Bear Stearns

Banks under subprime cloud

PUBLISHED : Monday, 10 March, 2008, 12:00am
UPDATED : Monday, 10 March, 2008, 12:00am


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As lenders such as HSBC unveil their massive provisions, questions remain over the outlook for financial institutions and their mortgage-related problems

Was the sum of US$17.24 billion enough to cover loan losses, mainly in last year's subprime mortgage portfolio of HSBC Holdings, Hong Kong's homegrown global lender?

Can financial institutions outside the United States, where the subprime credit crunch started, escape the scourge unscathed?

Investors are raising such questions over and over again in markets worldwide - and not just regarding HSBC but essentially any financial institution under the sun.

At its annual results announcement on Monday last week, HSBC Holdings disclosed impairment charges of US$17.24 billion for loan losses - mainly stemming from subprime lending - and a write-down of US$2.1 billion for subprime-related instruments and other deteriorating assets.

Just two days later, mid-sized Wing Lung Bank and its smaller rival Chong Hing Bank - both known to be conservative local lenders - announced combined provisions of HK$963.63 million in structured and collateralised investments, even though they never participated in subprime mortgage financing.

In the middle of last month, Bank of East Asia, the first among Hong Kong banks and blue chips to announce results, said it made a total write-down of HK$1.35 billion for last year.

Whether banks made sufficient provisions or need to reserve more this year are the market's major worries.

As it stands, working out the magic figure of how much (in provisions) to set aside is tantamount to gazing into a crystal ball. Industry participants are quick to say that despite regulators giving lenders an accounting standard as guidance, it is often a judgment call on just how bad some of the assets have become.

The Hong Kong Monetary Authority encourages banks to make provisions using its benchmarks. Banks are deemed prudent to set aside 20 per cent of the value of loans that are overdue for more than three months and 50 per cent for bad debts of more than six months.

Back in December, when warning that some banks may slip into the red on subprime woes, Joseph Yam Chi-kwong, the HKMA's chief executive, urged that banks make 'sufficient' provisions.

However, for want of a benchmark on myriad structured products with different assets and multiple ratings, when banks calculate provisions they have to make some assumptions on the likely default rate and the value of the collateral.

Herein lies the biggest swing factor in working out subprime-related bad debts in the form of structured investment vehicles (SIVs) and collateralised debt obligations (CDOs). Here is also where transparency may be compromised.

With HSBC, the write-down made for last year was probably sufficient, industry participants said. 'The more difficult to forecast is their write-down on exposure to SIVs and CDOs,' said an analyst with a brokerage house.

Some banks in the city with abundant liquidity invested in SIVs or CDOs to enhance their returns, especially when loan demand was low a few years ago.

The value of SIVs has plunged in recent months as investors started to shun mortgage-related debt when the subprime crisis surfaced. Some SIVs cannot even get their prices quoted.

As a banker rightly remarked: 'We can write down the value as a mark-to-market loss if the market value of the papers has fallen. But there's no market at all for SIVs now.'

And when a financial institution pulls the plug on its SIVs, investors are likely to be left holding empty bags. Wing Lung and Chong Hing, for example, have had to write off their notes issued by Whistlejacket Capital when Standard Chartered Bank withdrew its plan to rescue its troubled SIV unit.

Usually packaged by banks and financial institutions, SIVs raise funds through short-term commercial paper offering higher yields to finance long-term projects. As pools of housing or commercial property loans, CDOs are packaged into bonds with various credit ratings and maturities.

Given that the US economy may go into a recession, it is widely expected that the subprime problem will worsen, prompting analysts to predict that HSBC and other Hong Kong lenders with subprime-related investments will need to make further provisions this year.

'We remain cautious [on HSBC] given the potential for further increases in US provisions and further write-downs against residual asset-backed securities exposure,' Credit Suisse said in a report.

Michael Geoghegan, HSBC group chief executive, has said he was hopeful that the bank's subprime mortgage problem could be resolved by 2010.

That might be wishful thinking, said Billy Mak Sui-choi, an associate professor of Hong Kong Baptist University's department of finance and decision sciences.

'It may take the bank at least another four years to solve the problem completely,' said Mr Mak, using as an analogy Hong Kong's negative asset problem, which took nine years to unravel and resolve.

Lenders with CDO or SIV exposure are also expected to write off more bad debts this year.

'We estimate that BEA will have incurred a marked-to-market loss of HK$1 billion to HK$1.4 billion, equal to a write-down of 20 to 30 per cent,' a Nomura Securities report said. Bear Stearns predicted BEA might have to make another provision of HK$543 million for CDOs and SIVs this year.

As for Wing Lung, the further write-down for similar investments might be HK$442 million this year, the brokerage said.

Wing Lung probably would see a significant rise in provisions in the first half as a large portion of its CDOs and SIVs was not yet provided for, Morgan Stanley said.