Grim Warnings; Bond Buyers Losing Confidence

Grim Warnings Send Ripples Through Markets

By Burton Frierson and Mike Peacock | 7 November 2007

NEW YORK/LONDON (Reuters)—

Bleak warnings of more pain to come in the credit sphere snowballed on Tuesday and fears of subprime losses yet to be unearthed rattled money markets. Bank of England Governor Mervyn King said it would take months for banks to reveal their full losses stemming from risky mortgages and former Federal Reserve chief Alan Greenspan said the housing debacle was a major risk to the U.S. economy. Red ink flowed as IndyMac Bancorp Inc (IMB.N), one of the largest independent U.S. mortgage lenders, posted a third-quarter net loss of $202.7 million due to mounting delinquencies and a collapse in investor demand to buy its home loans. The loss was five times larger than it had projected, giving life to investor fears of more skeletons in the financial sector's closet. Emblematic of the market's mood, Goldman Sachs (GS.N) had to deny swirling rumors that it may need to write down mortgage-related losses.

International Monetary Fund chief economist Simon Johnson said financial market anxiety may have entered a second phase that could cause more credit tightening. Meanwhile, BoE's King reminded investors the banking sector had a long slog ahead.

"I think most people expect that we have several more months to get through before the banks have revealed all the losses that have occurred, and have taken measures to finance their obligations that result from that, but we're going in the right direction," he said in an interview with the BBC.

Balance-Sheet Shock

As fears rise of more balance-sheet shock, economists worry that the deteriorating value of the mortgage debt and derivatives banks hold will choke off the traditional lending they do to the rest of the economy, dragging down growth.

Giving credence to these fears, billionaire investor George Soros forecast on Monday that the U.S. economy is "on the verge of a very serious economic correction" after decades of overspending.

"We have borrowed an awful lot of money and now the bill is coming to us," he said during a lecture at the New York University.

Rising money market rates showed heightened concern among banks about the credit-worthiness of their counterparts. London interbank offered rates for dollar deposits (LIBOR) posted their biggest increase since late September.

"We are watching the credit markets with concern," said Johnson at the IMF.

In Europe, Germany's Commerzbank (CBKG.DE) posted a third quarter net profit of 339 million euros ($493 million) after writing off 291 million euros of assets exposed to the market for risky U.S. mortgages.

Others have already announced far bigger hits.

The head of U.S. banking giant Citigroup (C.N) quit on Sunday, taking the blame for expected losses of $8-11 billion before taxes, on top of $6.5 billion it wrote off three weeks ago.

Charles Prince's departure came five days after Merrill Lynch & Co (MER.N) ousted its chief executive, Stanley O'Neal, following an $8.4 billion write-down there.

Citigroup on Tuesday named Richard Stuckey, who helped stabilize the Long-Term Capital Management LP hedge fund, to fix its troubled subprime mortgage portfolio.

Estimates of eventual total losses vary but all the figures put forward are staggering. JPMorgan (JPM.N) thinks the financial services industry is sitting on $60 billion in undisclosed losses. Bill Gross, chief investment officer at the world's No. 1 bond fund PIMCO, characterizes the subprime crisis as a "$1 trillion problem."

Move Those Homes

Greenspan said about $900 billion of subprime mortgages had been securitized into fixed-income instruments, and the excess level of unsold homes was driving price declines that are eroding the value of the securities backed by those mortgages.

"The critical issue on the whole subprime, and by extension the whole financial system, rests very narrowly on getting rid of probably 200,000-300,000 excess units in inventories in the United States," he said.


Bond Buyers Are Losing Confidence

By Vikas Bajaj | 7 November 2007

After a recuperative October, investors in the credit markets are starting to feel a familiar sense of dread.

Investors and analysts say the large write-downs of mortgage securities by Citigroup and Merrill Lynch have unnerved the debt markets in the last week, though conditions are generally better than they were during the credit crisis in August.


Investors say they are most troubled by the accelerating pace of write-downs and credit downgrades in the residential mortgage area, but they are also starting to question the value of bonds in related areas like commercial mortgages and consumer debt. For instance, an index that tracks the cost of protecting bonds tied to commercial mortgages has surged since the end of October.

"In the market right now, things feel pretty fragile," said Derrick M. Wulf, a portfolio manager at Dwight Asset Management, an investment firm based in Burlington, Vt. "And it’s a function of people losing confidence, no longer believing everything they hear."

Unlike August, the markets for the investment-grade debt issued by nonfinancial corporations are functioning fairly normally, though prices are not as lofty as they were earlier in the year, analysts say.

Prices on riskier assets are falling, however, with high-yield debt falling steadily in the last three days of trading. The yield on those bonds, which moves in the opposite direction of price, jumped to 9.41 percent yesterday, from 9 percent at the end of October, according to the Finra-Bloomberg Active High Yield US Corporate Bond Index.

In the stock market, the worst losses have come among financial stocks, which are down 7.3 percent in the last five days. By contrast, technology and utility stocks are up about 1 percent. Trading is most strained in residential mortgage securities that are not guaranteed by government-chartered agencies like Fannie Mae and Freddie Mac.

"Buyers are very nervous about defaults in these securities," said Christian Stracke, an analyst at CreditSights, a bond research firm. "It’s not that the buyers don’t know what the value of these securities is. It’s that they believe it’s very low and the sellers are not ready to come to terms with that fact."

In the last few days, though, many big banks have been forced to acknowledge that the securities may be worth a lot less than they thought. Citigroup said yesterday that it would take at least through the middle of next year to clean up the mess from credit market losses. Its stock fell another 4.9 percent yesterday despite assurances from company officials that it would maintain its dividend.

In part, they are responding to a wave of downgrades to highly rated bonds issued by collateralized debt obligations, which in turn hold other bonds. "These downgrades are happening quicker than the banks can write down these securities," said Ed Rombach, a derivatives market analyst at Thomson Financial.

In a sign of the secondary effects that are still to come from the downgrades of mortgage securities, Fitch Ratings said yesterday that it was reviewing its ratings of financial guarantors that insure many of the debt obligations that have been downgraded in recent weeks.

Investors are also increasingly expressing concern about the health of the commercial mortgage market after a boom that was similar to the run-up in the residential market. In recent years developers built scores of office buildings, hotels and condominium towers in New York, Miami, Las Vegas and other big cities. At the height of that market this year, bankers were lending 100 percent or more of the value of projects being built or refinanced.

Default rates have been at historic lows because of low vacancy rates and rising real estate values. But investors are increasingly betting that they will rise as the economy and the job market weakens, according to trading in the CMBX index from the Markit Group which tracks the cost of insuring against losses in commercial mortgage bonds.

Another sign of growing stress in that market comes from data on how many commercial loans are being packaged into securities by investment banks. In October, banks issued just $8.6 billion in commercial mortgage deals, down from a monthly average of nearly $66 billion for the first nine months of the year, according to Thomson Financial. Commercial securitizations peaked at $131 billion in June and have since fallen steadily.

"Across the board, it’s tough to see these things go as far as subprime has," Mr. Stracke said about commercial mortgage bonds. "But that’s not to say there is not more trouble ahead."

Normxxx    
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