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5 CREDIT BUBBLE
BULLETIN Respite's
over By Doug Noland
COMMENTARY The autumn respite
from summer Credit tumult has run its course.
Global central bankers may have succeeded at least
temporarily in their aggressive liquidity
operations. This liquidity, however, has
characteristically avoided post-Bubble risky
mortgages and mortgage-related derivatives. Today,
a strong case can be made that Monetary Disorder
was only exacerbated. To be sure, the
unfolding spectacular bursting
of the Mortgage Finance Bubble runs unabated.
Meanwhile, myriad other global Bubble excesses
have gone to only more dangerous extremes –
certainly including global equities markets.
It was a week of worrying developments.
The degree of mortgage Credit deterioration was
confirmed by the dreadfully rapid earnings
deterioration being reported by the banking
industry. And the housing data out of California
suggests an unfolding disaster. If market
sentiment doesn't recover soon – and it’s not easy
to envision such a scenario in the face of a
strangling Credit tightening – we’ll be witnessing
a housing bust of historic proportions.
From Wednesday’s Los Angeles Times (Peter
Y. Hong and Maura Reynolds): “Home sales in
Southern California plummeted in September to a
two-decade low… ‘We’re on our way down and still
picking up speed,’ said Christopher Thornberg, a
Los Angeles-based economist… According to
Dataquick, September Southern California homes
sales were down 48.5% from a year earlier to the
lowest level since at least 1988. Things weren’t
much better up north. Dataquick puts Northern
California sales down 40% from a year ago. For the
entire state, September sales were down 27% from a
terrible August to the lowest sales in 20 years.
The lack of jumbo mortgage availability received
widespread blame. Credit conditions will likely
tighten further.
It is an ongoing theme
that I don’t expect Credit insurance (in its
various contemporary forms) to survive the
unfolding downside of the Credit Cycle. Current
tumult in the mortgage derivative arena is cause
for concern. The rapid deterioration in the
mortgage insurance business is quite alarming.
October 18 – Bloomberg (Erik Holm): “MGIC
Investment Corp., the largest U.S. mortgage
insurer, posted its first quarterly loss in 16
years and said it won’t be profitable in 2008 as
foreclosures increase from record levels. The net
loss of $372.5 million…was the worst quarter…since
it went public in 1991… Costs to bail out lenders
tripled to $602.3 million as home prices in the
biggest U.S. markets fell, making it harder for
banks to recover when loans go sour. Chief
Executive Officer Curt Culver said on a conference
call today that real estate prices may drop 10%
nationally over the next 18 months… MGIC wrote off
its $466 million investment in Credit-Based Asset
Servicing and Securitization LLC, jointly owned
with Radian Group Inc., after demand for subprime
loans collapsed… Culver blamed much of the surging
losses on larger claims from bigger mortgages and
fewer delinquent mortgages being returned to good
standing as housing markets deteriorated,
particularly in California and Florida… The number
of borrowers more than 60 days behind on privately
insured loans jumped 30% from year-earlier levels
in August… The company is forecasting declines in
home values of 20% in the Phoenix area, 18% in Las
Vegas, 13% in Orlando, Florida, and 7% in Los
Angeles over the next two years.”
October
18 – Bloomberg (Erik Holm): “PMI Group Inc., the
second-largest U.S. mortgage insurer… said today
it will lose $1.05 a share in the period and
withdrew earnings forecasts for the year… The cost
to bail out lenders is expected to increase
fivefold from the same period a year earlier to
about $350 million…PMI said… Stagnant home prices
make it harder for banks to recover when loans go
bad.”
There are certainly grounds today to
suggest that the unfolding California housing bust
will test the viability of mortgage insurance
industry. MGIC, in particular, noted increased
Credit losses in higher-end homes and in the
Golden State. But I don’t believe anyone has
modeled in the type of housing crisis that is
unfolding. This thinly capitalized industry in on
the hook for Trillions of insurance exposure. And
as the debt market begins to question the ongoing
solvency of these insurers, a major additional
uncertainty will plague the vulnerable
“private-label” ABS and MBS marketplaces.
Moreover, the thinly-capitalized GSEs have huge
exposure to the fragile mortgage insurance
industry. The next stage of the mortgage meltdown
is at hand.
Unfortunately, I don’t have
time this evening to properly highlight what was a
very poor week of bank earnings. Almost across the
board, Credit deterioration was much worse than
had been expected. It will get much worse.
October 19 – Bloomberg (David Mildenberg):
“Wachovia Corp. reported its first earnings
decline in six years and missed analysts'
estimates after a record $1.3 billion of
writedowns for bad loans and mortgage-backed
securities… Profit at the five biggest U.S. banks
totaled $18.7 billion for the quarter, the lowest
in almost four years, as demand for securities
linked to mortgages and leveraged loans dried up…
Home foreclosures have forced banks to write down
the value of mortgages and home equity loans.
Citigroup, Bank of America and JPMorgan together
wrote down more than $2.5 billion in loans for
leveraged buyouts of companies.”
October
19 – Bloomberg (David Mildenberg): “Wells Fargo
& Co., Regions Financial Corp., and KeyCorp,
three of the biggest U.S. banks, posted
lower-than-estimated third-quarter profit and said
rising loan losses may hurt future earnings.”
October 17 – Bloomberg (Elizabeth Hester
and Charles V. Zehren): “SunTrust Banks Inc.,
Huntington Bancshares Inc. and BB&T Corp.
posted third-quarter profits that fell short of
analysts’ estimates as the worst housing market in
16 years forced the regional lenders to write down
the value of bad loans. Net income at SunTrust of
Atlanta declined 23% while profit at… Huntington
fell 12%... None of the companies had a bigger
decline than the second-largest U.S. lender --
Bank of America Corp. of Charlotte, North,
Carolina -- which said earnings dropped 32% on $4
billion in writedowns and trading losses. Record
foreclosures and a decline in the value of
securities related to subprime mortgages forced
the banks to set aside more money to cover future
losses. SunTrust, the third-largest bank in
Florida, more than doubled its provision for loan
losses to $147 million and said loans no longer
paying interest climbed about 70% to $1 billion.”
From Bank of America’s Q3 earnings
release: “Unprecedented market disruptions
impacted trading results. As a result, Global
Corporate and Investment Banking (GCIB) net income
fell 93% to $100 million from $1.43 billion a year
earlier. Capital Markets and Advisory Services, a
business within GCIB which includes Liquid
Products, Credit Products, Structured Products and
Equities, posted a $717 million net loss compared
with net income of $298 million a year earlier.
Included in the net loss for the quarter were $247
million in markdowns...on leveraged and non-
leveraged loans and commitments. Contributing to
the loss in Credit Products was a $607 million
trading revenue loss due principally to the
breakdowns in traditional pricing relationships,
which made hedges ineffective, and the widening of
credit spreads. Structured Products, which
includes asset-backed and residential
mortgage-backed securities, commercial mortgages,
collateralized debt obligations (CDOs) and
structured credit trading had a net revenue loss
of $527 million. The loss arose from lower
investment banking fees and trading declines
principally due to the same conditions affecting
Credit Products... Provision for credit losses was
$2.03 billion, up from $1.81 billion in the second
quarter of 2007, and $1.17 billion in the third
quarter of 2006. Net charge-offs were $1.57
billion, or 0.80% of total average loans and
leases. This compared with $1.50 billion, or 0.81
percent, in the second quarter of 2007 and $1.28
billion, or 0.75%, in the third quarter of 2006.”
From Citigroup’s Q3 earnings release:
“This was a disappointing quarter, even in the
context of the dislocations in the sub-prime
mortgage and credit markets. A significant amount
of our income decline was in our fixed income
business... Fixed income markets revenues declined
$1.64 billion to $671 million, driven primarily
by: Losses of $1.56 billion, net of hedges, on
sub-prime mortgages warehoused for future CDO
securitizations, CDO positions, and leveraged
loans warehoused for future CLO securitizations.
Losses of $636 million in credit trading due to
significant market volatility and disruption of
historical pricing relationships... ending
revenues declined 14% to $412 million, primarily
driven by write-downs of $451 million, net of
underwriting fees, on funded and unfunded highly
leveraged finance commitments...Net investment
banking revenues were $541
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