Subprime, CDO Bank Losses May Exceed $265 Billion (Update5)

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, many of which were rated as high as AAA. The action was the broadest by the New York-based firm in response to rising delinquencies among borrowers with poor credit. Moody's Investors Service and Fitch Ratings today said that they're also toughening assessments of the securities as home prices fall and the economy weakens.

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 wave may descend on regional U.S. banks, Asian banks and some large European banks. The ratings actions may create a ``ripple impact'' that further reduces debt prices, 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.''

Widespread `Implications'

Almost half the subprime bonds rated by S&P in 2006 and early 2007 were cut or placed on review, also 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, S&P 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.

Potential forced sales by holders who must dispose of downgraded bonds may have ``implications for trading revenues, general business activity, and liquidity for the banks,'' S&P said in a statement yesterday.

``With any luck it will be so fragmented throughout the system that it won't materially hurt any single bank,'' Tanya Azarchs, a managing director at S&P's financial services ratings group, said in a telephone interview today. She said S&P is now ``investigating'' the size of holdings at individual companies, declining to name any companies or say how long the probe may last.

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

Moody's raised its predictions for losses on loans underlying 2006 subprime-mortgage bonds for at least the third time. The company, also based in New York, boosted its projection to between 14 percent and 18 percent, according to a statement today. The firm plans to reassess the credit quality of the bonds in the ``next couple of weeks,'' Nicolas Weill, a chief credit officer, said in a telephone interview.

S&P Reassess

After the resolution of the S&P's downgrade reviews announced yesterday, no ``further major ration actions'' will be needed for recent subprime-mortgages securities, analyst Ernestine Warner said on a conference call today. Reassessments of securities backed by ``prime,'' ``Alt-A'' and earlier subprime mortgages will continue, she said.

New York-based Fitch will begin using data on the dangers of metropolitan housing markets, rather than just state ones, to review bonds. The company will use the information and new data on the economy's stability to adjust how much will be recovered if a loan defaults, as well the likelihood of a foreclosure.

``The combined impact of these revisions generally produces a higher expected loss for subprime and Alt-A mortgages, and to a lesser extent, for prime mortgages,'' Fitch said in a statement today. Alt-A mortgages are loans considered more likely to default than prime mortgages. They more often include limited or no income documentation, investment properties, or terms that allow borrowers to defer principal repayments or increase debt.

S&P, Fitch and Moody's have been making sweeping cuts after being criticized by investors and lawmakers for their failure to better anticipate the extent of homeowner defaults. Some AAA rated CDOs lost all their value last year, and the ratings were slashed within months after the debt was created.

Accounting rules have allowed many financial companies to avoid writing down their holdings to market prices until the credit ratings fall if they intended to keep them until maturity or hold them for long periods. S&P said it will review the ratings of smaller banks that are ``thinly capitalized.'' It didn't name any of the institutions.

Regional Banks

The largest U.S. regional banks with the lowest Tier 1 capital ratios as Dec. 31 were Seattle-based Washington Mutual Inc.; National City Corp. of Cleveland; SunTrust Banks Inc. of Atlanta; 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.

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.

Foreclosures Increase

Analysts at Credit Suisse Group predicted earlier this month that Washington-based Fannie Mae and Mclean, Virginia-based Freddie Mac, the two largest providers of mortgage financing, could write down subprime holdings by $16 billion because they could no longer argue the declines may be reversed.

Not all of the 12 regional Federal Home Loan Banks, the cooperative lenders owned by banks and insurers, may face writedowns, Victoria Wagner, an S&P analyst, said in a telephone interview, because ``the majority of them don't hold any subprime AAA'' rated securities. As for Fannie Mae and Freddie Mac, which have more of the bonds, the effect ``remains to be seen'' in part because the AAA bonds have only been put under review, she said.

``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.

House Prices Fall

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 Charlotte, North Carolina-based Wachovia Corp. and JPMorgan Chase & Co. in New York.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net ; David Mildenberg in Charlotte at dmildenberg@bloomberg.net

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