Banking Crisis Starts

Jan. 14 (Bloomberg) -- Citigroup Inc., Bank of America Corp. and Merrill Lynch & Co. may report their worst-ever quarter, beset by $35 billion of writedowns that threaten to crimp profit through 2008.

The losses have depleted the banks' capital, forcing New York-based Citigroup and Merrill to seek more than $13 billion from foreign investors, and hobbled their ability to make new loans. Other sources of fees, including credit cards, are also in jeopardy as the U.S. economy slows, said CreditSights Inc. analyst David Hendler, who estimates Citigroup, Bank of America and Merrill won't earn more this year than they did in 2006.

``The banks are already operating like they're in a recession,'' by ratcheting back on trading and lending, said Adam Compton, who helps oversee $150 billion at San Francisco-based RCM Capital, which holds shares of Citigroup, Bank of America and Merrill. ``Everybody has tightened up tremendously.''

Citigroup may report a fourth-quarter loss tomorrow of $4 billion, the first for the largest U.S. bank since its commercial real estate holdings plummeted in value during the early 1990s, according to a survey of eight analysts by Bloomberg. The company also may announce that it received a new cash infusion of as much as $10 billion from investors in China and the Middle East, the Wall Street Journal reported on Jan. 11, citing people familiar with the matter.

Merrill, the world's biggest brokerage, probably will post a loss of $3.23 billion on Jan. 17, topping the record $2.24 billion loss reported in the third quarter, Stan O'Neal's last as chief executive officer, analysts estimate.

New CEOs

John Thain, O'Neal's replacement, may use the quarter's earnings to write down most remaining investments infected by subprime defaults, said Sandler O'Neill & Partners analyst Jeffrey Harte. Citigroup replaced CEO Charles O. ``Chuck'' Prince III with Vikram Pandit, who turns 51 today, a former investment banker with a Ph.D. in finance who has formed a dedicated task force to mitigate losses in the bank's subprime investments.

Prince, 58, resigned in early November when the bank said it might have $8 billion to $11 billion of subprime writedowns, based on a slide in prices for mortgage-related securities during October.

In a Nov. 15 interview, Thain, 52, said that in many market declines, ``asset prices tend to go much lower than they ultimately are worth, and it takes longer to work out of them than people think.''

Writedown Estimates

The loss at Citigroup may include almost $19 billion of writedowns on holdings of mortgage-related securities known as collateralized debt obligations, according to Goldman Sachs Group Inc. analyst William Tanona. CNBC reported earlier today that the company may announce a $24 billion writedown and job cuts of 17,000 to 24,000. Merrill was battered by $11.5 billion of writedowns, Tanona estimates.

Bank of America's fourth-quarter net income probably fell 79 percent to $1.08 billion, the biggest drop in at least a decade, according to a Bloomberg survey. Sanford C. Bernstein & Co. analyst Howard Mason estimates the bank had $5.5 billion of writedowns on mortgage-related securities.

Earnings per share would be 23 cents, the lowest since the Charlotte, North Carolina-based company was formed from the 1998 merger of BankAmerica and NationsBank, according to analysts' estimates. Citigroup was put together the same year through the combination of Travelers Group Inc. and Citicorp.

Bank of America, the second-biggest U.S. bank, increased its bet on the U.S. housing market last week when it agreed to acquire unprofitable mortgage lender Countrywide Financial Corp. of Calabasas, California, for about $4 billion.

JPMorgan's Outlook

Bank of America, led by 60-year-old CEO Ken Lewis, may face writedowns caused by the declining value of Countrywide's loan portfolio, said Sean Egan, managing director of Egan-Jones Rating Co. in Philadelphia. A 5 percent writedown on the portfolio would be more than $10 billion, or about half of Bank of America's 2006 profit of $21 billion, he said.

Even New York-based JPMorgan Chase & Co., the least damaged by the subprime losses, faces ``a challenging credit environment mired by further asset write-offs'' of $3.4 billion, Tanona wrote in a Dec. 26 report. JPMorgan's fourth-quarter earnings may drop 29 percent to $3.21 billion, the first decline in three years, analysts estimate.

JPMorgan fell 15 percent during the past 12 months in New York Stock Exchange composite trading, compared with Citigroup's 47 percent, Bank of America's 28 percent and Merrill's 43 percent.

Great Depression

Banks haven't lost this much money, in relative terms, since the Great Depression, said Richard Sylla, a professor of the history of financial institutions and markets at New York University's Stern School of Business.

U.S. banks, insurers and real-estate companies earned about $1 billion a year during the 1920s until the stock market crash of October 1929. The industry lost about $500 million in 1930, $1.7 billion in 1931, and $2 billion in 1932, Sylla said.

Within days of being inaugurated in March 1933, President Franklin Roosevelt issued an emergency order declaring a ``bank holiday'' to stem a run on deposits. About 7,000 banks, or a third of the U.S. total, failed and financial companies didn't return to profitability until 1936, Sylla said.

Last year's collapse of the subprime mortgage market was worse than the third-world debt crisis of the early 1980s, when soaring oil prices and surging interest rates pushed Mexico and other developing countries into default on their loans, said Charles Geisst, a finance professor at Manhattan College in Riverdale, New York, and author of ``100 Years of Wall Street.''

Abu Dhabi

``This is the classic credit crunch,'' Geisst said. ``It might not have gotten to credit cards, it might not have gotten to car loans, but it's coming.''

Citigroup, Bank of America and Merrill probably were profitable in 2007, earning about $23 billion on a combined basis, even after the second-half writedowns, according to Bloomberg data. The banks earned about $50 billion in 2006. They may earn $44.8 billion this year, analyst surveys by Bloomberg show.

Citigroup, which in November had to seek a $7.5 billion capital infusion from the ruling family of oil-rich Middle Eastern emirate Abu Dhabi, may have to cut shareholder dividends to maintain the capital cushion it keeps to absorb loan losses, Tanona wrote in a Dec. 26 note.

Even with the Abu Dhabi investment, Citigroup's so-called Tier 1 capital ratio, which regulators monitor to assess banks' ability to withstand loan losses, may fall to 7 percent by the end of this year, he estimated. While above the 6 percent needed to maintain its ``well-capitalized'' status from federal regulators, the capital ratio is below Citigroup's own target of 7.5 percent.

Fed Data

Bank of America's Tier 1 ratio fell to 8.22 percent in the third quarter, from 8.52 percent in the second quarter and 8.48 percent a year earlier. JPMorgan's ratio was 8.4 percent in the third quarter, down from 8.6 percent a year earlier.

The resulting tightfistedness at the banks may help push the U.S. economy toward recession, RCM's Compton said. In the third quarter, less than a tenth of U.S. bank loan officers witnessed ``substantially'' higher demand for commercial loans, down from more than 50 percent in the second quarter of 2005, CreditSights reported, citing data from the Federal Reserve.

The banks' ``willingness and ability to lend remain the leading issues for the risk and extent to which current turmoil in the financial credit markets spreads to the broader economy,'' wrote Jeffrey Rosenberg, Bank of America's senior debt-investing analyst, in a Dec. 20 report.

Loss Ratios

Profits may suffer as banks set aside higher reserves for bad loans, Sanford Bernstein's Mason wrote in a Dec. 31 report. Bank of America's net loss ratio on commercial loans this year may average 0.7 percent, compared with 0.42 percent in the third quarter and more than triple the rate of the fourth quarter of 2006, Mason estimated. Citigroup's losses on credit-card loans may climb to $7.6 billion this year from $6.4 billion last year and $5.8 billion in 2006.

``A lot of these banks have large consumer portfolios in addition to the subprime side,'' said Malcolm Polley, who helps oversee $1 billion at Stewart Capital Advisors in Pittsburgh, including Bank of America shares. ``As we sink closer to recession, consumer delinquencies are going to tick up.''

U.S. construction loans that were 30 days to 89 days overdue represented 0.7 percent of those outstanding in the third quarter, more than double the rate of a year earlier, according to analysts at Arlington, Virginia-based Friedman, Billings, Ramsey & Co. Delinquent commercial loans climbed to 0.36 percent from 0.3 percent in the same period.

Default Rates

The default rate on U.S. junk-grade corporate loans may reach 2 percent to 3 percent this year, compared with about 0.9 percent in 2007, according to Bank of America's Rosenberg.

``Credit deterioration will continue to pressure industry valuations well into 2008,'' Friedman Billings analysts James Abbott, David Rochester and Scott Cottrell wrote in the Jan. 3 report. ``Even modest upticks in delinquencies can drive lower returns.''

The banks misjudged how bad the home-loan market would get, and they accumulated more than $100 billion of AAA-rated securities they thought were safe. This quarter's writedowns may acknowledge that prices for mortgage bonds and collateralized debt obligations, which repackage assets such as buyout loans and mortgage bonds into new debt with varying risks, probably won't recover anytime soon, RCM's Compton said.

Asset Markdowns

Under U.S. accounting rules, banks and other financial firms have to take losses to ``mark'' the value of tradeable securities to current market prices. Morgan Stanley marked down some AAA- rated securities last month to as little as 30 cents on the dollar, while Zurich-based UBS AG, Switzerland's biggest bank, took marks as low as 22 cents, Credit Suisse analyst Susan Roth Katzke said in a Jan. 3 report.

Any holdings remaining after the fourth quarter may have to be written down further, said Andrew Seibert, who helps oversee $400 million at Nextier Wealth Management in Pittsburgh. He sold his bank stocks during the first half of 2007. Even after writing down subprime holdings by $11.5 billion in the fourth quarter, Merrill would have about $8 billion left, Tanona said.

``I don't think these guys actually know the total of the losses they have on the books,'' Seibert said. ``They're still digging through it all trying to figure out what's there.''

To contact the reporter on this story: Bradley Keoun in New York at bkeoun@bloomberg.net ; Elizabeth Hester in New York at ehester@bloomberg.net .

Last Updated: January 14, 2008 11:45 EST