Thursday, August 7, 2008

The Credit Crisis Isn't Anywhere Near Over

Every few weeks we get a new wave of "the bottom exists" in the financial shares happy talk. And then as if on cue, we get another wave of really bad news from the financial sector. Consider the following news we've seen this week so far.

From Marketwatch:

HSBC Holdings on Monday reported a 29% drop in first-half net income as bad-debt charges surged to more than $10 billion and write-downs continued to mount, though the banking giant increased its payout as profits in Europe and Latin America grew.

Loan-impairment charges and other provisions jumped 58% to $10 billion, with the majority of those bad-debt charges stemming from its U.S. business in personal financial services.

Overall, its North American operations reported a $2.89 billion pretax loss, compared to a profit of $2.4 billion in the first six months of 2007.

Loan impairment charges increased 58%. That is s huge increase. And the North American market is responsible for big losses. That means this segment of the world market isn't that great a place to be.

But here's the worst part:

HSBC, which bought U.S. lender Household International in 2003, is shrinking its U.S. mortgage book and said it will stop making new finance loans for vehicles.

The $13 billion vehicle-finance portfolio will be reduced by around 80% over three years, leaving the consumer-finance business mainly focused on credit cards and consumer loans.

At a time when the value of any of these bonds is highly questionable HSBC has to sell them. That's going to be murder on their bottom line until the process is complete. And then they get to time the best time in a bear market to sell these assets. Won't that be a whole lot of fun.

And then there is Freddie Mac:

Look past the devastating $821 million loss it reported for the quarter—nearly three times what Wall Street analysts had forecast. Ignore the $1 billion writedown the government-sponsored enterprise took on subprime and other risky mortgages, only the latest in a painful series. Disregard the rising rate of foreclosures, which grew 20% in the June quarter from the preceding quarter. Drill down to its fair value—a measure of the total worth of the assets on its balance sheet, minus its total liabilities. What do you see?

It looks an awful lot like a gaping hole. Freddie's fair value as of June 30 was a negative $5.6 billion. Based on this particular measure of its financial condition, if it had to sell its assets today, Freddie Mac would be worth less than nothing.

One of the largest players in the US mortgage market has a negative net worth. And they only wrote down $1 billion? Please. There is absolutely no way they only had $1 billion in losses on their mortgage portfolio -- not unless they were a whole lot smarter than everyone else in the mortgage market (and PS -- they weren't).

But, here's the news of the week that should indicate we're nowhere near bottom.

Mortgages issued in the first part of 2007 are going bad at a pace that far outstrips the 2006 vintage, suggesting that the blow to the financial system from U.S. housing woes will be deeper than many people earlier estimated.

An analysis prepared for The Wall Street Journal by the Federal Deposit Insurance Corp. shows that 0.91% of prime mortgages from 2007 were seriously delinquent after 12 months, meaning they were in foreclosure or at least 90 days past due. The equivalent figure for 2006 prime mortgages was just 0.33% after 12 months. The data reflect delinquencies as of April 30.


Data on other classes of mortgages suggest the same trend. Freddie Mac reported Wednesday that 1.38% of the 2007-vintage loans it purchased were seriously delinquent after 18 months compared with 0.38% of 2006 loans at the same point in their life. Freddie Mac generally purchases loans made to creditworthy borrowers.

Last month, J.P. Morgan Chase & Co. said it expects losses on prime mortgages that weren't securitized and remain on its books to triple from current levels. The increase in bad loans is driven mostly by jumbo mortgages originated in the second half of 2007, a company spokesman said.


Until these bad loans are fully digested, "foreclosures will remain at record highs, the financial system will be under severe stress and the broader economy will sputter," said Mark Zandi, chief economist of Moody's One piece of good news, he said, is that loans originated in the fourth quarter of 2007 and early 2008 appear to be performing better.

We're about 12-18 months into the 2007 vintage. This means we have at least another 12 months to go before we are through the initial problems of the portfolio. Until we are through these particular issues we can expect to hear about writedowns and the need to raise capital. That means the earliest we'll be out of the woods is next summer.