Financial Sector Faces More Housing Woes: Goldman

Goldman Sachs issued a gloomy report on the U.S. financial services sector, saying housing prices are likely to fall a lot further, write-downs will mount and some mortgage insurers and guarantors will be forced to raise capital just to survive.

A foreclosed home for sale.
David J. Phillip
A foreclosed home for sale.

Falling house prices and a worsening economy will drive down securities based on residential mortgages, especially those given to borrowers with the riskiest credit, Goldman Sachs financial analysts Lori Appelbaum, Thomas Cholnoky, James Fotheringham and William Tanona, wrote in a lengthy report released on Monday.

Meanwhile, the value of collateralized debt obligations -- bonds based on pools mortgages -- related to those subprime mortgages, could fall another $150 billion across the industry, the bank said.

That's on top of the $18 billion financial firms globally wrote down in the third quarter and the $22 billion that some companies have indicated they expect in the fourth quarter.

Share markets across the globe sank after an earlier report from the Goldman analysts downgrading Citigroup reignited fears that losses from the global credit crisis may widen.

Need for Capital

Stock benchmarks in the United States fell to their lowest levels in three months on Monday. In Asia MSCI's measure of other Asia Pacific stocks hit its lowest level since late September. Financial stocks were among the worst affected.

Inevitability, certain financial guarantors and mortgage insurers will need to raise capital to shore up their balance sheets.

The Goldman analysts said these companies will fall into two groups, the desperate -- those which will face the risk of going out of business if they don't raise capital -- and the needy -- those that could employ other means to do so, such as cutting dividends.

Goldman lists financial guarantors MBIA , Ambac Financial Group , Security Capital Assurance and Assured Guaranty as the desperate. It lists Citigroup, Washington Mutual , First Horizon National and National City in the "needy" column.

Without the riskier loans such as subprime or no-or-low documentation mortgages, returns in the mortgage business will be significantly lower.

"Investor appetite for high-yielding subprime mortgage securities fuelled the home pricing bubble and this investor market is not coming back," the analysts wrote.

Brokers will rethink their business models focused on these exotic loans, the analysts said.

Consumer Credit Fear

With home prices, consumer credit deterioration is not far off. The downturn in housing is spilling over into employment in some states and is leading to high consumer losses, the analysts said.

Falling home prices have put one-third of the United States, by Gross Domestic Product, in or near recession, the analysts wrote. California is the biggest concern as it represents 13 percent of the U.S. GDP. Card and auto losses will rise.

Although financial companies across the board have seen their stock prices walloped, despite attractive valuations, Goldman says a broad wave of industry consolidation is still another 12 to 18 months away.

"Credit risk, balance sheet deterioration, and business model risk continues to outweigh low valuations," the analysts wrote.

"We believe acquisitions are unlikely to occur until balance sheets stabilize and a market bottom is in sight," the analysts said.

Acquisition Targets

Once U.S. housing shows signs of bottoming out, there will be some solid but tarnished companies investors will view as likely acquisitions targets.

Suitors are likely to come from all parts of the globe, even from emerging economies such as China or India, as the dollar remains weak.

"We would not be surprised to see the first acquisition of a major U.S. broker or commercial bank by an emerging market institution," the analysts wrote.

Earlier on Monday, the analysts downgraded Citigroup to a sell because of its exposure to CDO revaluations and Discover Financial Services because of its vulnerability to consumer credit deterioration.

Additionally, the firm believes that three financial "babies" have been "thrown out with the bathwater" and recommend buying American International Group, US Bancorp and aircraft lessors, such as AerCap Holdings , Aircastle , and Genesis Lease.