Subprime City Confidential: May 13, 2008

Oppenheimer analyst Meredith Whitney treats the Street to lowered EPS estimates, while fresh trouble brews for IndyMac and Crédit Agricole

Spring, belated, but all the more welcome, is coaxing green into the most unexpected parts of the business garden. Except, alas, in Subprime City, where even the lilacs and dogwoods are past due. The denizens of the Markdown Metropolis eagerly await any sign of a seasonal thaw, be it lower long-term interest rates, narrower credit spreads, or a sudden change of heart from Mr. Retentive, the new chief loan officer at the Subprime City Savings Bank.

But fear not, le printemps will eventually arrive in all its glory (as soon as it lines up a capital infusion from overseas investors). So with spring in the air, and a song in our hearts, let's frolic in the fields of fun and gambol in the glades of gladness as we pick a fresh crop of subprime selections. (Note: Please exercise caution if you are undergoing treatment for a gamboling problem.)

Whitney Whips Wall Street

There are two things Wall Street potentates don't want to hear: (1) "Sir/Madam, there are some people from the SEC here to see you" and (2) "Did you see Meredith Whitney's latest note?" Yes, it seems that the Oppenheimer (OPY) equity analyst, who has bedeviled big financial firms such as Citigroup (C) (, 11/26/07) with her bearish calls in recent months, has struck again. In a May 13 note titled "What Goes Up Must Come Down," Whitney lowered her earnings-per-share estimates on Lehman Brothers (LEH), Merrill Lynch (MER), Goldman Sachs (GS), and Morgan Stanley (MS). The cuts were deep: Whitney reduced estimates by an average of 41% for the 2008 second quarter, 48% for fiscal 2008, and 20% for fiscal 2009.

The Oppenheimer analyst based her moves on her firm's outlook on the capital markets as well as "sizable estimated revenue reversals from FASB 159.&quot. For those of you who don't speak Acronym, here's the deal: The firms were able to mitigate some of last quarter's eye-popping credit losses with "write-ups resulting from spread widening on the firms' debts," writes Whitney. For example, Merrill was able to increase the value of its holdings by $2.1 billion in the first quarter, thanks to favorable credit-market fluctuations.

But the low-hanging fruit is gone, according to Whitney: Based on the action in spreads on collateralized debt securities (CDS) so far this quarter, "we believe the brokers' earnings will face sizable headwinds from the reversal of revenues resulting from the spread narrowing of firms' CDS spreads."

Just the kind of thing investors don't want to hear: Shares of the firms mentioned in Whitney's report each posted moderate declines on May 13.

IndyMac, When Are You Comin' Back?

This Indy may not be able to make any hair-breadth escapes like its cinematic namesake. Mortgage bank and thrift operator IndyMac (IMB) faces more tough times ahead. One day after the company announced a first-quarter loss of $2.27 a share—and suspended dividends on its preferred stock—Friedman Billings Ramsey (FBR) analyst Paul Miller cut his price target on the shares from $3 to $1. IndyMac's shares dropped 24% on May 13, to close at 2.32—a far cry from their 52-week high of 37.50 reached last June 6.

Miller, who kept his underperform rating on the shares, had a $2.50 loss estimate. The analyst says the company indicated that despite $97 million in new capital raised since mid-February, its capital levels could fall below "well capitalized" guidelines. In a May 13 note, Miller said that IndyMac, with an estimated capital cushion of just $107 million, will struggle with losses, which the company estimates at $108 million, through yearend. Miller's loss estimate is far harsher, at potentially more than $200 million.

Miller says that IndyMac needs to raise significant capital; the question is not if, but how much, capital will be raised and on what terms. Unless Indy finds a Lost Ark or a Holy Grail, the terms could indeed be onerous.

A Big Hole for Crédit Agricole

Let's visit the French Quarter of Subprime City, where massive credit losses are borne with a delightful Gallic insouciance. Our first stop: Crédit Agricole (CAGR.PA), which said on May 13 that it expected to post a year-over-year 66% drop in quarterly net profit. The French bank's first-quarter net profit was expected to come in at €892 million, well below analysts' consensus estimate of €1.301 billion, according to S&P MarketScope Europe.

The company will release official results for the quarter on May 14, and its board will also discuss a €5.9 billion "capital increase project," which is French for hitting up your shareholders in order to boost your balance sheet. Crédit Agricole's shares dropped 5.6% May 13 in Paris trading, to €19.56, well below their 52-week high of €33.10 one year ago.

The bank also plans a restructuring of its Calyon investment banking unit following €1.205 billion in subprime-related losses. Heads appear to be rolling after the debacle: French newspaper Les Echos reported on May 13 that Marc Litzler will leave his post as head of Calyon along with its current head of specialized financial services, Patrick Valroff. (The company's announcement did not mention Litzler or Valroff, notes S&P.)

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