Questioning Sell-Side Research On The Subprime Lenders

In "Now You Tell Us?" the Wall Street Journal's "MarketBeat" blog aptly sums up the state of what passes for analysis on Wall Street these days:

Analysts are bailing out en masse from major subprime lending companies today after profit shortfalls from the second- and third-largest lenders, HSBC Holdings and New Century Financial. But concern about deteriorating credit quality and rising interest rates is nothing new, and one has to wonder just how some analysts avoided seeing this coming.

New Century is down 28% today after saying it would restate financial results and file quarterly reports late. Coming into today, it had already lost 22% since the end of August, when interest rates were rising. Analysts have hardly been raging bulls on the stock — five had the equivalent of a "sell" rating on it — but another eight had either a "neutral" or "buy" on the shares.

One of the bullish houses, Jefferies & Co., had a "buy" on the nation's third-largest subprime lender since early 2004, which worked for a time, and finally dropped the stock to "hold" today. Merrill dropped its rating to "sell," after holding a "neutral" rating on the stock since Nov. 12, 2005 — in which time shares lost 15%. FBR lowered shares to "underperform." It held an "outperform" from Nov. 2004, when shares were at $104, to Oct. 2006, when shares were at $40. Since then it has watched the stock decline as it held a "market perform" rating on the stock.

Analysts were decidedly positive on HSBC Holdings coming into today. Brokerages covering the company out of Asia break down to nine "buy" ratings, eight "neutral" ratings and three "sell" ratings. But news that the capital needed to cover bad debts was $1.76 billion, or 20% higher than expectations, has only moved one analyst to action: J.P. Morgan Chase, which downgraded the stock to "underweight," noting a downgrade to "neutral" last month.

The continued bullishness on this stock comes as credit quality deteriorates and derivative indexes measuring risk in the sector widen out to record levels. American Depository shares of HSBC are down 2.7% today. As time goes on, more downgrades could be in the offing. Breakingviews.com's Mike Verdin notes today that "HSBC Finance's biggest problems are in recent loans, not the inherited book. As those loans mature, the bleeding may yet worsen."

So, it seems highly paid "experts" who had first-hand knowledge about what was going on in the mortgage business, who had plenty of advance warning about serious problems in the residential property market, and who could not have been unaware of the carnage that has been taking place in the U.S. subprime lending sector (described in devastating detail at The Mortgage Lender Implode-O-Meter website, which has been up and running since December 31st), were blindsided by today's disappointing news from the world's third largest bank.

It kind of makes you wonder if these people are anything like all those other highly paid seers who remain unequivocably bullish on stocks and who don't see any sign of a recession on the horizon.

Comments

[Malkiel:]

Why does nobody do their homework on this story? Yesterday's collapse of NEW was caused by the company's announcement, which would have travelled to every ticker that carries company news, that it made big accounting errors, would have to restate its earnings for 3 of the last 4 quarters, and would have to delay its most recent earnings reports for correction. That kind of problem would have sunk the stock even in a booming mortgage market. In the absence of any insider information about the accounting problem buyers of NEW were looking at a high dividend and a sub-prime market that's shaking out slowly, so buying it was not an unreasonable risk. In fact, it's cash position is healthy and the stock may be an excellent buy with 33% more upside now...

2007 Feb 09 11:28 AM