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Monday, October 1, 2007

When Banks Start To Fail

This week is back end loaded with important data. The report everybody will be watching like a hawk is non-farm payrolls on Friday.

Citigroup Cuts Profit Forecast 60% on `Weak' Markets (Update1): “Citigroup Inc., the biggest U.S. bank, said third-quarter profit fell about 60 percent because of “weak” credit markets and losses on leveraged loans and mortgage-backed securities.

The bank will write down $1.4 billion before taxes on leverage finance commitments, Citigroup said today in a statement. The New York-based bank lost $1.3 billion on subprime assets and about $600 million in fixed-income trading. Higher loan-loss reserves contributed to $2.6 billion in credit costs in the consumer-banking business.”

This is not unexpected. However, this is the first of many weak quarters as the combination of realizing losses and slower future growth take full effect. The stock most likely does not yet accurately reflect this reality.

“Citigroup fell to $45.66 in early trading from $46.67 at the close on the New York Stock Exchange on Sept. 28. The stock has lost 16 percent this year.”

UBS Has Loss, to Cut Jobs, After Subprime Writedowns (Update4): “UBS AG, Europe's biggest bank, had an unexpected third-quarter loss and plans to cut 1,500 jobs after writing down the value of fixed-income securities by more than 4 billion Swiss francs ($3.4 billion).

The pretax loss, the first reported by any of the world's largest banks, totaled 600 million francs to 800 million francs, the Zurich-based company said today. Huw Jenkins, the head of the investment bank, will step down and become an adviser to Chief Executive Officer Marcel Rohner. Chief Financial Officer Clive Standish will retire. The shares fell.

UBS's announcement surprised analysts, who had estimated the company would earn as much as 3.3 billion francs, and contrasts with Credit Suisse Group, which said today it had a profit of about 1.3 billion francs in the quarter. A portion of UBS's writedowns are related to securities owned by Dillon Read Capital Management, the hedge fund unit that cost the company $300 million and former CEO Peter Wuffli his job.”

That analysts were surprised by these losses isn’t surprising. Seriously though, these losses are very real and, unlike its competition, UBS is motivated to report them to the fullest extent. Rohner, the new CEO, is taking this opportunity to start tabula rasa and sticking Wuffli, the former CEO, with all the losses. However, for the competition, it is currently in their self interest to minimize the appearance of losses. Therefore, UBS should by far have the worst numbers and the most accurate.

NetBank Closed by U.S. Regulators; ING Assumes Assets (Update3): “NetBank Inc., the online banking pioneer whose finances deteriorated with mounting mortgage losses, was closed by the Office of Thrift Supervision, becoming the first U.S. savings-and-loan to fail in three years.

The U.S. thrift watchdog, in a statement today, cited NetBank's losses from weak underwriting and failed business strategies and said the Federal Deposit Insurance Corp. would take control of the bank. Separately, ING Bank announced it gained FDIC approval to assume $1.4 billion of the failed bank's deposits and 104,000 of its customers.”

NetBank quietly failed on Friday. The media buried this one. Although the bank was already in trouble due to ‘high operating expenses’ it was the ‘significant losses from loan defaults, weak underwriting, poor documentation, lack of proper controls and failed business strategies’ that finally sucked them under. Put another way, wild speculation and lack of both respect for, and understanding of risk. The marginal players go first and while stronger, fitter competitors will surely survive they still get hurt and have to retreat to lick their wounds.

Recession Concern Spurs U.S. Bond Rally on Fed Ease (Update1): “For the first time since 1995, the U.S. bond market is rallying on the assumption that the Federal Reserve has relegated inflation to a secondary concern because the central bank views a recession as a much greater threat to the economy.

The bellwether 10-year Treasury note, which depreciated as its yield climbed at least a quarter-percentage point when the Fed began lowering interest rates in 1998 and 2001, won't be recoiling anytime soon after the Fed lowered its benchmark by half a point to 4.75 percent on Sept. 18, the first cut in four years. Instead, the 10-year yield will fall to 4.51 percent by year-end from 4.58 percent, according to the median forecast of the 21 securities firms that trade with the central bank.”

With gold at $850, oil $82 and the US dollar in free fall it would be almost foolish to believe rates could decline at the longer end of the curve. Think about it, would you want to buy a bond that yielded about 2.5% more than core CPI in a declining currency? At some point something has to give. Keep an eye out for the first silent signs of a quiet capital flight out of US treasuries…

European Manufacturing Growth Slows on Credit Costs (Update1): “Europe's manufacturing industry grew at the weakest pace in almost two years in September after the collapse of the U.S. subprime-mortgage market boosted credit costs, raising concern of a slowdown in economic growth.

Royal Bank of Scotland Group Plc said today its manufacturing index, based on a survey of purchasing managers, declined to 53.2 in September, the lowest since November 2005, from 54.3 in August. That confirmed a Sept. 21 estimate. A level above 50 indicates growth.

The data adds to evidence that fallout from the U.S. housing slump is spreading to Europe. The slowdown may spell the end of almost two years of interest-rate increases by the European Central Bank. Gains in oil prices and the euro's increase to a record already threaten to damp economic growth. A gauge of new orders slid to the lowest since August 2005.”

Of course it would spread. DUH. This IS a global economy.

Swiss Manufacturing Growth Slows More Than Forecast (Update1): “Swiss manufacturing growth slowed more than economists forecast in September as rising credit costs dim the outlook for European economic growth, a survey of purchasing managers showed.

An index of manufacturing fell to 57.6, the first decline since May, from 65.1 in August, said Credit Suisse Group, which compiles the report with the Association of Purchasing and Materials Management. A reading of above 50 indicates growth. Economists expected a decline to 63, according to the median of 15 estimates in a Bloomberg News survey.”

The Swiss are just getting started with their slowdown.

Russian September Manufacturing Growth Slows to Seven-Month Low: “Russian manufacturing expanded last month at the slowest pace since February as new orders from consumers abroad fell, a gauge of industrial production showed.

VTB Bank Europe's Purchasing Managers' Index declined to 52.2 in September from 53.1 in the previous month, the bank said in an e-mailed statement today. A figure above 50 indicates growth, below 50 a contraction. The bank surveyed 300 purchasing executives among Russian manufacturers.

“A fall in new export orders was the primary reason for the weakening in overall new order growth, a key component of the headline index,” Dmitry Fedotkin, an economist at VTB, said in the statement. The PMI index declined to the lowest level since February, when the index dropped to 52, this year's low.”

Who knows how accurate or how volatile the numbers are coming out of Russia, but the general trend remains: Manufacturing outside of Asia is definitely slowing.

U.K. August Mortgage Approvals Fall to Four-Month Low (Update2): “U.K. banks approved the fewest mortgages in four months in August as borrowing costs increased, a sign demand from buyers in the residential property market may start to slow.

Lenders granted 109,000 loans for house purchase, the least since April, the Bank of England said in London today. Economists forecast 110,000, according to the median of 24 estimates in a Bloomberg survey. House prices stagnated in September for a second month, a separate report showed.”

Considering the ridiculous speculation and price appreciation that has occurred in the UK real estate market, expect far far worse to come.