Wall Street Junkies

The easy availability of money has facilitated the Privateers to buy out companies, load them up with debt, cash themselves out and then flog the debt-bloated companies back on the market to fund managers, who duly buy them with your money. Guambat has blogged on ad nauseum on this subject.

But now they are doing unto themselves as they have done unto others: sort of a "Goldie Rules".

Goldman, Merrill Almost `Junk,' Their Own Traders Say (Update2) By Shannon D. Harrington
Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds.

Prices for credit-default swaps linked to the bonds of the New York investment banks this week traded at levels that equate to debt ratings of Baa2, according to Moody's Investors Service. For Goldman, Morgan Stanley and Merrill that's five levels below the actual Aa3 rating on their senior unsecured notes and two steps above non-investment grade, or junk.

Traders of credit derivatives are more alarmed than stock and bond investors that a slowdown in housing and the global equity market rout have hurt the firms. Merrill since 2005 has financed two mortgage lenders that subsequently failed and bought a third, First Franklin Financial Corp., for $1.3 billion.

"These guys have made a lot of money securitizing mortgages over the years in a mortgage boom time," said Richard Hofmann, an analyst at bond research firm CreditSights Inc. in New York. "The question now is what is the exposure to credit risk and what are the potential revenue headwinds if they're not able to keep that securitization machine humming along."

Morgan Stanley and Goldman were among the top five traders of credit-default swaps in 2005, a group that represented 86 percent of the market, according to a September Fitch Ratings report. Lehman, Merrill and Bear Stearns were among the top 12.

The contracts were conceived by Wall Street to protect bondholders against default and pay the buyer face value in exchange for the underlying securities should the company fail to adhere to debt agreements. An increase in price indicates a decline in the perception of creditworthiness; a drop means the opposite.

Contracts tied to Morgan Stanley, Merrill, Lehman Brothers Holdings Inc. and Bear Stearns Cos. also are at 19-month highs.

Subprime mortgages, loans taken out by homebuyers with poor or limited credit histories, typically charge rates at least two or three percentage points above safer, so-called prime loans. They made up about a fifth of all new mortgages last year, according to the Washington-based Mortgage Bankers Association.

At least 20 lenders have shut down, scaled back or been sold this year. Countrywide Financial Corp., the biggest U.S. mortgage lender, yesterday said borrowers were at least 30 days past due at the end of last year on almost a fifth of the subprime loans that it serviced for others.

"There's been a little bit of a reappraisal of the financial sector, with a strong desire to get away from subprime exposure," said Scott MacDonald, director of research at Aladdin Capital Management LLC in Stamford, Connecticut, which manages $16.5 billion in assets.

Merrill equity analysts two days ago cut their recommendations on Goldman, Lehman and Bear Stearns shares as well as that of European banks Deutsche Bank and Credit Suisse Group to "neutral" from "buy" because they said earnings will probably decline next month as investors become wary.

Bear Stearns's stake in non-investment grade retained mortgage securities, or what its keeps from packaging loans into bonds, represents about 13 percent of the firm's "tangible" equity, according to CreditSights.

For Lehman, it's 11 percent. Goldman, Morgan Stanley and Merrill don't disclose how much of their total retained securities are rated below investment grade, or junk. Overall, their exposure is in "the low- to mid-teens," CreditSights said.

"Disclosures are kind of lacking," Hofmann at CreditSights said in an interview. "They don't tend to break out the subprime piece of their retained interest."

Subprime Troubles Grow

Federal bank regulators announced a crackdown on loose lending standards on subprime home mortgages as two major lenders struggled to cope with losses and regulatory problems.

New Century Financial Corp., one of the nation's largest subprime lenders, announced that it has been informed of a federal criminal inquiry into its accounting and trading in its securities. New Century also said that a failure to obtain waivers from lenders or find new funding sources could prompt its auditors to warn of "substantial doubt" over its ability to remain in business.

Another big lender, Fremont General Corp., said it plans to stop making subprime residential loans and is in talks with various parties aimed at selling that business. Subprime loans are those for people with weak credit records or high debt in relation to income.

A proposed policy statement released Friday by regulators comes after rising defaults already have rattled investors and forced subprime lenders to be more cautious in extending credit. "There seems to be a growing realization that not everybody can buy a house today," said Scott Stern, chief executive of Lenders One, a St. Louis-based cooperative for mortgage-banking firms. Lenders will have to tell some borrowers to save for a down payment, he said.

US triggers $11bn HSBC fall-out by John Waples and Grant Ringshaw

EUROPE’s biggest bank, HSBC, is to write off $11 billion to cover mounting losses in its troubled American offshoot, HSBC Finance Corporation.

Stephen Green and Mike Geoghegan, the bank’s chairman and chief executive, are making the huge provisions — which will be announced alongside tomorrow’s full-year results — in an attempt to draw a line under the bank’s miserable experience since buying the business, then known as Household, for $14 billion (£7.2 billion) four years ago. The duo are under unprecedented pressure from shareholders over ballooning bad debts at its US mortgage business.

HSBC’s US business has faced escalating losses from thousands of low-income families who have been unable to repay loans. But the scale of its write-off, largely linked to the US business, will surprise many investors; they will want to know whether the worst is now over and whether the write-off, technically called an “impairment charge”, covers anticipated losses for this year as well.

The provision is equivalent to a third of last year’s operating profits of $30 billion and half its pretax profits, expected to be just north of $22 billion. This will be the highest-ever profit made by a British-based bank. To put it in context, the write-off is equivalent to the overall profits of £5.7 billion announced by HBOS, Britain’s fourth-largest bank, last week.

HSBC's Green, Beset With U.S. Losses, Plans Comeback in Asia By Ben Livesey and Jon Menon

HSBC Holdings Plc, founded in Hong Kong and promoted in ads as "the world's local bank," had an edge when lending went global. Now, after a costly adventure in the U.S., the 142-year-old bank is scrambling to reclaim Asia.

In his first year as chairman, Stephen Green, 58, has been preoccupied with HSBC's biggest problem, U.S. bad loans of $10.6 billion. Defaults on high-risk mortgages will likely result in the first profit decline at the London-based bank since 2002, analysts estimate. HSBC shares reached their lowest since October 2005 this week, falling 0.8 percent yesterday to 884 pence.

Green, a Church of England lay minister in his spare time, has fired top American managers, tightened loan requirements and embarked on a new growth strategy: retake emerging markets. When Green presents 2006 earnings on March 5, analysts and investors want proof he has scrapped predecessor John Bond's U.S. strategy and moved the world's third-largest bank back to its roots.

"HSBC should be allocating resources more aggressively to emerging markets, where the company made its name," said Sandy Chen, an analyst at Panmure Gordon & Co., who has a "hold" rating on the stock. "The returns on invested capital are far greater in those markets."