Subprime Problems Continue

By Glenn Dyer | More Articles by Glenn Dyer

The problems rolling across the US housing industry and associated financial markets show no sign of ending their snaring of new victims.

Two more have emerged: one in the US with worrying implications for the wider housing and finance sectors, and the other is in Germany.

News of the new problems comes as Asian stockmarkets fell (helped by the poor election result for the Japanese Government), while Australian shares steadied and waited for a clearer lead from Europe and the US last night.

At the same time, high yield currencies like the Australian and New Zealand dollars continued to be sold off yesterday as the Japanese yen rose to a month's high against the euro. The yen was not spooked by the losses inflicted on the Abe Government by Japanese electors on Sunday.

In Germany IKB Deutsche Industrie bank AG, a German industrial bank that invested in US sub-prime mortgages has revealed that profit will be "significantly'' lower than forecast.

It also sacked its chief executive officer as a consequence, according to a statement issued on a financial news wire yesterday. Its shares plunged 20 per cent as a result.

"IKB is no longer in a position to maintain its earnings forecast of 280 million euros ($US382 million, or around $A425 million),'' the Dusseldorf-based bank said in a statement.

IKB shares have shed 18% in value so far this month as investor worries mounted about its exposure to the problems in the US sub-prime mortgage market. It is predominantly a lender to small and medium companies in Germany, so what it and an associated group were doing playing the US sub-prime mortgage market is hard to fathom.

KfW Group, the German government-owned finance agency that owns 38% of IKB, will cover the company against potential losses. IKB didn't quantify the impact of the sub-prime rout on its earnings in its statement but it must have been significant to issue the statement, to sack the CEO and for KfW to issue a statement saying it would cover the losses.

The text of the statement has more:

"IKB Deutsche Industriebank AG (IKB) has felt the impact of the crisis in the US sub-prime mortgage market, as spreads widened sharply during last week's violent fluctuations, causing massive uncertainty amongst institutional investors.

"In this context, the ability of the Rhineland Funding conduit (managed by IKB) to access funding appeared to be threatened, in which case IKB would have been drawn upon liquidity facilities provided to Rhineland Funding.

"Rhineland Funding – and, to a lesser extent, IKB itself – have invested in structured credit portfolios, which include exposures to US sub-prime real estate loans.

"Despite market discounts affecting the valuation of such assets, to date there have been few loan defaults, and only some rating downgrades affecting portfolio investments.

"Nevertheless, towards the end of last week IKB's creditworthiness was being questioned due to said exposures. There was a risk that this confidence crisis would deteriorate further.

"KfW, IKB's main shareholder holding a 38% stake, took immediate action, implementing measures to safeguard IKB's creditworthiness without delay. Specifically, KfW will assume IKB's financial obligations under the liquidity facilities vis-à-vis Rhineland Funding with effect from 30 July 2007.

"In addition, KfW will protect IKB against risks resulting from certain portfolio investments. These measures will maintain IKB's strong creditworthiness, in particular in its banking business with German medium-sized businesses.

"Given the developments outlined above, IKB is no longer in a position to maintain its earnings forecast of € 280 million for the 2007/08 financial year. From today's perspective, results will be significantly lower. As late as July 20, there was no sign of the problem when IKB and KfW both reported solid rises in first quarter earnings."

That is a serious situation.

More than 40 companies, including two hedge funds in Australia and their investors (Absolute and Basis Capital) around the world have lost money to varying degrees in the collapse in the sub-prime mortgage market which is now showing signs of spreading to parts of the American home loan market thought healthy.

Dillon Read Capital Management LLC, one of UBS's hedge fund units collapsed in May after more than $US120 million of losses from mortgage-related holdings, and possibly more in the June quarter, according to European bank analysts.

And there are those two Bear Stearns hedge funds which are being rundown and could produce losses of around $US2 billion.


And in the US, there are signs the sub-prime crisis is reaching into the broader housing market.

Last week the biggest lender, Countrywide Financial revealed a 33% drop in earnings and a huge rise in capital set aside to cover write-downs and losses.

On the weekend another mainstream lender, American Home Mortgage Investment, revealed that it is delaying paying dividends on its ordinary shares, and may do the same on its preferred shares because its banks have demanded that it put up more cash after the mortgage lender slashed the value of its loan and security portfolios.

This news sent the shares plunging 45 per cent yesterday on Wall Street as investors abandoned what they saw as a sinking ship

American Home Mortgage's borrowers tend to have higher ‘prime' or ‘near prime' credit ratings. The news would also confirm fears that the sub-prime mess is hitting the so-called "Alt A' group of mortgages which have better credit ratings.

American Home said in a statement that these moves were necessary, "in order to preserve liquidity until it obtains a better understandi

Glenn Dyer

About Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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