Brokerage firms fall as mortgage concerns reemerge

Mar.19, 2008 in Market Outlook, U.S Hot Stocks

Brokers fall as mortgage concerns return

By Alistair Barr, MarketWatch

Last Update: 5:43 PM ET Mar 19, 2008

SAN FRANCISCO (MarketWatch) - Brokerage stocks dropped on Wednesday as concerns
about mortgage exposures in the business reemerged after the sector’s strong
rally Tuesday.

Morgan Stanley managed to eek out a 1.4% gain to close at $43.45 after the firm
(MS) reported better-than-expected first-quarter results.

But rival firms fell, with Merrill Lynch (MER) slumping 11% to $41.45. Lehman
Brothers (LEH) dropped 9.2% to $42.23 and Goldman Sachs (GS) shed 5.2% to
$166.49.

Shares of Bear Stearns Cos. (BSC) dropped 9.8% to $5.33. The beleaguered broker
agreed to be acquired on Sunday by J.P. Morgan Chase (JPM) to prevent an imminent
bankruptcy. The offer price stood at $2.32 at the close of trading on Wednesday,
so Bear shares are still trading at a huge premium.

Merrill’s 11% drop came after the firm sued bond insurer Security Capital
Assurance (SCA). The broker claims that the insurer is trying to back out of more
than $3 billion of obligations under seven credit default swap contracts.

These types of derivatives were used by bond insurers to guarantee bits of
complex mortgage-related securities known as collateralized debt obligations
(CDOs). With the housing market falling, some of these CDOs have slumped in
value, sparking concerns that some bond insurers will have to pay big claims.

Security Capital is trying to survive. The insurer said last week that it had
terminated seven credit-default swap contracts and noted that its counterparty
was disputing the decision. The company didn’t identify the counterparty.

Merrill’s suit on Wednesday reminded investors that some brokerage firms and
banks are exposed to mortgage problems through the bond insurers. Several brokers
and banks hedged mortgage exposures by buying guarantees from these insurers. But
if bond insurers collapse or are downgraded a lot, those hedges become less
valuable.

The financial sector outside brokerages contained some bright spots.

Fannie Mae (FNM) climbed 8.8% higher to $30.71, while Freddie Mac (FRE) advanced
15% to $29.90.

The Office of Federal Housing Enterprise Oversight said it’s allowing the two
companies’ capital surpluses to be invested in mortgages and mortgage-backed
securities.

The move is expected to add up to $200 billion of immediate liquidity to the
market for mortgage-backed securities. Fannie and Freddie have to raise more
capital as part of the agreement with their federal regulator.

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