From fear and uncertainty to calming policy moves, more
disclosures and the start of loss recognition
We believe reactions to Citigroup’s and UBS’ 3Q07 disclosures, earnings
warnings and MTM losses on MBS, CDOs, CLOs, leveraged loans suggest
markets are progressing from fear/uncertainty to damage assessment and
loss recognition, helped along by the Fed’s earlier moves to inject liquidity
and cut rates to prevent markets seizures and the economy from derailing.
Eye of the storm, or at the cusp of recovery? Some reset risks, too
Four factors make us uneasy to fully embrace “at the cusp of recovery”
views and an outright positive stance on the entire sector: (1) US
subprime/property markets as sizable, long-tailed, slow-motion underlying
problems; (2) risk of far higher-than-expected loss severity on subprime
NPLs; (3) knock-on macro impacts of these and rising levels of mortgage
loans in negative equity; (4) some risk of 2008 revenue/earnings resets.
Meaningful but manageable collateral damage for some in Asia
Two large US/Euro banks/capital mkts players have initially taken sizable
10%-15% haircuts on senior AAA-rated high-grade CDOs and MBS, with
the risk of higher haircuts for Asia financials if holding lower-tranche
paper, or if underlying loss severity proves high as feared. Assuming 40%
impairment losses on disclosed sub-prime CDO/ MBS/SIV exposures, we
estimate losses as % of 2007E PPOP at 82% for CIFH, 77% for Shin Kong,
42% for Cathay Fin, 31% for BOC, 27% for DBS.
Path of least resistance still the best
We prefer franchise names in solid-growth markets with minimal CDO
exposures, particularly in the China, HK, India, Indonesia banking sectors.
