Is The Worst of the Credit Crunch Behind Us?
One of the more common refrains we keep hearing is that the worst of the credit crisis is behind us. Not only that, but banks have written down so much bad debt, that there is an upside surprise ahead of us!
I'm not so sure about that. As to the first part, credit spreads, mortgage rates, and the actions of the Bank of England strongly imply we are still in the thick of it. As to the latter, I simply doubt management has been that forthcoming.
I am not the nly one with such doubts. The WSJ looks at the specific accounting quirks that allow banks to write down much less bad debt -- about 20% less -- than they actually have:
"Outsize losses reported last week by Citigroup Inc. and Merrill Lynch & Co. could have been a lot worse except for a quirk in the way companies account for different types of securities.
Citigroup took $15 billion in write-downs and credit charges, leading the big bank to report a first-quarter loss of $5.1 billion. But $2.3 billion in other write-downs didn't hit the company's income statement.
The same was true at Merrill. The broker had $6.6 billion in write-downs, leading to a loss of $1.9 billion. But Merrill took at least $3.1 billion in other write-downs that didn't count toward its loss."
Best of all, its all legal according to the accounting rules:
"So, where did those other charges go? Into a special bucket in shareholders' equity called "other comprehensive income." The beauty of this bucket is the charges land on the balance sheet, but don't dent the companies' bottom line.
It all gets down to how a company classifies a security. A company can say it plans to hold a security until it matures, that it is available for sale or that it is being actively traded. Securities being held to maturity are held at their original cost and their value is written down only if they are deemed to be impaired. Securities that are traded are always marked to market, and gains or losses immediately hit profit.
The available-for-sale category is a middle ground in which the value of the securities is written down or up depending on market prices, but the loss or gain ends up in the "other comprehensive income" bucket. It stays there until the change in value is considered more permanent. At that point, a company finally takes the losses out of the bucket, and they hit the bottom line.
How much worse the balance sheets of the major banks and brokerages will get before the credit crunch is fully behind us is still anyone's guess. Those of you who have been trading the beaten up banks best be nimble enough to reverse course if another leg down starts.
As to BoE, their announcement today of a plan to swap about "50 billion pounds ($100 billion) of government bonds for mortgage-backed securities to lower credit costs" shows the global impact of the credit crunch remains unabated:
The plan will "unfreeze the situation we've got at the moment,'' Chancellor of the Exchequer Alistair Darling said yesterday in an interview with the BBC, without specifying how much would be made available. "What the Bank of England will do is, in effect, lend the banks that money. In the meantime, the Bank of England will take a security.''
Prime Minister Gordon Brown's government is trying to encourage lending after a surge in borrowing costs prompted banks to withdraw their best mortgage offers, threatening to exacerbate the worst housing downturn since 1992. The plan is a change of approach by the Bank of England after three interest-rate cuts since December failed to ease the logjam."
Some people have been calling the banks an opportunity of a lifetime. I am far less sanguine about the sector over the intermediate and longer term. This remains a troubled sector, with its losses not fully realized yet.
Credit crisis a "global calamity"--Kaufman
Reuters, Fri Apr 18, 2008 11:40am EDT http://www.reuters.com/article/ousiv/idUSN1845613820080418
A Way Charges Stay Off Bottom Line
WSJ, April 21, 2008; Page C1
Bank of England Will Unveil Swap to Ease Home Lending
John Fraher and Gonzalo Vina
Bloomberg, April 21 2008
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They are the opportunity of a lifetime on traditional valuation and earnings analysis. I also think we're looking at "Boiled Frog" syndrome. For the traditional view to be right the existing business models which shifted to trading on own account using leverage from the original get fees, provide services and make sound loans has to be sustainable, right and executable. If the Finance Industry as a whole fails any of those tests then the traditional analysis. Personally IMHO we're facing a decade long worth of work to re-think the business models and improve the management systems. And the work hasn't begun because there is general denial that it's required. That's hardly my sole opinion and several astute observers have made similar ones:
http://tinyurl.com/4tytv2 or http://tinyurl.com/48ggwk for some readings on the subject including JPM's that we're facing a decade of turmoil.
Posted by: dblwyo | Apr 21, 2008 8:19:19 AM
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