Many investors are hoping an end to the current credit crisis is around the corner, but several financial industry experts at the Standard & Poor's annual bank conference Tuesday in New York said banks have not even hit the last stretch.
The mood was in contrast with another banking conference just a few blocks away, where the chief executives at Goldman Sachs Group Inc. and JPMorgan Chase & Co. — two banks that have navigated the rough financial waters better than their peers — indicated they are well-positioned for the fourth quarter.
Laurie Goodman, global co-head of fixed income research at UBS, said at the S&P conference that credit troubles are likely to last well into 2009, primarily because mortgage lending standards were the loosest in late 2006 and early 2007.
The adjustable-rate mortgages issued then do not reset until late 2008 or early 2009 — meaning the borrowers with those mortgages won't see their rates shoot higher for at least another year.
When that happens, the better-positioned borrowers can refinance into a mortgage from government agency like Fannie Mae, but weaker borrowers will default. As a result, home prices will keep declining and continue to drag on the economy, she said, leading to more housing-industry job losses and a pullback in consumer spending.
"We're going to muddle through, and it's going to be painful," she said.
"Frankly, the financial markets are in a recession, if the economy isn't," said Edward Marrinan, managing director of JPMorgan's North American High Grade Research, calling the credit crunch a "multi-quarter event."
He said banks may make their most significant writedowns this quarter, but the first half of 2008 is going to be a "challenging time" for the financial sector.
Besides further housing market problems, there's the continual struggle for banks and brokerages over what to do with their structured fixed income products, particularly collateralized debt obligations.
CDOs are instruments that include various types of chopped up and repackaged debt, and any weak slices in those bundles have deterred investors because they don't want any exposure to debt that might default. The major banks that issue CDOs have said these portfolios have plunged in value — some by billions of dollars.
Wall Street's investment banks have written $43 billion off their balance sheets this year, according to a Deutsche Bank estimate.
Because these structured products have been so numerous and complicated, "investors didn't have a good understanding of what they were investing in," said Madelyn Antoncic, who does risk management at Lehman Brothers. The complexity of the products means problems will continue to "dribble out," she said. "I think this is very far from over."
The chief executive of JPMorgan Chase said he is not too worried about JPMorgan's exposure to collateralized debt obligations and is continuing to originate subprime mortgages — loans given to customers with poor credit history.
Chase has about $1.5 billion in current CDO exposure, and another $6.8 billion in warehouse holdings of CDOs, as of Sept. 30, Jamie Dimon said at the Merrill Lynch Banking and Finance Conference in New York. But, Dimon added none of the CDO exposure is tied to subprime mortgages.
"I think we're fine," Dimon said.
Goldman Sachs, which recorded $1.48 billion in charges for the third quarter but reported a rise in profit, offered a fairly optimistic view, too. Chief executive Lloyd C. Blankfein said the investment bank does not expect to further write down the value of its portfolio.
By contrast, Merrill Lynch & Co. disclosed a $7.9 billion write-down just three weeks after the bank estimated a $4.5 billion charge. Citigroup Inc. has recorded about $6 billion in credit losses and warned it may have to record as much as $11 billion in further losses.
S&P analysts issued a reminder that even the golden boys of the investment banking industry during the third quarter remain vulnerable to market dislocations.
"Accidents can happen anywhere," said Scott Sprinzen, managing director in S&P's financial institutions segment. "There shouldn't be an assumption that they are going to be able to defy gravity indefinitely."