Factor In Reality

Implications: Write downs are not actual losses and a mark-to-market loss is not a cash loss. Widening spreads in the credit default market, although real, must be recognized for what they are; namely, market monetization of perceived risks compared to recent backwards looking asset and cash flow valuations. Recovery in the general credit market should produce non-cash reported earnings increases starting in 2009 and similar narrowing of the exact credit default spreads that widened recently.

Analysis: To truly assess the credit default risk inside money center banks, analysts must bore down at least two more levels of reported information to determine the cash losses from assets held or sold.

Unfortunately this level of detail in not generally available even after pouring through all the footnotes. However, certain conclusions can be gleaned from marrying public information from the bank with published information that is available. Note the source of the write-down or loss.

Write-downs that are directly related to a portfolio of assets not held for resale or later financing are usually meaningful, since the bank would have conducted an internal analysis of the composition of the assets and the loans or contracts that comprise that portfolio segment. The internal analysis would have revealed that delinquent but not defaulted assets have increased and real losses will meet or exceed previous expectations. This is real money.

Write-downs and losses that relate to assets that are warehoused, held for resale or held for refinancing were never intended to be held to maturity. Due to market conditions, the related or secondary transaction has made these assets illiquid or more illiquid. There is no practical method to determine a static value of these assets in the first place. Mark-to-market writedowns of these assets are bookkeeping entries and only foolish managements sell them outright and realize the losses.

The financial press reports these events in the same way - beware and look for the truth then the opportunities in hidden values.