January 28, 2009: Morning Call

January 28, 2009: Morning Call

Fair Value: SP500 – 842.66; NDX: 1194.18; DOW: 8133.05

Technical Levels:


SPX: 752-755, 800, 816 support/848-852, 899-908 resistance

Events:

Pre-market EPS: BA (.79/13.42B); BDX (1.15/1.78B); BHI (1.28/3.04B); COP(1.62/60.75B); DOV (.86/1.78B); HES (.61/10.81B); LM (-4.01/827.4M); ROH(.62/2.28B); SAP (.97/4.62B); T (.66/31.42B); WFC (.30/10.96B)
07:00: MBA Mortgage Applications
08:00: T earnings call
08:30: WFC earnings call
09:45: MET presents at Citi Financial Services Conference
10:30: DOE Crude Oil and Gasoline Inventories
10:00: HES earnings call
11:15: NTRS presents at Citi Financial Services Conference
14:00: NYX presents at Citi Financial Services Conference
14:00: NYB presents at Citi Financial Services Conference
14:15: FOMC Interest Rate Decision: 0.25%
16:45: QCOM earnings call
19:00: COST Annual Meeting
Post-market EPS: ALL (1.34/6.64B); BEN (.85/1.05B); BXP (1.33/371.5M); DST(1.07/418.7M); MTW (.56/1.20B); MUR (.84/5.79B); PHM (-.66/1.45B); QCOM(.46/2.44B)


Foreign Market Summary/Key Macro News/Commentary:

The S&P and NASDAQ futures are both 20 points above fair value on speculation that the Obama Administration will form a bad bank that will be run by the FDIC. Although recent speculation has centered around a “bad bank” plan, CNBC reported last night at 5pm that details could be announced by the middle of next week. Index futures moved sharply higher with financial stocks outperforming. The key open questions are: what is the pricing mechanism? What assets will the bad bank acquire? What is the size of the purchasing pool? Will the bad bank model allow zombie institutions (C, BAC AIG, ect) to stay afloat or will they be seized and liquidated? The fact that FDIC’s Shelia Bair is lobbying to run the bad bank could imply that bad banks will ultimately be seized and liquidated. Although the seizure and liquidation of bad banks would likely trigger panic selling in the short-term, over the long-term this policy would likely create some stability as private capital (with government assistance) would be able to establish a floor on asset prices.

Impact Research Calls/Market Moving News:

Washington Post discusses Obama Administration's approach to bank bailout plans
CNBC reported last night that the Obama Administration is close to deciding on a plan to purchase bad/illiquid assets from banks, and may ultimately adopt a bad bank approach which prices illiquid assets generously. The Post echoes this headline but does not indicate Obama has settled on just one approach, reporting that Obama's advisers are in the final stages of debating several options to right the financial system. Citing sources, the Post says that the administration is likely to try a combination of initiatives rather than a single, all-encompassing solution to help the financial system. This combination could include: Federal guarantees protecting banks against losses on assets that are backed by failing mortgages and other troubled loans, as used with Citi and BofA, though the cost of this approach is said to be very high. A new government institutions to buy toxic assets, the so-called "bad bank" approach. The Post notes that the pricing issue is said to be the most vexing for the Obama team, though they feel these assets must be dealt with directly. Officials are said to be likely to combine some funds approved by Congress with additional money from the Fed in establishing new government institutions to buy up distressed assets. The injection of more money into financial firms in exchange for ownership stakes. The Post notes that explicit nationalization has little support among key Obama officials, and these officials worry that by taking over a substantial portion of a bank's stock and wiping out shareholders, the government could precipitate a sell-off across the banking system. For this reason, Obama officials feel that the government may need to find a way to safeguard existing shareholders when it provides aid.

Financials trading sharply higher pre-open: As noted in our Overnight Summary and market updates last night, financials have led the market higher following the CNBC report last night suggesting that the Obama Administration is close to deciding on a plan to purchase bad/illiquid bank assets, and that the pricing mechanism might be favorable for banks. A Washington Post report, while also indicating that the Administration was in the final stages of planning, was less definitive about the eventual plan, saying that the bad bank approach could be used in combination with other strategies, and that the question of pricing illiquid assets remains the most vexing. The Post did, however, note that officials are wary of punishing shareholders given the risk that this might precipitate a sell-off across the banking system. Financials are trading sharply higher globally: AIB+22.1%, BCS+21.3%, C+21.1%, DB+18.2%, BAC+18%, WFC+16.6%, ABK +13.4%, GNW+10.6%, HIG+10%, HBC+10.4%.

WFC (16.19): Wells Fargo reports Q4 GAAP EPS ($0.79): Note the ($0.79) in earnings is for Wells Fargo only and includes the following items: $0.99 credit reserve build through Wells Fargo earnings, which includes $0.69 to conform reserve practices of both Wells and Wachovia; $0.08 in OTTI charges; $0.07 in write-downs on aged loans in mortgage warehouse and additions to the mortgage repurchase reserve; $0.05 net charge-offs related to Madoff fraud; and $0.01in merger-related integration and severance expenses. Excluding all of these items, adjusted EPS totals $0.41; however, it is unclear at this time whether any or all of the charges were unaccounted for in analysts' models. Reuters is $0.32 and First Call is $0.33. Wells Fargo reports Q4 results: Net charge-offs as a % of avg total loans were 2.69% versus 1.96% in Q3; allowance as a % of nonperforming loans was 319% versus 161% in Q3. Average loans increased 2.4% sequentially to $413.9B and average core deposits grew 7.7% to $345B. Net interest margin increased 11 bp to 4.90%. Tier 1 capital totaled $86.4B for a ratio of 7.9% at quarter end; this includes the impact of de-risking Wachovia's balance sheet, which reduced the Tier 1 ratio by 230 bp in aggregate. Company goes on to note that it has no plans to request additional TARP capital.

GE (13.06): Moody's reviews General Electric and GECC's 'Aaa' long-term ratings for possible downgrade: Moody's placed the long-term ratings of General Electric Company (Aaa senior unsecured) and General Electric Capital Corporation (GECC; Aaa senior unsecured) on review for possible downgrade. The firms' Prime-1 short-term ratings were affirmed.

GE (13.06): UBS maintains Short-Term Sell rating on General Electric: Firm has a higher conviction that credit losses will surpass the company's forecast following the Q4 release. UBS notes that the Capital Finance earnings run rate is well below guidance on an annualized basis and that non-performing loans are increasing. Target is $12.

LM (19.44): Legg Mason reports Q3 EPS ($10.55), unclear if comparable to Reuters ($4.01): Company reports revenues of $720.0M vs Reuters $827.4M. Assets Under Management were $698.2B, down 17% from $841.9B at September 30, 2008, reflecting net client outflows and market declines. AUM were down 30% from $998.5B at December 31, 2007.

X (31.49): U.S. Steel estimates lowered, reiterated sell at UBS: Firm lowers Q1 and '09 EPS further below consensus following the company's Q4 results and guidance for a Q1 loss. UBS now forecasts '09 EPS to be breakeven vs consensus $3.59. Firm is unconvinced that underlying demand will merit the company restarting capacity beyond its breakeven capacity utilization. Firm also thinks it is unlikely spot sheet prices will rise enough to see positive operating leverage. Target is $25.

X (31.49); AKS (8.64); NUE (39.80); STLD (11.78): Goldman Sachs reduces estimates and targets on steel stocks: AKS target reduced to $11 from $15; rating remains buy. X target reduced to $23 from $36; rating remains neutral. NUE target reduced to $44 from $50; rating remains buy. STLD target reduced to $13 from $15; rating remains buy

FCX (25.63): Freeport-McMoRan upgraded to hold from sell at Canaccord Adams: Price target increased to $26 from $22.50. Firm notes lower costs and does not see significant liquidity or debt covenant issues at current commodity prices.

DO (63.85): Diamond Offshore upgraded to buy from neutral at Goldman Sachs

Jumbo mortgages under pressure – WSJ: Citing data from LPS Applied Analytics, a mortgage-data research firm, the Journal reports that about 6.9% of prime, jumbo loans were at least 90 days delinquent in December, up sharply from 2.6% in the year earlier period. Of interest, delinquencies of non-jumbo prime loans that qualify for government backing increased to 2.1% from 0.8%. Defaults on jumbo mortgages tend to result in outsized losses for lenders given that expensive homes are much more difficult to sell when the real estate market sours. According to the article, three lenders accounted for nearly half of all jumbo loans made in the first nine months of 2008. The top two originators, Chase Home Finance and Washington Mutual, both of which are part of JPMorgan (JPM), made more than 25% of all jumbo loans. In addition, BofA (BAC) and Wells Fargo (WFC) each accounted for 11% of the jumbo market. The article goes on to discuss expectations for a more pronounced decline in jump mortgage originations this year, as well as research from Credit Suisse that estimates that 42% of prime jumbo mortgages will exceed the value of the homes they backed if prices decline another 15% over the next two years.

GSE capital calls suggest government has embraced off-balance-sheet vehicles – WSJ: In a "Heard on the Street" column, the Journal argues that the government seems perfectly content to use the balance sheets of Fannie and Freddie to intervene in the housing market. The paper adds that this dynamic has been evidenced by the lack of public response from the Treasury regarding recent comments from Fannie and Freddie that they may need $16B and $35B, respectively, in additional capital to stave off insolvency. The article goes on to concede that unlike most of the banks into which the government has pumped capital, at least the GSEs are lending