sales are exceptionally low in the final months of 2007, total sales for 2008 will be only modestly higher than 2007,” Yun said.

Existing-home sales are likely to total 5.67 million this year, the fifth highest on record, rising to 5.70 million in 2008, in contrast with 6.48 million in 2006. Existing-home prices should be down 1.9 percent to a median of $217,600 for all of 2007, and then rise 0.3 percent to $218,300 in 2008.

Chief cheerleader Lawrence Yun put beyond any shadow of a doubt that he has any credibility as a forecaster. Remember this is the same muppet who downgraded his forecast for pending home sales 9 times this year.

Remember back in September Goldman Sachs came out with a forecast of 4.9 million for existing home sales in 2008 and since then they have become appreciably more bearish. As usual Calcualted risk has some great articles on why the NAR is being way too optimistic. Below is an excerpt.

At the bottom of a housing cycle, sales typically fall to 5% or even 4% of owner occupied units (a measure of turnover). There are currently just over 75 million owner occupied units in the U.S., so 6% (the median for the last 40 years) would be sales of about 4.5 million in 2008, 5% would be sales of 3.75 million, and 4% would be 3.0 million units. This isn't a forecast - just a review of historical data - but it is possible that sales could fall sharply from the current levels.

Click on the two links above for two separate articles from Calculated Risk.