The Wall Street Journal-20080114-Ahead of the Tape
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Ahead of the Tape
Is It Too Early
For Thoughts
Of a Recovery?
To some stock investors, Bank of America's bailout of Countrywide Financial marked the bottom of the financial crisis created by the mess in the mortgage market. Financial stocks were among the few winners in Friday's market rout.
This week, which will be flush with earnings reports from many financial firms, could show whether stock investors were right to start thinking about a recovery in financials. In wary credit markets, the message is that stock investors might have gotten ahead of themselves.
The credit-default swap market is one way to measure that worry. These instruments are insurance contracts that pay off when a company defaults on its debt.
The cost of buying default insurance on a wide range of financial companies soared in the past few months as the mortgage crisis spread. It got cheaper on Countrywide debt after Bank of America rode in as White Knight last week. For other financial firms, however, it is getting costlier, a sign of the troubles investors still see lurking.
That's the case for municipal bond insurers MBIA and Ambac Financial, which have lots of exposure to flailing mortgage debt. Friday, it cost $898,000 annually to buy default insurance on $10 million of MBIA's own debt over five years, according to Credit Derivatives Research LLC. That was 7% more than it cost two days earlier, before the Countrywide bailout got some investors talking about bottoms.
Those who already poured money into MBIA -- Warburg Pincus, Third Avenue funds, and others -- have seen their investments quickly go south. MBIA managed to raise another $1 billion in capital last week by selling new debt securities, but it had to agree to pay a hefty 14% interest rate on them.
"Are there other time bombs? Absolutely," says Kevin Murphy, a bond portfolio manager at Putnam Investments in Boston. "The financial sector will continue to take some significant losses, and the system still has risk. Some capital has been destroyed and it needs to be replenished."
Citigroup, Washington Mutual, Merrill Lynch and others report fourth-quarter results this week. They're all expected to report sizable mortgage-related write-downs. Merrill and Citi may detail plans to raise additional capital from foreign investors. Large layoffs also seem likely.
The cost of insuring Citi's debt, at $88,000 annually on $10 million of debt, is lower than the $150,000 it costs to insure Merrill's debt. Both prices dropped a little after the Countrywide bailout, a sign of some relief. But those prices are much higher than a few weeks ago. Residential Capital, the struggling mortgage-finance unit of GMAC Financial Services, is seen as a bigger risk. It costs more than $2 million on average annually to insure $10 million of its debt.
"The market mood now seems to be that until good news comes out about a company, the presumption is the worst case," says John Tierney, credit-derivatives strategist at Deutsche Bank.
Over time, "the market's focus will move away from the immediate crisis to how the firms will reorganize themselves to make money in the coming year," he says. For many firms, we're still far from that moment.
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Corrections & Amplifications
A chart accompanying yesterday's Ahead of the Tape column listed the cost of default insurance for financial companies as of Jan. 9. The chart incorrectly said the values were as of Jan. 11.
(WSJ Jan. 15, 2008)
