A Lehman Brothers analyst downgraded a slew of mortgage and card stocks, including Countrywide Financial Corp., Washington Mutual Inc., American Express Co., and Discover Financial Services LLC on fears that the mortgage credit crisis could worsen and spill over into other areas of consumer finance.
"The hefty expected losses in the mortgage sector cannot happen in a vacuum, and … it is just a matter of time before problems spill over to other loan sectors," the analyst, Bruce Harting, wrote in a research note published Monday.
In the worst-case scenario, he wrote, industrywide losses could reach $242 billion over the next few years and not begin to level off until 2009, when they would peak at $45 billion. That scenario assumes home prices would drop 10% to 12%.
However, a more likely outcome would involve 6% home price depreciation and industry losses of $174 billion, Mr. Harting wrote.
Mortgage insurers are likely to be the hardest-hit group, according to the note; their losses could climb to $16.6 billion within the next six years. That forecast is "in line" with one issued last week by MGIC Investment Corp., which said it would not be profitable next year because of paid claims ranging from $1.2 billion to $1.5 billion. Mr. Harting wrote that the Milwaukee company is likely to suffer $4.15 billion of losses over the next few years.
He downgraded shares of Capital One Financial Corp., Amex, and Discover to "equal weight," from "overweight," because of rising card delinquencies and slower consumer spending. He downgraded his overall outlook for the sector to "neutral," from "positive," and lowered his price targets by $10 for Amex, to $60 a share, by $5 for Discover, to $23, and by $23 for Capital One, to $72.
Mr. Harting wrote that Lehman's greatest fear for the card sector was that general economic weakness and ongoing deterioration in home prices could result in higher card chargeoffs. "If unemployment starts to pick up faster than some expect, chargeoffs may reach levels above historic peaks."
MasterCard Inc. escaped a downgrade because of its international diversification and the weakness of the dollar, which could help the Purchase, N.Y., company increase its revenue through things like cross-border transaction fees, he wrote.
(Also, unlike Amex and Discover, MasterCard does not issue its own cards.)
For the mortgage sector, Mr. Harting lowered his sector rating to "negative," from "neutral," and warned that only a small fraction of the $100 billion of the industry's previously forecasted mortgage losses had been recognized to date.
He downgraded Countrywide to "underweight," from "equal weight." Particularly for home equity and "layered risk" loans, Mr. Harting wrote "there is no way of telling how large the embedded losses are in any mortgage lender's portfolio," including Countrywide's. He advised investors to "steer clear" of most mortgage stocks until market conditions stabilize, and he warned that stabilization is unlikely anytime soon, despite rate cuts this month.
