Subprime hangover lingers over bank earnings

By Walden Siew - Analysis

NEW YORK (Reuters) - Financial firms that had hoped to swallow their subprime mortgage pain and move on are finding the hangover is lasting longer than expected.

Bonds of banks and insurers that have been crushed as their subprime losses surged still may not be cheap enough to buy.

The conventional wisdom last year was that companies such as Citigroup (C.N: Quote, Profile, Research, Stock Buzz) and Merrill Lynch & Co (MER.N: Quote, Profile, Research, Stock Buzz), under new leadership, would use the last quarter of 2007 as a so-called "kitchen sink" quarter, to report their worst write-downs and losses, and move on.

That didn't happen.

Earnings results from banks, bond insurer MBIA Inc (MBI.N: Quote, Profile, Research, Stock Buzz) and American International Group Inc (AIG.N: Quote, Profile, Research, Stock Buzz) show the situation is worsening and may stretch beyond the second quarter or longer. As a result, investors are mostly avoiding their bonds and stocks for now.

"To say we hit some speed bumps and now we're ready to race again, is not the case," said David Hendler, an analyst at research firm CreditSights. "This is a prolonged problem and this is not going to get better next quarter and maybe even next year."

Financial shares have dropped almost 11 percent this year, the worst performing sector year-to-date, versus a 3.7 decline in the Standard & Poor's 500 Index. Bank and brokerage debt has lost 3 percent year-to-date, versus a 0.3 percent gain for overall high-grade corporate debt, according to Merrill Lynch data.

Finance firms continue to underestimate exposure to mortgage losses, missing their earnings targets as a result. At the same time, major revenue streams are drying up, such as those from building specialized bonds like collateralized debt obligations, or CDOs.  Continued...