Posted by Becca_FL on 3/6/07 8:55am
Msg #178442
The latest on subprime...and the bail out.
I found this on another board.
Subprime Wreckage
Entices Bargain Hunters
Some Wall Street Banks
Bet Big on a Recovery
In Risky-Loan Game
By MICHAEL HUDSON, JAMES R. HAGERTY and KATE KELLY
March 6, 2007; Page C1
As fallout spreads from soaring defaults on riskier home-mortgage loans, some big investors see a recovery coming and are preparing to increase their bets on the so-called subprime market.
Others already have reaped big gains wagering against it.
Yesterday, shares of one of the biggest subprime lenders, New Century Financial Corp., plunged 69% on the New York Stock Exchange in the wake of Friday's disclosures that the company can't quantify losses for 2006 and that federal authorities are investigating stock trading ahead of its recent reports of accounting problems. Fremont General Corp., another big subprime lender, shut down its subprime business over the weekend; its stock fell 32% on the NYSE. In all, more than two dozen subprime lenders have been forced to close in recent months.
Wall Street firms already have tentacles in almost every corner of the risky market. They bankroll subprime lenders with credit, package and sell bonds backed by their loans, and operate their own subprime lending shops. New Century alone had $8.5 billion in credit lines with four investment banks as of late last year -- Credit Suisse Group, Morgan Stanley, Bank of America Corp. and UBS AG. In the past year, such firms have made a bigger push in this area, buying more subprime lenders.
"We think that in the long term, there's a very good business there," Warren Spector, co-chief operating officer of Bear Stearns Cos., told investors last month. Bear Stearns last month completed a takeover of subprime lender Encore Credit Corp.
Last week, Citigroup Inc. jumped deeper into the fray when it struck a deal to shore up ACC Capital Holdings Corp., parent of subprime lender Ameriquest Mortgage. The move comes a few years after Citigroup agreed to pay hundreds of millions of dollars to settle federal allegations of subprime-lending abuse. A Bear Stearns report says subprime mortgages represent 25% of Citigroup's total $160.9 billion in mortgages and 6% of its total loan portfolio of $695.9 billion.
"We think this is an important market in which borrowers need access to credit that is appropriately structured and provided, and investors seek access to quality products," said a Citigroup spokeswoman.
J.P. Morgan Chase & Co. recently sold most of the subprime mortgages that it originated last year, but Chief Executive James Dimon said that he would have "no problem" scooping up some of those loans if the price was right.
Some firms have reduced their risks in recent months by cutting off troubled lenders' credit, pushing some to the brink -- and creating fire-sale prices for other firms.
After buying $3.5 billion of loans from ResMae Mortgage Corp., Merrill Lynch & Co. in December demanded that the company buy back $308 million worth that were in default. The move pushed ResMae to bankruptcy court last month, setting the stage for a takeover auction. Citadel Investment Group LLC appears to have outbid Credit Suisse for the assets.
Such moves are pretty risky, analysts say. "Some investment banks will discover that it's harder to operate a mortgage-production business than they thought," says Morgan Stanley analyst Kenneth Posner.
Over the past year or so, investment banks had a great run, but since Feb. 22, shares of Lehman Brothers Holdings Inc., Bear Stearns, Goldman Sachs Group Inc. and Merrill Lynch -- which all have mortgage exposure -- are down about 13% each.
Yesterday, Standard & Poor's downgraded Merrill's shares to "hold" from "strong buy." S&P analyst Matthew Albrecht said in an interview, "All the news of subprime defaults coming out and big players in the market saying late-payment rates are going up should cause anybody in the sector to re-evaluate it."
Trouble for the firms may also be brewing in the market for credit default swaps -- essentially insurance policies that pay off when bonds drop in value. Analysts at Moody's Credit Strategy Group say that based on last week's swap prices, the implied market rating for Goldman, Bear Stearns, Lehman, Merrill and Morgan Stanley have slipped several notches below their actual credit ratings. The market is subject to swings and could easily bounce back. "The [credit default swap] market tends to overreact a little bit," says Allerton Smith, a senior vice president in the strategy group.
Still, a recent research report by Sanford C. Bernstein & Co. concludes that even if subprime performance gets worse, Bear Stearns and Lehman Brothers would suffer no more than a 4% to 5% reduction in earnings, while Merrill Lynch, Goldman Sachs and Morgan Stanley would absorb much smaller hits.
In the past, big firms with subprime investments ended up with costly headaches. In 2000, Wachovia Corp.'s corporate predecessor, First Union Corp., took a $2.8 billion charge mostly relating to shutting The Money Store Inc., which it had bought two years earlier for $2.1 billion.
HSBC Holdings PLC entered the U.S. subprime market in 2003 by shelling out $14 billion for Household International Inc. The company acknowledged last month that its systems for assessing loan applicants and avoiding defaults were flawed. Yesterday, HSBC said its bad-debt costs soared 36% to $10.57 billion in 2006.
Big banks could also see less revenue from selling subprime-mortgage-backed securities as fewer bond deals are launched.
A report from S&P says subprime-mortgage bond volume declined by 29% from the fourth quarter of 2005 to the same period in 2006. David Williams, a Morgan Stanley analyst, estimates the downturn in the subprime market could produce earnings hits totaling $2.1 billion for five European banks: Barclays PLC; Credit Suisse; UBS, of Switzerland; Germany's Deutsche Bank AG; and Royal Bank of Scotland Group PLC.
Many investors and analysts predict that some of the biggest mortgage lenders will emerge stronger as weak rivals are forced out. Ed Groshans, an analyst at Fox-Pitt, Kelton Inc. in New York, predicts that large home lender Countrywide Financial Corp. will gain market share as it has in the wake of past slumps. Less than 10% of Countrywide's lending business falls below prime quality, and the company began scaling back on the riskiest types of loans more than a year ago, he says.
Other mortgage lenders he thinks will emerge strongly from the current turmoil include Wells Fargo & Co., J.P. Morgan Chase, Citigroup and IndyMac Bancorp Inc.
Meanwhile, some hedge-fund managers have made money betting against the subprime market. James Melcher, who runs a $100 million hedge fund for Balestra Capital Ltd. in New York, reported big gains recently on derivative contracts that rise in value when mortgage defaults increase. His hedge fund lost almost 4% last year because defaults remained subdued. Through the end of February, though, he is up 10%, topping most other hedge funds and market indexes.
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