Banks fear a new round of write-downs

The International Herald Tribune

February 20, 2008 Wednesday

BYLINE: Jenny Anderson - The New York Times Media Group

SECTION: FINANCE; Pg. 16

Wall Street banks are bracing for another wave of multibillion-dollar losses as the crisis that began with subprime mortgages spreads through the credit markets.

In recent weeks, one part after another of the debt market has buckled. High-risk loans used to finance corporate buyouts have plummeted in value. Securities backed by commercial real estate mortgages and student loans have fallen sharply. Even auction-rate securities, arcane investments usually considered as safe as cash, have stumbled.

The breadth and scale of the declines mean more pain for major banks, which have already written off more than $120 billion in losses stemming from bad investments related to mortgages.

The deepening losses might make banks even more reluctant to make the loans needed to prod the slowing U.S. economy. They could also force some banks to raise more capital to bolster weakened finances.

The losses keep piling up. Leading brokerage firms are likely to write down the value of $200 billion in loans they have made to corporate clients by $10 billion to $14 billion during the first quarter of this year, Meredith Whitney, an analyst at Oppenheimer, wrote in a research report last week.

Those institutions and global banks could suffer an additional $20 billion in losses this year on securities and other debt instruments tied to commercial mortgages, according to Goldman Sachs, which predicts commercial property prices will decline by as much as 26 percent.

Analysts at UBS go further, predicting that the world's largest banks could ultimately take $123 billion to $203 billion in additional write-downs on subprime-related securities, structured investment vehicles, leveraged loans and commercial mortgage lending. The higher estimate assumes that the troubled bond insurance companies fail, a possibility that, for now, is relatively remote.

Such dire predictions underscore the way the turmoil in the credit markets is hurting Wall Street, even as the U.S. Federal Reserve reduces interest rates. Already, once-proud institutions like Merrill Lynch, Citigroup and UBS have humbly gone to Middle Eastern and Asian investors to raise capital.

''You don't have a recovery until you have the financial system stabilized,'' Whitney said. ''As the banks are trying to recover they will not lend. They are all about self-preservation at this time.''

One of the latest areas to come under pressure is the leveraged loan market. In recent weeks the market for these corporate loans has plummeted, driven by fear that banks have too many loans to manage.

Prices have fallen as low as 88 cents on the dollar, levels not seen since 2002, when default rates were more than 8 percent. Loans to some companies, like Univision Communications and Claire's Stores, are trading in the high 70s, analysts say.

When banks make loans, they hold them until they can sell the debt to institutional investors like hedge funds and mutual funds. But lately the market for this debt has seized up and many banks have been unable to unload the loans. As the value of this debt declines, lenders must recognize as a loss the difference between the value at which they made loans and the prices of similar debt in the secondary, or resale, market.

''This correction feels a lot deeper and wider and more prolonged than what we have seen historically,'' said one senior Wall Street executive who was not authorized to speak to the media.

Many analysts say that the financial health of many companies has not deteriorated as much as loan prices suggest.

''People don't know what's out there, they haven't sorted out what's good and what's bad, so they are throwing all credit assets out,'' said Meredith Coffey, director of analysis at Reuters Loan Pricing. Median loan prices were lower than those in 2002 when defaults peaked, even though very few defaults have actually occurred.

There has also been a marked deterioration in the market for commercial mortgage-backed securities, which are commercial mortgages packaged into bonds.

To some, the troubles plaguing commercial mortgage securities seem a logical extension of the turmoil in the residential real estate market. But some strategists argue that the commercial real estate market is not as vulnerable as the housing market. The pressure to package loans that was so evident in the residential market never materialized in the commercial market, these analysts say.

Also, commercial loans tend to be made at fixed, rather than adjustable, rates, and are not usually refinanced for long periods of time.

Nevertheless, the cost of insuring a basket of commercial mortgage-backed securities has soared. Last October, for example, it cost $39,000 to insure a $10 million basket of top-rated 2007 commercial mortgages - super senior AAA, in Wall Street language - against default.

Today that price has increased to $214,000. For triple-B-rated securities backed by commercial mortgages the cost of protection during the same time has soared from $672,000 to $1.5 million.

The deterioration of the CMBX, the benchmark index that tracks the cost of such credit protection, ''started off as a fundamental repricing and then it escalated into something much more than that,'' said Neil Barve, a research analyst at Lehman Brothers. ''We think there is some downside in a challenging macroeconomic environment, but not nearly what has been priced in.''

Goldman Sachs seems to disagree. Its analysts predict commercial real estate loan losses totaling $180 billion, with banks and brokers bearing $80 billion of that in total and about $20 billion this year.