Heading into the most recent third quarter earnings season, prevailing wisdom held that the quarter's earnings reports would be of the so-called 'kitchen sink' variety -- in which market participants purge all of the bad news at once. While the earnings news in the mortgage industry this past quarter has certainly been mostly bad (and in some cases surprisingly bad), it's pretty clear yet that earlier prevailing wisdom has been replaced by what can best be described as market uncertainty. Morgan Stanley on Wednesday reported a $3.7 billion writedown tied to its subprime exposure, and today Wachovia followed suit, saying the value of its subprime holdings had lost $1.1 billion. The bank also said it would set aside as much as $600 million to cover loan losses. From Bloomberg:
"Any financial institution holding any of this paper doesn't really have a good grasp on what the true value is," said Michael Nix, who helps manage $800 million at Greenwood Capital Associates, in Greenwood, South Carolina, including 116,864 Wachovia shares. "We'll see continued writedowns that come out of the fourth quarter." Wachovia Chief Executive Officer Kennedy Thompson bought Golden West Financial Corp. for $24 billion in October 2006 to expand into California as housing prices reached peak levels. California and Florida are now Charlotte, North Carolina-based Wachovia's most challenging markets as more borrowers pay late or default on their mortgages, Chief Risk Officer Donald Truslow said on a conference call today ... "The housing market has been deteriorating very, very quickly in certain parts of the country," Truslow said. "We are not immune."
Wachovia isn't alone, with both Bank of America and JPMorgan saying today that they'll face further write-downs amid worsening problems in the secondary markets and increasing losses on non-performing mortgage loans. In an SEC filing today, BofA said it expects "extreme dislocations" in credit markets to "adversely impact" fourth quarter results. Some interesting language in the discussion section (emphasis added):
Subsequent to September 30, 2007 the credit ratings of certain structured securities (i.e., CDOs) were downgraded which among other things triggered further widening of credit spreads for this type of security. We have been an active participant in the CDO market and maintain ongoing exposure to these securities (see pages 78 and 90 for a further discussion of our CDO exposure). We expect these significant dislocations in the CDO market to continue, and it is unclear what impacts these dislocations will have on other markets in which we operate or maintain positions. ... We anticipate that these developments will adversely impact our results during the fourth quarter.
It looks like even financial giants like Bank of America are starting to realize how bad of an idea it was to invest heavily in something so opaque (BofA said today it holds an estimated $2.4 billion of CDOs, although most HW readers know that value is pretty much a guess). On to JPMorgan, per Bloomberg:
JPMorgan, based in New York, said today that it had $40.6 billion of loans to finance leverage buyouts as of Sept. 30, along with unfunded commitments that were difficult to hedge. "Further markdowns could result if market conditions worsen," the company said in its quarterly report. The slowdown in the mortgage market may make it harder to sell LBO loans, the bank said. Investment banking fees and trading revenue may also decline in the fourth quarter, along with collateralized debt obligations, subprime mortgage holdings and trading positions, the bank said.
I feel the need to remind everyone that a lot of this mess is rooted in early-stage losses that appeared in subprime mortgage-backed securities, and the associated loss of market confidence that went with it. I also feel the need to remind everyone that we aren't going to see the worst losses in terms of subprime mortgages until after the first quarter of 2008...