Wednesday, October 31, 2007

UBS – It Is Halloween and It Is Time For A Scary Story

I am not picking on UBS, but at least they are forth right in their comments of the bank and the credit markets going forward. The point is that there are still losses in future quarters that will have to be taken. Text in bold is my emphasis. The first portion of the post is from a WSJ article:

UBS AG's fourth-quarter warning stoked increasing anxiety that the pain from the credit-market turmoil that started this summer might last longer than investors had hoped.

But Switzerland's UBS warned yesterday of more potential losses ahead on U.S. mortgage-backed securities. The bank reaffirmed an estimate of a pretax third-quarter loss in the range of 600 million to 800 million Swiss francs ($515 million to $687 million). The bank, which has already announced a write-down of four billion Swiss francs in the third quarter, said the fourth quarter started well, but it may see further write-downs amid a new wave of downgrades on mortgage securities.

"UBS is not assuming that the quarter will continue as positively as it has begun, or that the current difficulties will be resolved in the short term," the bank said.

"There had been a feeling...that we'd seen the worst, and that the third quarter was going to be an opportunity for banks to basically clean out their balance sheets," said Simon Adamson, an analyst at credit-research firm CreditSights in London. But in the past week or two, there has been "a resurgence" of "nervousness and volatility, and concerns have resurfaced about the subprime market," Mr. Adamson says.

Much of the optimism was driven by hopes that credit markets would rebound once investors managed to separate good securities from bad. Instead, mounting losses on subprime loans and persistent waves of downgrades have begun to affect even the most highly rated securities, many of which are sitting on banks' books. A section of the ABX index that tracks the value of Aa-rated bonds backed by subprime mortgages was trading at only 50 cents on the dollar yesterday, down from roughly 65 cents on the dollar Oct. 19.

The second art is also from the WSJ and are comments made about the credit markets for mortgage backed securities:

As defaults and downgrades on mortgage-backed securities mount, banks, insurers and specialized funds around the globe are facing a problem: Some $60 billion in what were supposed to be perfectly safe investments are precipitating a new round of losses.

At issue are the so-called super-senior portions (or tranches) of collateralized debt obligations, investments that divide pools of securities into slices with different levels of risk and return. The tranches reaped the highest possible credit ratings because they were designed to be the last to suffer any losses.

But as the outlook for the U.S. housing market has deteriorated and defaults on mortgage loans have kept rising, chances have risen that losses on many CDOs -- those containing pools of lower-rated mortgage-backed bonds -- could reach all the way up to the super-senior tranches. As a result, billions of dollars in investments could be rendered worthless.

UBS AG Chief Executive Marcel Rohner shed light yesterday on the scale of the problem, calling a recent wave of ratings downgrades on mortgage-backed CDOs a "very serious second dislocation" that could prove painful for banks.

In October alone, ratings firms Moody's, Fitch Ratings and Standard & Poor's have downgraded or put on watch for downgrade more than $100 billion in CDOs and the mortgage securities they contain. Among the hardest hit have been so-called mezzanine CDOs, which consist entirely of lower-rated bonds backed by subprime-mortgage loans.

In a glimpse of how much banks have at stake, Mr. Rohner said UBS holds more than $20 billion of super-senior tranches, some two-thirds of which are part of mezzanine CDOs. They're among the reasons UBS, which yesterday reported a third-quarter loss of 830 million Swiss francs ($712.8 million), has warned that its investment bank is likely to face further losses in the current quarter. Nonetheless, UBS said the bank, boosted by its wealth-management business, should be profitable in the fourth quarter.

The potential for losses, analysts say, goes beyond the Zurich-based bank. Michael Hampden-Turner, a credit strategist at Citigroup Inc. in London, estimates that a total of some $60 billion in super-senior tranches of mezzanine CDOs are outstanding, mainly on the books of banks and specialized funds known as structured investment vehicles, or SIVs. Merrill Lynch & Co., for example, said losses on super-senior tranches accounted for most of the $8.4 billion third-quarter write-down involving CDOs and mortgage securities that it announced last week.

CDOs that own lower-rated mortgage-backed bonds are "one area that the market is particularly concerned about," said Mr. Hampden-Turner. Some ratings firms and analysts, he said, are forecasting scenarios in which the super-senior tranches would be rendered worthless.

Super-senior tranches were the biggest part of most mortgage CDOs that were underwritten by Wall Street in recent years. In many cases, they comprised 60% to 80% of the dollar value of each CDO, according to analysts.

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