Subprime: worse yet to come?

Last week's strong earnings report from Lehman Brothers may turn out to be an anomaly in a procession of weak quarterly earnings from major investment banks.  As the credit crisis sweeps through Wall Street, there is a growing feeling that the worst is yet to come.

Next up is Morgan Stanley, a bank that fired its co-President Zoe Cruz in November after it disclosed $3.7 billion in mortgage losses.  Even greater writedowns are expected, following an industry trend of more aggressive markdown rates for troubled sub-prime assets as equity markets move toward full disclosure of losses.  The trend raises questions about where Western investment banks will find fresh sources of capital as the financial market squeeze creates tight credit conditions. 

One possible solution, as UBS and Citigroup have found, is to look further afield to sovereign wealth funds in Asia and the Gulf States.  Last week, UBS, Europe's largest bank by assets, announced losses in the fourth quarter and possibly for 2007 and $10 billion in writedowns.  Seeking a capital liquidity injection, UBS will raise $11.5 billion by taking on strategic investors in Singapore and the Middle East.  Citigroup, the biggest US bank by assets, recently sold a 4.9% stake to Abu Dhabi Investment Authority (ADIA) for $7.5 billion.  Continued sub-prime fallout provides clear incentives for increasing capital investments from sovereign wealth funds.

There will be few shivers of schadenfreude as Morgan Stanley comes clean. For Merrill Lynch and the US' three biggest banks, Bank of America, Citigroup and JPMorgan Chase, are due to report their final results for 2007 in January.