More Market Panic Ahead As Banks 'Fess Up' On Sub-Prime

Source : The Straits Times, September 10, 2007

Confidence in banks exceptionally low, says JP Morgan Asia

(SINGAPORE) Be prepared for more market panic as major banks continue to 'fess up' to their holdings of US sub-prime mortgage securities over the next several months, said Ivan Leung, JP Morgan Asia chief investment strategist.

The world's financial markets are in turmoil as worries over exposure to the US sub-prime mortgage debt has led to a freeze in the credit market with global central banks having to step in to provide liquidity.

Around the world, banks are under intense pressure as investors and analysts cast a spotlight on their exposure to sub-prime, or high-risk, property loans in the US through their investments in collateralised debt obligations, known as CDOs.

There is little information on the amount of CDOs held by banks, which has led to 'exceptional low' confidence in the banks, said Mr Leung in an interview last week. In the past month, European and Asian banks including DBS Group Holdings and United Overseas Bank have revealed their CDO holdings.

'(US banks) originate it, they package it, they sell it - but it doesn't necessarily mean they hold on to it,' Mr Leung said.

He said that, often, US banks do hold on to some of these CDOs in structured investment vehicles - off their balance sheets - so there is no transparency on their holdings. He described this as scary.

'European banks, and to a lesser extent - so far as we have seen - Asian banks, were purchasers of these products,' Mr Leung said.

'So the crisis in confidence is not so much that there could be a 80 billion or even a 200 billion dollar loss of sub-prime; the confidence issue is that we don't know exactly who is holding all this debt,' he said.

And we don't really know the prices of all this debt, and how much of it will be subject to default, he said.

'The confessions, you see them once in a while; that's why we think this is an issue, because over the next three to six months, some banks will begin to confess that they have some on their balance sheet, and some off-balance sheet, but clearly right now, nobody really has a true picture of what's going on. 'It's the worst of all situations - nobody knows.'

Mr Leung expects the markets to veer between confidence and 'blind panic' each time there is another disclosure.

Bank shares skidded on Aug 24 after DBS and three of Asia's biggest banks revealed bigger-than-expected exposure to the US sub-prime mortgage crisis.

DBS said that it had US$1.6 billion (S$2.43 billion) in holdings of CDOs - more than the S$1.3 billion disclosed on Aug 7.

An additional 1.5 million sub-prime borrowers may fall behind on their mortgage payments as introductory interest rates on those loans rise this year and next, US Federal Deposit Insurance Corp chairman Sheila Bair said last week.

Among the 2.5 million sub-prime mortgages with interest rates that are expected to be reset this year and next, '1.5 million will be in financial distress', Ms Bair said.

Getting any kind of centralised data collection will be very challenging, she said.

JP Morgan estimates that US$600 billion worth of adjustable rate mortgages will be reset over the next 12 months.

But, following the adage that there are always opportunities when risks are high, Mr Leung said that one way for investors to take advantage of the current extreme volatility in the markets is to buy 'plain vanilla' short-term structured notes with capital protection.

The notes are designed to give a high payout even if the stock markets move only slightly higher, he said. 'When volatility is as high as it is right now, we can go for simple structures,' Mr Leung said.

The notes that JP Morgan is offering are meant for investors who share the view that the US mortgage crisis will not lead to a recession. Lower growth, yes, and therefore moderately bullish stock markets still.

Mr Leung said that JP Morgan was positive on undervalued markets such as Thailand and South Korea and favours Singapore and China companies which have superior corporate and economic fundamentals.