Morgan Stanley's (MS: 18.56 +2.26%) first quarter earnings are expected to be negatively effected by the recent rebound in its bond prices, according to a report by the Wall Street Journal Thursday. The Journal's sources told the pub that an "accounting treatment" used on certain bonds issued before the financial crisis escalated would cause the firm to take a hit anywhere from $1.2 billion to $1.7 billion on its quarterly earnings, which are due out later this month.

Although the bonds in question — valued recently at $29 billion — rallied recently, the Journal reported that the gains forced Morgan Stanley to increase the paper value of certain bonds it owes to investors. Morgan Stanley was trading at just over $24, up almost 7.5 percent, by mid-morning Thursday after the reports began circulating.

The anticipated impact on first-quarter performance would mark the second quarterly posting of worse-than-expected earnings. Morgan Stanley posted a substantial fourth-quarter loss of $2.19 billion, or $2.24 per share, driven by “unprecedented market turmoil” and mortgage-related write-downs. Fixed income sales and trading — which include its mortgage business — registered net losses of $1.2 billion.

“The global capital markets – and the financial services industry — have experienced unprecedented turmoil in the past few months,” chairman and CEO John Mack said in December. “These exceptional market conditions profoundly impacted our performance this year, especially in the fourth quarter.”

Write to Diana Golobay at diana.golobay@housingwire.com.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

Finally, a bit of good news from the banking industry. Wells Fargo & Co. (WFC: 29.60 +1.89%) on Thursday said it expects to post a record net income of $3 billion — or 55 cents per share — in its first-quarter earnings statement, which is due out April 22. The expected gain would come after accounting for $372 million in dividends paid to the Treasury Department on its TARP capital investment.

As part of the gain, Wells said it expects $20 billion in total revenue, offset by combined net charge-offs of $3.3 billion for both Wells and Wachovia (from $6.1 billion in the fourth quarter). Wells built its credit reserve by $1.3 billion, bringing the total credit loss allowance to $23 billion, the company said. The company also said it had seen stronger-than-expected business out of acquired Wachovia Corp.

“Wachovia’s outstanding franchise has proven to be everything we thought it would be when we announced this acquisition, and the financial contribution from Wachovia exceeded our expectations in the first quarter,” CEO John Stumpf said in the company's preliminary earnings statement. Wachovia's business contributed 40 percent of Wells' combined revenue, the company said.

“Business momentum in the quarter reflected strength in our traditional banking businesses, strong capital markets activities, and exceptionally strong mortgage banking results — $100 billion in mortgage originations, with a 41 percent increase in the unclosed application pipeline to $100 billion at quarter end, an indication of strong second quarter mortgage originations,” said chief financial officer Howard Atkins.

Wells said it had committed $175 billion in loans, mortgage originations and mortgage securities purchases in the first quarter, had seen $190 billion in mortgage applications from more than 800,000 prospective borrowers and had funded more than $100 billion in both purchase and refinance mortgage loans for more than 450,000 homeowners. The company also touted more than 150,000 "mortgage solutions" in the quarter.

Read the preliminary earnings statement.

Wells' shares were trading at $18.85, up almost 27 percent, shortly after the announcement when this story was published. The announcement marks a stark return from red territory entered in the fourth quarter of last year; Wells had posted a loss of $2.55 billion — or 79 cents per share — in late January. The loss, which excluded Wachovia's business, was Wells' first in seven years. Three short months later, the bank seems to have more than turned that around (ironic that early reports of the bank's anticipated return from the red came days before Easter Sunday, but we'll leave you to draw the similarities there).

The announcement also puts some perspective on last week's reports that Wells would soon offer up to $4 billion in warehouse lending to independent mortgage bankers that are finding themselves increasingly shut out of diminishing warehouse credit from fewer warehouse lenders. If the bank is in fact over the credit-crunch hump, so to speak, it may very well find itself in a position to offer quantities and forms of lending that were considered imprudent while banks were still getting their arms around huge default- and write-off-related losses.

What remains to be seen, however, is whether Wells' projections will hold up when it officially releases first-quarter earnings, whether this may signal a turnaround for other lenders that shed a substantial amount of red ink in the fourth quarter and whether any such turnaround implies a real bottom to the credit crisis. What's clear is that, for at least one lender, there is some kind of light flickering at the end of the tunnel.

Write to Diana Golobay at diana.golobay@housingwire.com.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

The Congressional Oversight Panel — aptly shortened to COP — which polices Treasury Department actions regarding the Troubled Asset Relief Program and monitors financial markets and the relating regulatory actions, in its April report took a critical look at the Treasury's strategy six months and a combined $4 trillion into the TARP implementation. The COP report, submitted Tuesday, also studied some strategies that could be used going forward based on their effectiveness in recent historical case studies, specifically liquidation, receivership, or subsidization of firms.

In the brief 150-page report file — complete with supplemental views and an exhaustive run-down on correspondence (at times lack thereof) with the Treasury — the COP stressed that historical lessons show the most effective response to banking crises has involved a combination of ousting "failed management" and liquidating banks. The April report scrutinizes the Treasury's responses in these areas, its general view of the causes of the crisis and how effectively it has implemented its goals in dealing with the crisis.

The COP found that through "an array of programs" within the TARP, in concert with the Federal Reserve's efforts on the secondary securitization markets side, the Treasury has spent or committed $590.4 billion. That's after the adjustment for expected spending through the Capital Purchase Program from $250 billion to $218 billion. The total value of all spending, loans, and guarantees — including those at the FDIC, Treasury and FED — has topped $4 trillion, COP said. But simply throwing billions of dollars around will not resolve financial crisis, as the April report went on to illustrate four "critical elements" to any resolution strategy: transparency, assertiveness, accountability and clarity.

COP members described assertiveness as a "willingness to take aggressive action to address failing financial institutions by (1) taking early aggressive action to improve capital ratios of banks that can be rescued, and (2) shutting down those banks that are irreparably insolvent." Accountability, panel members wrote, implies a "willingness to hold management accountable by replacing – and, in cases of criminal conduct, prosecuting – failed managers," while clarity in the Treasury's strategy will help consumers and investors know what to expect, bolster confidence in the system and encourage open communication with the administration

Liquidation: a 'Hobson's choice'?
Although the April report acknowledged some panel members disagreed on some findings, overall the COP report thoroughly outlined some pros and cons to the various strategies suggested. Under government reorganization, bad assets can be removed, failed managers can be ousted or replaced, and business segments can be spun off from the institutions. "Depositors and some bondholders are protected, and institutions can emerge from government control with the same corporate identity but healthier balance sheets," panel members wrote.

Another strategy, subsidization, entails government-provided financial resources to financial institutions "at risk of becoming insolvent." Although the panel members acknowledged an institution's bank holding company must support it before any institution receives aid, "by the time a crisis is reached, a distressed bank will have already exhausted available assets of its [holding company]," the COP wrote. The subsidization method, in which one weak institution receives federal aid while a stronger one continues without it, "can have a substantial negative impact on the functioning of competitive markets," panel members wrote. Subsidies also "carry a risk of obscuring true valuations," the COP noted.

"They involve the added danger of distorting both specific markets and the larger economy," the report reads, in part. "Subsidization also carries a risk that it will be open-ended, propping up insolvent banks for an extended period and delaying economic recovery…. Rather than subsidizing large distressed banks as going concerns through government investment under the TARP, critically undercapitalized banks could be selected for effective liquidation by being placed into the receivership of the [Federal Deposit Insurance Corp.]."

The COP report reiterated that in either a receivership or conservatorship, the FDIC can remove failed managers from these institutions, as well as sell assets at current market value, which would raise funds and remove bad assets from the bank's balance sheet.  The FDIC can also sell off parts of the institution's business, meaning it could "break up one or more large, systemically significant institutions into several smaller, more manageable banks." The process has worked in the past — and more than a dozen times so far this year — without consumer panic, the COP noted, because of the FDIC's long-standing reputation as a conservator. The liquidation method has its drawbacks, as well, report authors said.

"Some investors would nearly always be wiped out under liquidation or reorganization strategies," panel members noted in the report. "This is a harsh outcome, but the investors also reaped profits during the good times, for which they agreed to take the losses when things went sour."

Time is of the essence
The COP report acknowledged time as a continued essential factor in implementing any strategy — management-ousting, asset-liquidating or other. A fast implementation and clear exit strategy are necessary goals, but the question remains whether "time is on our side," panel members said.

"If, with the passage of time, assets will be restored to their earlier, true values and banks will come back to life on their own accord, then time is on our side," panel members wrote. "In such a case, the risks of action likely outweigh the risks of inaction." But the banking system itself could pose a timing issue, if the economy does not recover on its own, taking away the possibility of banks relying on a natural recovery of their balance sheets. Such a scenario could lead to indefinite reliance on federal funds, particularly by financial weak banks and institutions, the COP report noted.

"The existence of weak institutions that are sustained only by taxpayer guarantees and infusions of cash threatens the health of all banks, drawing off depositors and undermining public support," the COP report reads, in part. "Continued operation of systemically significant but weakened institutions at the heart of a nation’s financial system may prevent a robust economic recovery of the sort that would cause time [to] be on our side. In such a case, delay and half steps would seem to be the main enemy."

The Treasury has faced considerable criticism in recent months, not only for a combination of such "half steps," but for an overall lack of transparency in reporting details of its programs, goals and total funding initiatives. It's an issue that doesn't appear to be lost on the panel.

In a late-March letter, COP chairwoman Elizabeth Warren chided the Treasury's "lack of responsiveness" with regards to the recent public/private investment fund program (PPIP) announcement, details of which were not immediately provided to the panel, although it had previously requested details on all relevant programs.

"It is unacceptable," Warren wrote. "…Information from the Treasury…should be readily available to the Congressional Oversight Panel, and your failure to cooperate jeopardizes the credibility of the recovery process."

Read the report.

Write to Diana Golobay at diana.golobay@housingwire.com.

Fitch Ratings said Wednesday that it had placed 532 classes from 50 fixed-rate CMBS conduit transactions from the 2006 through 2008 vintages on Rating Watch Negative — meaning downgrades are highly likely in the next few weeks for affected deals. The rating agency said a recent review of the expected economic conditions and their effect on CMBS performance led the firm to estimate performance closer to a 'moderate to severe' scenario the agency ahd outlined last July, with commercial property values falling as much as 35 percent.

"While losses are yet to be realized, Fitch expects losses on these recent vintage transactions to average 4.5-5%, while certain deals, particularly from 2007 which contain large concentrations of loans with pro-forma underwriting could reach as high as 7.5%," Fitch said in a press statement. "This could impair credit enhancement to some of the 'AAA' (AJ) classes which may lead to their downgrade."

A sharp decline in economic conditions and the lack of available real estate financing have begun to impact commercial property and CMBS loan performance, Fitch noted — echoing comments earlier in the week from Standard & Poor's Rating Services, which said Tuesday that it, too, was likely to begin downgrading CMBS credits.

CMBS loan defaults increased approximately 95 basis points over the last year to 1.28 percent, according to Fitch; the agency said it expects defaults to reach 3.5 to 4 percent by the end of this year. The $18.1 billion affected by the ratings watch Wednesday adds to earlier collateral that had been placed on negative watch, bringing the total U.S. CMBS fixed rate deals on Negative Watch to $24.2 billion of the $272.1 billion outstanding from these vintages, the agency said.

Fitch also said that it expects on average that property cashflow from recent vintages will decline by 15 percent from current levels; the agency also said it expects commercial property values to decline an average of 35 percent from the original appraised amount, because these loans were originated in the peak of the market.

For more information, visit http://www.fitchratings.com.

Write to Paul Jackson at paul.jackson@housingwire.com.

The Federal Reserve has assumed an "unaccustomed" role in "dramatically and proactively" restoring vibrance — largely through fiscal stimulus — into the "grim" U.S. economy said Federal Reserve Bank of Dallas President Richard Fisher in Japan Wednesday.

But he said monetary policy alone won't cure the ailing economy. "Monetary policy accommodative techniques are necessary but insufficient to the task," Fisher told a symposium hosted by a private think tank in Tokyo. "The trick to fiscal policy is to provide the spark, to provide the right incentives, get the small and medium-sized firms to create jobs again, create dynamism in the economy without planting the seeds of inflation."

There is presently a "palpable lack of circulating confidence in the business community" in America, Fisher said.  And rightfully so — the economy contracted at an annual rate of 6.3 percent in the fourth quarter of last year, and Fisher said he expects that when the numbers are properly tallied, the contraction rate will be very similar for first-quarter 2009. All the while, the unemployment rate is rising and is expected by many, including Fisher, to surpass 10 percent by year-end.

Confronted with such a dysfunctional economy, Fisher said the federal reserve has undertaken a rapid series of initiatives — hence, expanding the Federal Reserve's balance sheet more than twofold from 2008. And "it is clear that we will grow our balance sheet even more…" he said — a prerogative which has fueled concerns over inflation, the demise of the dollar and the independence of the Federal Reserve.

"We realize … we are at risk of being perceived as monetizing the fiscal largess of Congress" and that by intervening in mortgage-based securities and other markets could be seen as blurring the lines between fiscal and monetary policy — a threat to the Fed's independence, he said.

But "we are the central bank of the largest economy in the world, and we are duty bound to apply every tool we can to clean up the mess that our financial system has become and get back on the track of sustainable economic growth with price stability."

Fisher didn't offer a projected timeline for recovery, but he assured the audience that the government's continued attempts to fuel a "spark" to the U.S. economy, wouldn't present a serious threat of inflation.

Write to Kelly Curran at kelly.curran@housingwire.com.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.