Analytical Wealth

The thinking was that Q3 woes were really due to the impact of the credit crunch, not the first wave of losses from poor lending standards, bad investments in debt securities, poor risk management, etc. Meanwhile skeptics like me noted that their earnings guidance was a bit off since the impact of the credit crunch in late Q2/Q3 wouldn’t be felt until Q4, not to mention the fact that the overall banking environment wasn’t going to suddenly improve in Q4. I felt this was especially true for Countrywide as their overall business was deteriorating rapidly, and even without a credit crunch the mortgage crisis was going to cause them significant difficulties moving forward.

Fast forward to the present:

Proving my skepticism was not only correct but a bit optimistic, in order to avoid going into bankruptcy Countrywide had to sell itself to Bank of America at a price that is approximately a 60% discount to CFC’s market cap at the time of their claims of a “return to profitability”. It’s not as if a series of singular calamities befell the company, instead it was nothing more than the result of a poorly managed business and the real impact of Q2 and Q3s credit squeeze. CFC’s fate should not have been a surprise to anyone.  

Unlike CFC Citibank may still be an on-going independent concern, but their Q4 results were nothing short of abysmal. Not only did they not return to a “normal earnings environment”, but they announced 11 billion more in write downs just a few days after the previous claim of earnings normalcy. Then we had the following news items from Citibank:

• In a move that ran contrary to its previous claim that it would not bail out its SIVs, the company announced that they were bailing out 7 of its SIVs and taking on $49 Billion onto their balance sheet.
• Then they company went looking for investors to inject much needed cash into the company, between the money from Abu Dhabi, Saudi Arabia and the investments noted in their Q4 earnings report, the company has taken in over $20 billion in investment dollars to shore up their balance sheet.
• Then we have the Q4 results: $18 billion in write downs and a $10 billion loss for the quarter that completely wiped out 2007’s profits. On top of that, the company is slashing its dividend and laying off thousands of people to reduce costs. 

The earnings guidance provided by Citibank and Countrywide Financial was clueless at best, outright lies at worse. The earnings guidance ignored the fact that they had tons of bad investments, decisions, a worsening business environment, etc, which had yet to be truly reflected in their earnings results and wouldn’t be until Q4. These problems have been festering for some time now and didn’t just suddenly appear, what we’re seeing now is just the result of months, if not years of bad decision making, investments and weak lending standards.  

The leaders of these companies should’ve been well aware of what was going to happen in the coming months and shouldn’t have fluffed investors with dubious claims to the contrary. However, when all is said and done C and CFC will have plenty of company with respect to dubious guidance and leaders who are disconnected from reality.

As the Q4 earnings season gets under way, be mindful of the fact that many of the banks haven’t let go of the faulty assumptions and overall disconnect from reality that got them into trouble. After all, many banks tried to blame their losses almost entirely on the credit crunch as opposed to the years of bad investments, weak lending standards, poor risk management, etc, that created the credit crunch in the first place. The bank’s behavior in this regard is analogous to someone shooting themselves in the foot and then blaming the existence of bullets for their problems.

Finally, don’t be surprised if they’re some more surprises/negative news down the road, as the banks have such deep seated problems that it will probably be Q3 or Q4 ’08 (if not sometime in 2009) before they get their acts together and cleanse their balance sheets. Remember, a lot of people were calling a bottom in Q3 and its quite obvious (at this point) that the Q3 results were just the tip of the iceberg.

Sources:

Seeking Alpha: “Countrywide Financial Q3 2007 Earnings Call Transcript” – October 26, 2007

Bloomberg: “Bank of America to Acquire Countrywide for $4 Billion” – David Mildenberg – January 11, 2008.

Forbes: “Citi Gets Caught in the Squeeze” - Evelyn M. Rusli, October 1, 2007

Forbes: “Citigroup Goes It Alone To Rescue SIVs” – Liz Moyer – December 13, 2007  

Seeking Alpha: “Citigroup Q4 2007 Earnings Call Transcript” – January 15, 2008