Thursday, January 31, 2008

Subprime, CDO Bank Losses May Exceed $265 Billion, S&P Says

By Jody Shenn and David Mildenberg

Jan. 31 (Bloomberg) -- Losses from securities linked to subprime mortgages may exceed $265 billion as regional U.S. banks, credit unions and overseas financial institutions write down the value of their holdings, according to Standard & Poor's.

S&P cut or put on review yesterday the ratings on $534 billion of bonds and collateralized debt obligations tied to home loans made to people with poor credit, the most by the New York-based firm in response to rising mortgage delinquencies.

While banks and securities firms such as Citigroup Inc. and Merrill Lynch & Co. accounted for most of the $90 billion in writedowns to date, S&P said the next round will be borne mainly by smaller financial institutions in Europe, Asia, and the U.S. The ratings actions yesterday may create a ``ripple impact'' that further reduces prices of the securities, S&P said.

``There's a lack of confidence in the markets and this exacerbates that,'' said Anthony Davis, a banking analyst at Stifel Nicolaus & Co. in Florham Park, New Jersey. ``This will have a chilling effect on the markets.''

Almost half the subprime bonds rated by S&P in 2006 and early 2007 were cut or placed on review, potentially forcing credit unions and government-sponsored enterprises such as Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks to write down their holdings, the firm said. The securities represent $270.1 billion of subprime mortgage bonds and $263.9 billion of CDOs. About 35 percent of all CDOs comprised of asset-backed securities were put under review, S&P said.

Widespread `Implications'

``It is difficult to predict the magnitude of any such effect, but we believe it will have implications for trading revenues, general business activity, and liquidity for the banks,'' S&P said in a statement yesterday.

Some of the largest banks have already taken ``significant'' losses related to subprime mortgages and CDOs, and aren't likely to report more writedowns, S&P said. CDOs package assets into new securities with varying degrees of risk, from AAA to unrated classes.

Accounting rules have allowed smaller banks to avoid writing down their holdings until the credit ratings fell if they intended to keep them until maturity. S&P said it will review the ratings of smaller banks that are ``thinly capitalized.'' It didn't name any of the institutions.

The largest U.S. regional banks with the lowest Tier 1 capital ratios as of June 30 were Seattle-based Washington Mutual Inc.; Wachovia Corp. in Charlotte, North Carolina; National City Corp. of Cleveland; Atlanta-based SunTrust Banks Inc.; and Regions Financial Corp. in Birmingham, Alabama. Tier 1 capital measures a company's ability to cover losses.

Spokespeople for the banks either declined to comment or couldn't be reached for comment.

Credit Unions

The nation's biggest credit unions by assets include Navy Federal Credit Union in Vienna, Virginia; State Employees Credit Union in Raleigh, North Carolina; and Pentagon Federal Credit Union in Alexandria, Virginia, according to American Banker. Spokespeople for the credit unions didn't immediately return calls for comment.

Even before the S&P downgrades, analysts at Credit Suisse Group predicted that Washington-based Fannie Mae and Mclean, Virginia-based Freddie Mac, the two largest providers of mortgage financing, would write down their subprime holdings by $16 billion because they could no longer argue the declines would be reversed.

``We expect that the U.S. housing market, especially the subprime sector, will continue to decline before it improves, and we expect housing prices will continue to come under stress,'' S&P said in the report.

Foreclosures Increase

S&P's move came a day after RealtyTrac Inc. said the number of U.S. homeowners entering foreclosure climbed 75 percent in 2007 from a year earlier as mortgages became more difficult to refinance and falling property values made it tougher to sell.

More than 1 percent of U.S. households were in some stage of foreclosure during the year, up from 0.58 percent in 2006, according to RealtyTrac, an Irvine, California-based seller of real estate data. Home prices in 20 U.S. metropolitan areas fell 7.7 percent in November, the 11th consecutive decline, according to the S&P/Case-Shiller home-price index released this week.

The Federal Reserve yesterday cut its target interest rate for overnight loans between banks by half a percentage point to 3 percent, the lowest since June 2005. Lower borrowing costs may help borrowers of subprime loans by reducing the scheduled rate increases on their mortgages, according to reports by analysts at banks including Wachovia and JPMorgan Chase & Co. in New York.

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