S&P: Two years of problems ahead

Speaking in a conference call today, financial institutions analyst Tanya Azarchs said: "It is not a very rosy picture for the next 18 months or two years. We may get more surprises in the fourth quarter."

Azarchs named over-leverage and subprime exposure as the two main problems facing major financial institutions - of these, subprime was by far the more serious, she said.

"Over-exuberant underwriting created valuation issues for the loans, but it seems to be working its way through; I think banks will get out of it at the current mark-to-market and maybe with some clawback."

S&P listed 10 major banks with exposure to leveraged loans totalling $302.3 billion at the end of September; gross write-offs so far total $12.13 billion.

Write-offs in the mortgage-backed securities sector have been more severe - Citigroup and Merrill Lynch have both made write-offs of 27% of their total exposure, for example.

"What concerns us is the risk management implications," Azarchs said. "For example, Citigroup - how did banks allow such a large pileup of warehousing [these securities]?" Analyst Vicki Wagner added: "We still haven't seen the full effect of the mortgage malaise on the general economy. It could affect the economy across the board. The risk management capacity has fallen short in some cases, because the market was much more unpredictable and volatile than the technology could cope with."

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