After Merrill Lynch (MER) announced it would sell its ABS CDO portfolio for a $4.4 billion loss at $0.22 cents on the dollar, many analysts and commentators speculated that this would be the “watershed” writedown that could set the bottom for financials.
At the very least, it gives the market a better idea of what those toxic mortgage-backed assets are actually worth, removing at least some uncertainty from the equation. Citigroup (C) continues to insist that its CDOs are of a different vintage and therefore more valuable, but the market may soon force a writedown to Merrill’s bargain-basement level. CNBC:
“This was a very painful step that management inevitably had to take,” Fox-Pitt securities analyst David Trone said on CNBC. “This is interesting, because Citi has I think an obligation to Wall Street to mark to this level.”
If the remaining banks with massive subprime exposure move forward using Merrill’s price on the CDOs, that could lead to Wall Street clearing off its vast subprime exposure, getting the worst news out and sending the market off its prolonged bear pattern and onto a higher level.
Really? This is the final purge of sketchy assets that the sector needs before it can begin to recover from record low valuations? Atlantis Asset Management analyst Michael Cohn thinks it could be:
They’ve established a benchmark for everyone else. These guys who have cash waiting on the sidelines for the final puke of these securities are now making phone calls trying to find out who else wants to puke, who else wants to sell at 22 cents on a dollar. There, that’s where the bottom hits.
The flip side of the coin, however, is that Merrill’s markdown could only be a sign of things to come. Non-performing assets as a per cent of total loans have continued to grow in the second quarter. House prices are nowhere near a bottom, and credit quality continues to deteriorate. What’s more, if inflation stays high, the Fed may raise interest rates by the end of the year, raising borrowing costs and pressuring net interest margins. Banks could have 2 or 3 more tough quarters to go before they can put the ugliness behind them. Steve Hochberg of Eliot Wave International:
It’s a process that’s working its way through, but we don’t think we’re near the end of it yet. Bottoms are created when you have the greatest amount of pessimism. It’s a little perverse, but I think people need to get scared.