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Bill Miller on This Tough Market

I guess Bill never read this WSJ article last week

No sooner had financial stocks gotten up off the mat than poor existing-home sales body-slammed them.
The abrupt halt Thursday to the relief rally that started last week underscored how little confidence investors have in the sector. Many feel they can't get a handle on bank balance sheets.
Details that emerged earlier this week from Bank of America's purchase of Countrywide Financial help explain why that is the case. The deal's numbers show that big losses could still lurk in banks' closets.
If so, their loan portfolios are worth far less than the stated values, and reserves taken against possible losses are inadequate. And if bank capital is overstated, firms could again be forced into dilutive capital raising.
Turn to Countrywide -- and the huge amount by which Bank of America wrote down its assets. In second-quarter results out earlier this week, Bank of America said Countrywide's equity available to common stockholders, or its net worth, on a market-value basis at June 30 was just $100 million.
To put that in perspective, Countrywide had $172 billion in assets at the end of June. Plus, Bank of America paid $4.1 billion for the firm, once the country's biggest mortgage lender.
How could Countrywide's net worth be just $100 million? When a financial firm is acquired, the purchaser applies market values to all its assets and liabilities. Banks normally hold a big portion of their loans at historical cost with a reserve set aside for potential losses.
At Countrywide, this marking to market of its loan portfolio resulted in a $9 billion hit, which was on top of about $5 billion in reserves. This, along with some offsetting items, took common equity to $100 million from $8.4 billion.
The new market value was equivalent to about a 15% average mark on the firm's nearly $100 billion loan portfolio, David Hendler, an analyst at CreditSights, said in a research note. The mark was driven by low market values for home-equity, option-adjustable-rate mortgages and subprime assets.
Granted, such a mark is a point-in-time estimate based on all the assets being sold. In reality, banks offset credit losses over time with earnings. And most big banks wouldn't face anywhere near as severe a market-value hit.
Still, the reduction in the value of Countrywide's loans raises the question of what would happen to other banks if they similarly marked loan portfolios to prices they could fetch if sold in the market today. Typically, banks create reserves equal to 1.5% to 3% of those portfolios, but the prices applied to Countrywide's loans show those set-asides could be too low.
Applying a mark of 5% -- more aggressive, but still well below Countrywide's -- at Citigroup, J.P. Morgan, Wells Fargo, Wachovia, Washington Mutual and Bank of America results in 10% to 30% reductions in the banks' stated book values. Push the mark to 7.5% and book values are 20% to 50% below stated levels.
"That is why you see so many banks trading at such a discount to book value," says Craig Emrick, a bank analyst at Moody's Investors Service.
That explains why many investors didn't think share prices were irrationally low in the beginning of July. It also shows why markets could again plumb those lows if bank losses exceed current expectation