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Financials In Need of Capital


In 2008 we will see many firms announce that while their hedges were correct, their counterparties for those hedges were not.


Here are a couple of quick observations from the financial services front:

First, Countrywide (CFC) is now trading at 30% of its book value. At this valuation it makes it all but impossible to raise additional equity without blistering dilution to existing shareholders. At the same time, given the leverage to CFC's balance sheet, I would caution to everyone that at its current price, CFC stock is likely to trade with the volatility of an option. And, at least to me, positions should be sized accordingly.

Second, the proposed sale of China International Investment Corp., or CICC, by Morgan Stanley (MS) is a perfect example of the kinds of asset divestitures we will be seeing more of from struggling financial institutions as these firms seek to raise capital. CICC is non-credit, non-strategic, there are obvious buyers, and its market value relative to book value is enormous.

Third, I think the most overlooked article in the Wall Street Journal yesterday was about CIBC. In the article it states that "CIBC wasn't sure ACA Financial, a unit of ACA Capital Holdings Inc., could continue to be a "viable" counterparty to about $3.5 bln in the bank's subprime real-estate exposure." As I have written previously, I expect that in 2008 we will see many firms, both financial and otherwise, announce that while their hedges were correct, their counterparties for those hedges were not. CIBC is the first major firm I have seen put this issue out there front and center. And as you can see, the notional amounts are large.

Finally, beyond November's enormous increase in credit card debt announced by the Federal Reserve yesterday, I would highlight that there has been no increase in non-mortgage consumer credit securitization for several months. Why do I highlight this? Because all of the growth in revolving credit is now landing on the balance sheets of banks, along with the associated need for funding, capital and loan loss reserves.

While small relative to the other charges banks have been taking lately, by my calculations the on-balance sheet growth in credit card balances since the summer represents a further $1.5 bln drain on scarce capital.

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