markets-hub.com

Home equity lines of credit will be the next chapter in the ongoing credit deterioration saga, and specialty finance and regional banks are going to bear the brunt of HELOC risk, Goldman Sachs said.

The warning came in a research note that was relatively upbeat on other financial sector stocks—analyst Richard Ramsden upgraded some brokers and asset managers and said fears about established names such as Lehman Brothers were exaggerated.

“Within mortgage, home equity is taking the lead as the biggest near-term problem,” he wrote Tuesday. Ramsden lowered estimates at most banks and downgraded mortgage bankers including Wells Fargo, Marshall & Isley and Zion Bancorp. He predicted median earnings-per-share growth for the sector in 2008 will dip 4% versus 2007.

Losses in the $1.1 trillion home equity market are entering uncharted territory, he said.

“We now forecast that the 2006 vintage of home equity will have 3.3% cumulative losses, and the 2007 vintage will have 11.1% losses … For the 2007 vintage, these loans will have credit card-like cumulative loss rates with mortgage-like yields – clearly a losing combination.”

Annual losses will rise to 1.75% in 2008 from 0.41% in 2007, 0.16% in 2006 and 0.1% in 2005, he estimated.

Only a very small percentage of HELOCs have been securitized, he pointed out, which leaves “a significant percentage of the risk on bank balance sheets.” Ramsden sees total home equity-related credit losses ahead of $52 billion.

HELOC delinquencies are already soaring—according to BMO Capital Markets analysts Peter Winter and Lana Chan, delinquencies increased 17% sequentially and 59.9% year-over-year at the last quarter. Citing American Bankers’ Association figures, Winter and Chan noted that delinquent consumer accounts in the fourth quarter reached a level—2.56%—not seen since 1992, when it was 2.68%.

“We believe that it is still too early to start buying bank stocks as we expect another shoe to drop on bank earnings from rising credit costs and further margin pressure,” they wrote in a note to clients Tuesday. “[L]oans that were poorly underwritten over the last few years do not all of a sudden become good loans just because the Fed is cutting rates,” they said.

Richard Bernstein at Merrill Lynch echoed that caution on banks and warned that apparently undervalued financial stocks are actually a value trap for investors looking to take advantage of a bottom.

“Our work seems to suggest that investors have considered only credit conditions and have largely ignored the coming slowdown in global growth,” he wrote in a research note Tuesday. HELOCs “are a bigger issue for small-and mid-cap bank stocks than are mortgages themselves,” he said.

It’s no secret that the credit crunch has held Wall Street in a stranglehold for the past six months, but the question on everyone’s mind has been just how tight.

Since its onset in July 2007, the credit monster has squeezed more than $2 trillion from the global liquidity pool and more than $1.3 trillion from U.S. debt underwriting, according to Oppenheimer analyst Meredith Whitney, and it doesn’t show any signs of weakening its grip.

“As bank balance sheets show similar strain to brokers’ own balance sheets, there is little room in the system to ‘pick up the slack’ vis a vis corporate lending,” Whitney wrote in a research note Thursday. “To put it into context, $1.3 trillion of lost debt liquidity is over half the entire U.S. debt market underwriting volume in 2007 and nearly half of the entire U.S. debt market underwriting in 2006.”

March marked the ninth straight month of year-over-year declines for total global debt volumes and total U.S. debt volumes, Whitney wrote, the “greatest consecutive decline since 1990.” Whitney said other sectors of the market also found themselves tapping the mat in submission during the month, including the “dismal” capital markets and the “anemic” fixed income issuance, which struggled in all categories and geographic regions, even in plan vanilla high grade debt.

“As the capital markets had almost fully disintermediated by the mid-1990s, the transition of re-intermediation, which we believe will be inevitable due to a ‘buyers strike’ on structured products, will be highly disruptive, more expensive, and more protracted than most investors currently envision,” Whitney added.

The credit monster also reared its ugly head in global equities issuance, merger and acquisition activity, and the performance of global indexes. The $20 billion Visa initial public offering helped to buoy global equities issuance, but overall the area slipped 16% year-over-year with volume declining in most of the rest of the world. Elsewhere, M&A completed deals and announced deals tumbled more than 65% in the U.S. and more than 40% in Europe, while global indices were flat to down for the month, according to Oppenheimer.

“Given the weak global markets, it is not clear that what may be in investment banks’ pipeline will get executed,” Whitney said. High margin structured products will not return in any material form this year, creating “serious replacement issues. From the lost revenue, the issue of excess capacity becomes relevant and ultimately further disruption vis a vis restructuring for the brokers.”

Bargain-hunting investors everywhere have begun to pick up on the fresh trail of broker stocks, but, according to Sanford C. Bernstein & Co., it’s not the time to jump in just yet.

“The stock prices of large capitalization security firms are testing recent lows and price-to-book valuations are all within the bottom two deciles of their historic trading ranges,” Bernstein said. “Typically, this would represent an excellent entry point for these firms. However, the current environment is anything but typical.”

While its price target for the group implies an average 44% upside over the next six to 12 months, Bernstein recommends investors stay on the sidelines until the credit and liquidity crunch stabilizes, taking into account that these firms rely on the health of the credit markets to finance their heavily leveraged balance sheets.

“The brokers are susceptible to further book value deterioration,” the firm added. “We believe there are several more write-downs to come as the financial leveraging that had benefited the group and the overall financial market during 2004 to the first half of 2007 continues to unravel.”

Bernstein rates Bear Stearns, Goldman Sachs, Lehman Brothers, and Merrill Lynch all at a market perform, and gives its lone outperform rating among the group to Morgan Stanley.

Apparently the bargain hunters were listening, as shares of Bear Stearns, Lehman Brothers, and Merrill Lynch all sank to new 52-week lows in mid-day trading. Bear Stearns was the biggest decliner on the day, tumbling 13% to a five-year low of $60.26.

“The credit markets are experiencing historical levels of turbulence. Problems are emerging in nearly every corner of the market, even those once considered safe (i.e. money market funds, municipal bonds),” Bernstein said. “As you know, it is impossible to forecast the credit markets, so until we begin to see stabilization we would avoid exposure to these names.”

And just when the hunters thought they were closing in for the kill.

Federal Reserve Chairman Ben Bernanke is fighting a three-front war: recession, inflation, and credit market depression. The question, then: Is the Fed capable?

The Fed has cut rates and taken a series of liquidity-boosting measures over the past few months, yet there’s no sign the credit market crisis is receding; the U.S. economy remains on track for a recession.

The Federal Reserve said on Friday it’ll raise the total size of its March TAF (Term Auction Facilities) auctions to $100 billion and begin 28-day term repurchase agreements that are expected to total $100 billion, to “address heightened liquidity pressures in term funding markets.” The TAF is a targeted facility that allows banks to access funds at interest rates lower than those offered at the discount window. The Fed also said it’ll expand the ways it delivers liquidity to banks, which includes using less-liquid assets as collateral for term repurchase transactions.

You can bring a horse to water, but you can’t make it drink. Senior Fed officials warned that while these decisions were in response to the rapid deterioration in term funding markets, they are not sure their new measures will calm the turmoil in the credit markets.

Financial markets are still expecting the Fed to aggressively lower interest rates in the coming months. An Action Economics weekly survey showed all are expecting at least a 50-basis points reduction in the federal funds rate to 2.5% from the current 3% by the March 18 policy-setting meeting. According to the survey, fed funds estimates ranged from 2.50% to 2.25% for the March policy meeting, and 2.5% to 1.5% by June.

But the question remains: is it possible that no matter how low the Fed cut rates, it won’t stop the economy and credit markets from worsening? New York Fed President Timothy Geithner said very directly in a speech Thursday that “even with those reductions in short-term interest rates in place, financial conditions have tightened as risk spreads on a wide range of asset classes and institutions have increased considerably.” He said “we cannot know with confidence today what level of the short-term real funds rate will be consistent with our objectives of sustainable growth and low inflation.”

Tony Crescenzi, market strategist at Miller Tabak, is more optimistic, believing the Fed still has more aces up its sleeve. if the Fed’s new TAF measures fail, and if the term markets seize up, Crescenzi said he would expect that “the Fed would consider purchasing agencies for their own account.”

“The Fed currently owns only Treasuries but has the authority to buy agencies,” he said. “Another possibility mentioned by Bernanke in 2002 is the idea that the Fed would buy long-term Treasuries. These are both extreme measures but they are potent tools.”