Morgan Stanley takes a subprime hit

It was Morgan Stanley's (MS) turn today to bite the subprime bullet and writedown the value of some its toxic waste assets. From Bloomberg:

Morgan Stanley's Subprime Assets Fell by $3.7 Billion

Morgan Stanley, the second-biggest U.S. securities firm, said its subprime mortgages and related securities lost $3.7 billion in the past two months, after prices sank further than the firm's traders expected.

The decline may cut fourth-quarter earnings by $2.5 billion, the New York-based company said in a statement today. The figure is subject to change until the end of this month, Morgan Stanley said. The average estimate of analysts surveyed by Bloomberg is for a $1.93 billion profit in the quarter.

Another 4Q07 earning revision on the way no doubt. Even Morgan Stanley does not think this is a one quarter event but more like a one year event. I expect it will take longer. In other subprime related news from marketwatch.com:

AIG quarterly net falls 27% as subprime crisis bites

American International Group reported a 27% drop in third-quarter net income late Wednesday as the subprime mortgage crisis pushed the insurance giant's results below Wall Street expectations.

The company's shares fell 2.8% to $56.28 during late-trading. That extended losses of 6.5% during regular action, before the insurer reported results. The stock is now trading at its lowest level since July 2006.

AIG said net income came in at $3.09 billion, or $1.19 a share, vs. $4.22 billion, or $1.61 a share, a year earlier. Adjusted net income, which excludes net realized investment gains and losses and other items, was $3.49 billion, or $1.35 a share, the company reported.

AIG was expected to make $1.62 a share, according to the average estimate of 19 analysts in a Thomson Financial survey.

I heard a great comment from an analyst on Bloomberg poking fun at those who had said and keep saying that the subprime and credit market problems are contained. He said "yeah it's contained to planet earth" great stuff.

Moody's turns the heat up on SIV's

Always late to the late to the party but better late than never rating agency Moody's downgraded SIV's with approximately $33 billion worth of debt. From marketwatch.com:

Moody's cuts more SIV ratings

Moody's Investors Service downgraded more ratings on structured investment vehicles on Wednesday and warned that the funds are in a more precarious position than they were in early September, previously considered the height of this year's credit crisis.

Moody's said it cut or may downgrade ratings on structured investment vehicles (SIVs) with roughly $33 billion in debt. That affects 28 debt programs run by 16 SIVs, including Victoria Finance, Harrier Finance Funding and Kestrel Funding, the agency noted. More than 10% of all SIV debt was affected by the move.

Victoria, with more than $11 billion in debt, is run by SIV specialist Ceres Capital Partners. Harrier, also with more than $11 billion in debt, is sponsored by German bank WestLB. Kestrel, which has more than $3 billion in debt, was also set up by WestLB....

"The situation has not yet stabilized and further rating actions could follow," Moody's said in a statement. "SIV senior note ratings continue to be vulnerable to the unprecedented large and sustained declines in portfolio value combined with a prolonged inability to refinance maturing debt."

Credit crunch 2.0 is starting to kick into gear.

Rate rises to further pressure Aussie Housing

From the Australian Bureau of Statistics:

Value of Dwellings Financed

The total value of dwelling commitments excluding alterations and additions (seasonally adjusted) decreased 2.7% in September 2007 compared with August 2007. The trend series for total value of dwelling finance commitments decreased by 0.7% in September 2007....

Number of Owner Occupied Dwellings Financed

The number of owner occupied housing commitments (seasonally adjusted) decreased by 2.4% (down 1,553) in September 2007 compared with August 2007, following an increase of 1.4% in August 2007. Decreases were recorded in purchase of established dwellings excluding refinancing (down 1,125, 3.0%), refinancing of established dwellings (down 389, 2.1%) and purchase of new dwellings (down 106, 3.5%), while construction of dwellings rose (up 67, 1.4%). The number of owner occupied housing commitments (trend) decreased 0.9% in September 2007.

The number of dwelling commitments is off 5.3% from the June peak. It's a bit early to say that housing is taking a leg down however yesterday's interest rate rise with the possibility of more pushes affordability levels to historic lows.

The dreaded level 3 assets

By now you may have heard the term level 3 assets. These are assets that financial institutions conveniently are able to value using their own assumptions rather than mark to market as there are supposedly "no observable inputs." Although personally I find the ABX indices fairly easily observable.

The Financial Accounting Standards Board's new rule 157 will put pressure on companies to put more realistic values on such assets. Whilst the new rule is effective from November 15th we probably wont get a feel for its effect until companies report 4th quarter earnings in January although some of the brokers will report in December and we could get some pre-earnings announcements before the year is out.

Royal Bank of Scotland today released a report that estimates up to $100 billion of writedowns could come as a result of the new accounting rules. From Bloomberg:

Banks Face $100 Billion of Writedowns on Level 3 Rule

U.S. banks and brokers face as much as $100 billion of writedowns because of Level 3 accounting rules, in addition to the losses caused by the subprime credit slump, according to Royal Bank of Scotland Group Plc.

The Financial Accounting Standards Board's rule 157 will make it harder for companies to avoid putting market prices on securities considered hardest to value, known as Level 3 assets, Royal Bank's chief credit strategist Bob Janjuah in London wrote in a note today. The new rule is effective Nov. 15.

"This credit crisis, when all is out, will see $250 billion to $500 billion of losses," Janjuah said. "The heat is on and it is inevitable that more players will have to revalue at least a decent portion" of assets they currently value using "mark- to-make believe."

Does anyone really think 4Q07 earnings are going to be in the double digits? Interestingly the golden boy of brokers Goldman Sachs has the most exposure to level 3 assets as a percentage of it equity.

RBA may yet have more to do

Whenever the Federal Reserve releases a statement on monetary policy the pundits spend days parsing the statement for clues on the direction of monetary policy. Thankfully the RBA's comments are much less cryptic.

In their media release today, after the decision to raise interest rates by 0.25%, they left little doubt as to where the risk lay for the likely direction of interest rates. To summarize briefly:

The RBA expects inflation to rise to over 3% by 1Q08 driven by the strong pace of domestic demand and output which shows little sign of slowing. The global turmoil in credit markets has had less effect in Australia than elsewhere and whilst dampening growth expectations in some overseas economies, the world economy is still forecast to grow above trend in the medium term with Australia poised to benefit from the strong demand for commodities, particularly for China.

Further rate rises will be data dependent however if inflation continues it's upward march outside the into RBA's preferred 2 - 3% range they may lift rates again as early as next month. Even if they don't go next month without evidence that inflationary pressures are likely to moderate further rises are on the cards in the medium term.

Beazer cuts dividend still Chapter 11 front runner

Last month I speculated that Beazer Home USA Inc. (BZH) had thrust themselves forward as the most likely candidate to file for Chapter 11 amongst the major US homebuilders. Beazer moved one step closer to that reality yesterday by cutting their dividend to shore up their capital position. From marketwatch.com

Beazer Homes eliminates dividend

Atlanta-based Beazer, which has indicated it will need to restate previous financial results due to an internal probe of its lending and other practices, said late Monday that it's eliminating the 10-cent-a-share dividend, a move designed to save about $16 million annually....

Beazer estimated it can reach a settlement with regulators in a range of $8 million and $15 million to resolve the violations of HUD regulations related to the mortgage-origination business.

On Monday, Beazer said it was unable to report its fourth-quarter and fiscal 2007 results but was providing preliminary, unaudited data. It has negotiated waivers of default from its lenders due to its failure to report financial results on time....

The company also said it continues to scale back its land position in response to lower prices and sales activity in the U.S. housing market. For the latest quarter, it forecast $230 million of charges related to inventory impairments and the abandonment of options on real estate....

"The housing industry continues to face the most difficult business conditions in over a decade," said Chief Executive Ian McCarthy in a statement.

Beazer said it let go about 650 workers, or 25% of its staff, during October.

This really is a company fighting to survive. As is the trend of late, shareholders are calling for the CEO's head. This from Bloomberg:

Shareholder Group Calls for Ouster of Beazer Chief Executive

CtW Investment Group, an adviser to union pension funds with $1.4 trillion of assets, called for the ouster of Beazer Homes USA Inc. Chief Executive Officer Ian McCarthy for his ``stunning leadership failure.''

McCarthy ``allowed Beazer to violate federal law, improperly account for land development costs and sale-leaseback transactions, and provide undisclosed loans to executives,'' CtW Investment said today in an e-mailed statement.

Also in homebuilder news Hovnanian Enterprises Inc. (HOV) announced some nasty preliminary results for the quarter ended October 31st. From the same marketwatch.com article above:

Hovnanian's deliveries down, cancellations up

Another large builder, Hovnanian, said it delivered 19% fewer homes during the October quarter compared to the year-earlier period.

Red Bank, N.J.-based Hovnanian's cancellation rate rose quarter-over-quarter to 40% of gross contracts, up from 35%.

Hovnanian is scheduled to release full fourth-quarter results on Dec. 18.

Some interesting commments from the CEO.

Ara Hovnanian, the company's CEO, Tuesday said U.S. housing won't likely get back to a "balanced marketplace" until 2010.

Meanwhile, 2008 will be "another challenging year" and he's not looking for strong earnings from home builders.

"By the tail end of 2008 we should get some positive momentum in sales, setting up a recovery in 2009," Hovnanian said. Home builders by then should return to profitability, although earnings will be more meager than the recent boom years, the CEO said at the UBS conference.

With at least 2 years to get back to some semblance of normalcy in the homebuilding industry there has to be some consolidation. That means some homebuilders will go under whilst others will be acquired by others with stronger balance sheets. Expect that consolidation phase to kick-in in earnest next year.

Ominous signs for US Commercial Real Estate

As noted a while back Commercial Real Estate and Retail spending will be the last shoes to drop signaling a recession. Two interesting posts appeared today on that topic suggesting Commercial Real Estate maybe about to take a turn for the worse. The First from Mish at MGETA:

Commercial Real Estate Heads South

Simmering beneath the surface and unbeknownst to most is a pronounced deterioration in commercial real estate. The evidence is can be seen in widening spreads in the tranches of Commercial Mortgage Backed Credit Default Swap Benchmark CMBX Indices.

Commercial real estate problems are in addition to massive problems in the guarantee business as evidenced by the huge widening of spreads on the two largest bond guarantee companies, Ambac Financial Group (ABK) and MBIA Inc (MBI).

For more on the systemic risk in the bond guarantee business, please see a Downward Spiral of Deep Junk.

Rising spreads represent a greater chance of default. In commercial real estate, most spreads are now wider than they were in the peak of the mid-summer credit crunch. This indicates two things:

* Problems that previously affected only residential real estate have now spread in a big way to commercial real estate.
* In spite of the big stock market rally off the summer lows, underlying credit conditions are deteriorating rapidly.

Click on the link to see the charts of the CMBX Mish talks about. The other post comes from Calculated risk, the author has an interesting graph showing tightening lending standards and demand for CRE loans is turning down sharply and if history is any guide that means CRE investment is sure to follow.


Commercial Real Estate Update

This graph shows the YoY change in nonresidential structure investment (dark blue) vs. loan demand data (red) and CRE lending standards (green, inverted) from the Fed Loan survey.

The net percentage of respondents tightening lending standards for CRE has risen to 50%. (shown as negative 50% on graph).

The net percentage of respondents reporting stronger demand for CRE has fallen to negative 34.6%.

Loan demand (and changes in lending standards) lead CRE investment for an obvious reason - loans taken out today are the CRE investment in the future. This report from the Fed suggests a slowdown in CRE investment in the near future.