Wednesday, April 22, 2009

Meredith Whitney: Part 2

From the increasing popularity caused by correct assessment and prediction after correct assessment and prediction, Meredith Whitney resigned from Oppenheimer on February 19, 2009, just three weeks after the clip above, to establish her own firm, Meredith Whitney Advisory Group LLC. In one of her most recent interviews with Steve Forbes on April 5th, she was asked if we are currently out of the water. To read the entire transcript, click here.

Below, we have excerpted some of our favorite thoughts....enjoy!

STEVE FORBES: Back in the summer of 2008 when a lot of people thought we were out of the woods on the financial crisis, you said no, the worst was to come. First of all, why did you think there was such devastation in the banking sector that was unprecedented? And are we finally climbing out of the thing?

Meredith Whitney: What worried me last summer, summer of 2008 was what happened to IndyMac in the summer, in July, when you had a run on the banks. And what I knew at the time, was that there would be runs on other banks, and those that were heavily weighted towards commercial deposits.

So, at the time, it was a guarantee of $100,000 or below. And so, the commercial deposits, that which you pay your payroll through, there was your 30-plus percent of the banking system, 35% of the banking system, uninsured. And so, if you look at what was, who had the most exposure to the commercial deposits, obviously, those were the first to flight.

So, what you saw then was an effective on the bank of Washington Mutual, and an effective on the bank at Wachovia, and NatCity and some others. And so, what we didn't see was, all of those deals were done inside of the third quarter. So, what you didn't see was what happened to their deposits inside of the third quarter. So, July was part of the third quarter.

And by September, Wachovia and Washington Mutual were part of another entity. We never saw how bad things were. But I saw that on the come. I also knew that it was clear that the banks were carrying bad math assumptions. So, one key variable in evaluating your mortgage, what your mortgage portfolio is worth is, No. 1, what employment is.

But No. 2, where you think home prices are going to go. And as an example, Wachovia, which was, I put a sell rating on Wachovia in July. And the stock was $9 or something. It was a pretty wild call. But I knew that they were expecting home prices to decline by 21%; 60% of their exposures were in California. Case-Schiller is now down 30% in the top 10 MSAs. So, it was clear that they would have to play catch-up. And it is also clear that the banks still have to play catch-up. The banks, all the big banks anyway, carry their mortgage books with an assumption that home prices would decline peak-to-trough 30%, 31%.

Well, we're already there. So, what you'll see in first-quarter results is a catch-up to what now the future of market is doing, viewing the peak-to-trough home prices to be 37%. So, you're constantly having to reevaluate your reserves against loans. That puts earnings pressure on companies.

And it creates an environment where it's almost impossible to regenerate your own capital, to grow your own capital. So, you've got to have your hands out for other people's capital. And it's been sovereign wealth fund's capital. It's been U.S. investor's capital. It's been our taxpayer's dollars as capital. And I don't see that ending anytime soon.

SF: Now, in January and February, it seemed, at least to an outsider, that even regardless of what the books said, the banks seemed to be doing very well on a cash-operating basis, the rollover alone. You were paying fees. You are paying fees. You were paying 10,000 points above LIBOR. Do we have a disconnect here? Where on a cash basis, the banks are doing well; where in a statutory, regulatory basis, they're still not out of the woods?

MW: On an accrual basis, that's where you get into problem areas. Because your loan is only as good as it pays you back. And so, the loans are paying back less. As I said, one of the two main assumptions that goes into valuing any of your loans, accrual-based loans, is home price appreciation, but also unemployment.

A lot of the banks were carrying seven-and-a-half to eight percent unemployment. We're already over 8%. So, there are going to be big true-ups this quarter. Some parts of the business are OK. And what's interesting, for a Goldman Sachs, 70% of the capital markets competition has gone away, or dramatically pulled in their horns.

So, it's a smaller pie. But you're getting more of a market. And the government actually is churning a lot of fees for Wall Street. So, there's trading activity there. I don't know how sustainable it is because bank revenues, cash-based revenues on the non-accrual-based loans, should correlate to some multiple of the GDP and global GDP. And as we know, the global GDP is coming down.

It should be clear from this transcript, the numerous TV appearances, and publicized predictions proven correct, that Meredith Whitney knows her stuff. Stay tuned for Friday, however, when we take Ms. Whitney off her pedestal as David Weidner of the Wall Street Journal helps us rip her a new one...we ain't Fox News, but we ARE fair and balanced.

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