Monday, August 4, 2008

Meredith Whitney Continues to be Negative on Financials (and Housing)

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Meredith Whitney has created a star for herself by going against the pack (along with certain bloggers) and denouncing the "this is the kitchen sink quarter in financials" thinking that pervaded the market last summer and fall. I've remained negative along with her [Mar 26: I'm on Meredith Whitney's Side] although it is a lot easier to be negative as an analysts than a stock picker because we've had these constant oversold bounces in the group which can rip your head off if you overstay your welcome on the short side. But as I repeat constantly, each oversold bounce is still a new shorting opportunity in my book.

She is out in a few media outlets this morning - I cannot embed most video from CNBC but this is a most worthy 6 minute video from this morning in CNBC. I could not agree with her points more - even when the "recovery" happens you will have (in most cases) companies with very impaired situations. Another 8 minute video here discussing her rise to prominence - another worthy video. I urge readers to view both - it is worth your 15 minutes and it combats all the Kool Aid you hear almost daily about how everything is just fine and dandy or will be "soon". [Jul 29: The Bottom is in Financials - Version 23,472] Here are some comments via CNBC website focusing more on home prices, which of course we've been pounding the table with similar comments since last summer.
  • Housing prices will fall more than 30 percent before the market recovers and banks will continue their reluctance to lend until the credit crisis clears up, Oppenheimer analyst Meredith Whitney said on CNBC.
  • In a wide-ranging interview, Whitney said the housing deterioration will be worse than even the doom-and-gloom predictions that already have circulated regarding the market. "There's one obvious area where the bad news isn't all out yet, and that's with home prices ... Home prices are going to fall much more than people expect," she said.
  • "I think it's going to be well worse than 33 percent, and here's why: If you look at the futures market, it's indicating a range right around between 2002-2003 levels, when home ownership rates were actually higher, but fewer people can qualify for a mortgage because you've got to put 20 percent down, and that's a lot of money for people," she continued. "Furthermore, then you've got to find a bank to lend to you, because, Countrywide's not lending to you."
  • While a number of factors have generated the troubles for real estate, the industry is getting no help from banks, who have largely used Federal Reserve liquidity-raising efforts not to lend money but rather to bolster their damaged balance sheets.
  • Whitney said banks originated $900 billion loans last year, but just $100 billion so far in 2008.
  • "No one has capital (and) no one wants to sell when your stock's down 80 percent," she said. But more importantly, everyone's just holding on."
Whitney is also in Fortune - some excerpts
  • The credit crisis is far from over, star analyst Meredith Whitney tells Fortune magazine in its upcoming issue. Whitney, who audaciously - and correctly - predicted last October that Citigroup (C, Fortune 500) would have to cut its dividend, tells the magazine that banks in general today are still facing much bigger credit losses than what they've reported so far.
  • The Oppenheimer & Co. analyst warned last year - and continues to warn today - that the "incestuous" relationship between the banks and the credit-rating agencies during the real estate bubble will have a long-lasting impact on banks' ability to recover.
  • For years the ratings agencies, which are paid by the issuers of bonds, gave high marks to securities backed by subprime mortgages. Many of those bonds, of course, turned out to be anything but safe. (we discussed this often last winter)
  • With Moody's (MCO) and Standard & Poor's (MHP, Fortune 500) now trying to make up for past wrongs, the pace of downgrades on mortgage securities is quickening. This is a problem, because every time their portfolios are hit by significant credit downgrades, banks are forced to improve their capital ratios. Often that means issuing reams of new stock, which leads to serious dilution.
  • In fact, she was the first analyst to sound the alarm loudly about subprime mortgages, predicting back in October 2005 that there would be "unprecedented credit losses" for subprime lenders. The problem, as she saw it, was that loose lending standards and the proliferation of teaser-rate mortgage products had artificially inflated the U.S. home-ownership rate. (again it's easier to be an analyst than a stock picker because if you went negative in late 2005 you were a year and a half early and would of suffered serious losses, but let's give her kudos for being early as an analyst which is their supposed job - although many have turned into cheerleaders) :)
  • Whitney's current concern is that banks aren't slashing costs and cutting losses in their loan portfolios fast enough. On the cost side, she says, banks have yet to come to terms with the disappearance of the securitization market, which she believes will stay in hibernation for the next three years. (so no recovery in "6 months"? hmmph - what a downer you are Whitney - but don't worry the financials will rally strongly again sometime in the next few months on "hope" that the turnaround is not too far off)
  • Why does this matter? From 2001 through 2005, for every dollar of bank capital used to make mortgage loans, 10 were supplied via investors in mortgage securities. All that secondary-market capital is now sidelined, but the staffing levels of bank lending departments don't yet reflect it.
  • She also argues that banks need to "get real" about how they're valuing their problem mortgage-related debt, much as Merrill Lynch has now done. Merrill recently sold a large package of toxic mortgage debt for just 22 cents on the dollar. (nah, it's a lot better to leak out bad news slowly, quarter after quarter while constantly reassuring investors it's the 7th to 8th inning of the credit crunch - that's how it works!)
  • Whitney's critics, and there are many among bankers and analysts, contend her bearishness at this point shows she simply doesn't now how to measure the remaining downside risk. (clearly! She got the first part completely correct but she has now lost her touch. Thanks for the input Kool Aid touters - let me listen to you, most of which completely missed the entire first part of the credit implosion while you were trying to sell me Citigroup at $55 or Merrill Lynch near $100)
  • Her response: If she has no idea how to properly value bank stocks now, it's because the metrics don't work. Price-to-earnings ratios are useless when earnings are nonexistent. And valuing banks on price-to-book ratios is just as futile. Those book values - which reflect underlying assets and liabilities - are moving targets.
  • "I do not think we are near the end of write-downs," she tells Fortune, "so I continue to see capital levels going lower, capital raises diluting existing shares further, and stocks going lower." (Bingo, but not before ripping off the shorts ahead a few times as the government intervenes to try to prop up a "very sound" system that is in the "8th inning" of the correction)

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