Banking's Black Hole Forbes
02.25.08, 4:08 PM ET
Sit tight in your bunker for a while longer. Investment banks face another $30 billion in write-downs in the first quarter thanks to deteriorating conditions in the credit markets, particularly in leveraged loans.
Citigroup again finds itself under pressure, not least from the vocal Oppenheimer analyst Meredith Whitney, who in a research note Monday predicted Citi's shares would drop to levels not seen since the real estate lending crisis of 1990 (that is to say, below $16. It's trading at $25 now) all because of mounting pressure on the bank to shed assets amid further write-downs.
"Core fundamentals are rapidly deteriorating, liquidity has been choked, and recovery rates are in the process of dropping to historic proportions," Whitney wrote in a note to clients. A Citi spokeswoman had no comment.
But Citi is just the poster child for an industry that has yet to see any signs of easing in the credit crisis that began last summer. Things are so gloomy on Wall Street that even the mighty Goldman Sachs is seen having a lukewarm quarter, barring any stealth hedging strategy that could lift it out of normalcy.
Revenues at Goldman are seen dropping 50% from the third quarter and 32% from the first quarter last year, and analysts' average $3.27 per share profit estimate for the quarter, if accurate, would be the lowest quarterly result for the firm since the third quarter of 2006.
In recent days, analysts who follow Wall Street banks have been slashing their estimates for first-quarter earnings, which for Goldman, Lehman, Morgan Stanley and Bear Stearns, include the months of December through February.
Goldman's estimate has slipped from nearly $6 at the beginning of the year. Citigroup is seen reporting 56 cent-a-share profits, down from the earlier 86 cent estimate, according to Thomson Financial. JPMorgan's estimate is 98 cents, down from $1.12, Bear Stearns' is $1.70 down from $2.06, Lehman's is $1.31, down from $1.62, Merrill's is 84 cents, down from $1.52, and Morgan Stanley's is $1.23, down from $1.61.
"The global capital markets environment was very challenging" in the first quarter, says William Tanona of Goldman Sachs. "Both credit and equity markets deteriorated significantly."
The index tracking leveraged-loan trading fell 6% over the last three months, an indication that the weakening credits will force banks to write-off a chunk of their exposures.
Citigroup, already reeling from more than $24 billion in write-downs since October, has the biggest leveraged loan exposure, $43 billion, on its books, followed by JPMorgan Chase and Goldman Sachs, each with $26 billion.
Whitney of Oppenheimer calculates that Citi's leveraged loan write-downs alone could cost another $2 billion to $3 billion in the first quarter, and JPMorgan and Goldman up to $1.8 billion each.
Adding to the expected misery, merger advisory and stock underwriting had their weakest quarter since 2005, the $16 billion-plus planned initial public offering announced Monday by Visa notwithstanding. Investment banking revenues are seen falling 35% from the fourth quarter.
Write-downs are expected to spread to areas previously untainted by the subprime contagion. Take commercial real estate, for example. Tanona of Goldman Sachs expects the value of commercial real estate to fall 21% to 26% over the next two years, dragging down the performance of banks that hold exposure to the sector. That would be just about every Wall Street firm.
Already, commercial real-estate-backed securities have declined 8% since the third quarter, suggesting losses of about $1 billion to $2 billion for each of the banks in the fourth quarter, Tanona says.
More write-downs are exactly what Citigroup doesn't need. The bank is facing scrutiny of its structured products business. In a regulatory filing last week, Citi said it had received subpoenas and information requests relating to subprime mortgages, mortgage securities, derivatives and off-balance-sheet funds.
And its balance sheet is burdened with distressed asset-backed securities and mounting credit losses in its consumer lending division. Last year it raised $7.5 billion in new capital from the Abu Dhabi investment fund, and earlier this year it cut its dividend, but some say it may need to raise even more capital.
Citigroup's balance sheet is "highly constrained" from an inability to sell lower quality assets, said Oppenheimer's Whitney, adding that Citi might have to sell some $100 billion in assets to free up capital. Unfortunately, "under duress, Citi will likely be forced to sell what it can and not what it should."