The Wall Street Journal-20080117-Ahead of the Tape
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Ahead of the Tape
Will Banks Drop
Flashy Stuff
After Troubles?
Merrill Lynch becomes the next bank to offer a confessional to investors today. As the parade of write-offs continues, it's time to ask what lies ahead for Wall Street after it cleans up its current mess.
Banks had been riding high for years on hefty fees generated by bundling loans and securities into complex structured products they turned around and sold. As much as 30% of all investment-bank earnings in 2006 and the first half of 2007 came from structured-finance fees, according to CreditSights.
It would be hard to imagine this business coming back soon. Citigroup researchers expect issuance of collateralized debt obligations to drop as much as 60% in 2008 from 2007. CDOs, many of which were backed by subprime mortgages, were a favorite of the structured finance boom but have rapidly gone sour.
Bank of America said Tuesday it was curbing activities in structured products, including CDOs. Meantime, issuance of CDO cousins, collateralized loan obligations tied to corporate loans, is also down.
"It's back to nuts and bolts investment banking and none of this flashy stuff," says David Hendler, senior financials analyst at CreditSights.
The flashy stuff had helped make banking very profitable the past few years. The average return on equity among Wall Street's five big investment banks jumped from 12% in 2002 to 23% in 2007, says SNL Financial.
Investor wariness could cause a long-lasting breakdown in the securitized-debt assembly line. Banks could in turn be forced back to the tried-and-true -- and less profitable -- business of holding loans on their own books.
Investor demand for structured products could return once the subprime turmoil calms, or if returns get juicy enough to overcome today's worries.
For now, the erosion to bank earnings power could last for some time.
The Two Dreaded Words
At General Motors
General Motors CEO Rick Wagoner must address two "R" words at an automotive analyst meeting today: ResCap and recession.
U.S. auto demand is at a decade-long nadir. At the same time, GMAC Financial Services -- 49% owned by General Motors -- is weighing several options for its money-losing Residential Capital mortgage unit. Analysts advocate a range of things, including a sale and bankruptcy.
GM's stock is down 42% the past three months. Its market value has dropped to just $12.6 billion.
GM executives want to discuss core auto operations. That won't quiet the questions, especially after GM just sold several lucrative businesses, including a truck unit. "You're getting out of medium-duty trucks, why stay in mortgages?" asks Lehman Brothers analyst Brian Johnson.
The economy is the other source of uncertainty. The company's chief financial officer last month pointed to a 2% drop in 2008 industry sales. Other executives sounded far more optimistic at the Detroit auto show this week. Mr. Wagoner has indicated he would cut more production if the market erodes further.
"They should be realistic about this downturn in sales and use it to launch a new wave of restructuring," says Bear Stearns analyst Peter Nesvold. Doesn't that sound familiar?
-- John D. Stoll
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