S&P Subprime Global

September 17, 2008
Global Financial Institutions Eye Another Wave Of Write-Downs As U.S. Housing Woes Spread
Primary Credit Analyst: Scott Bugie, Paris (33)1-4420-6680; scott_bugie@standardandpoors.com Secondary Credit Analyst: Nick Hill, London (44) 20-7176-7216; nick_hill@standardandpoors.com
Table Of Contents
Write-Down Estimates Have Increased Unwinding Lehman's Trades Will Further Depress The Market Values Of MBS Losses Have Spread Beyond Subprime A Rising Tide Of Write-Downs Alt-A Segment Risk Is Increasing Negative Home Equity Leads To Second-Lien RMBS Defaults CMBS Remains Resilient ABS CDOs Are Likely To Rack Up Heavy Losses EOD Clauses Force Sales At Depressed Values A Hold-To-Maturity Estimate Assesses Economic Value The Industry Moves From Write-Downs To Loan Losses
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The pain of the global financial industry remains largely linked to the declining fortunes of the U.S. housing sector. Securities backed by U.S. mortgage loans have lost hundreds of billions of dollars in value since summer 2007. The losses have spread beyond subprime, which represents only 10%-15% of residential real estate borrowing in the U.S., to other pressured areas of U.S. housing finance. Three prominent players--Citigroup Inc. (AA-/Negative/A-1+), Merrill Lynch & Co. Inc. (A/Watch Dev/A-1), and UBS AG (AA-/Negative/A-1+)--account for 40% of the more than $300 billion in write-downs of mortgage-backed securities (MBS) and leveraged loans taken through the first half of 2008. Beyond that concentration, the write-downs have been spread geographically and by institution. Intermediaries and investors across the globe took part in the financing of highly leveraged U.S. households during the boom years; they consequently are bearing their share of losses from the decline. Standard & Poor's Ratings Services believes that turbulent capital market conditions and continuing negative news from the U.S. mortgage market will lead to another large wave of write-downs in the second half of 2008. The rare true sales of nonprime MBS in 2008 have been at depressed prices. The stunning collapse of Lehman Brothers Holdings Inc. (Lehman; D/--/D) and the unwinding of the group's trades surely will place additional downward pressure on values of nonprime MBS via forced sales under unfavorable market conditions. While the global industry likely has passed the halfway mark for write-downs, a wider range of MBS segments are at risk and all segments of MBS have deteriorated in recent months. We expect financial institutions with material residual balances of nonprime MBS to take significant additional write-downs in the second half of 2008. In fact, this has already begun with the third-quarter earnings releases of the U.S. broker-dealers. The drop in value of several MBS segments is the result of accelerating rates of delinquency and default of U.S. mortgage borrowers as well as the complex financial engineering of collateralized debt obligations (CDOs) that has amplified the impact of the MBS decline. (See "The Credit Market Dislocation: Putting The Key Factors In Perspective," published Sept. 3, 2008, on RatingsDirect.) CDOs of asset-backed securities (ABS) represent the lion's share of losses at this stage in the cycle. Also representing significant risk concentrations are the Alternative-A, closed-end second mortgages (CES), and home equity line of credit (HELOC) segments of RMBS. The values of other bank assets that are marked to market--leveraged loans, commercial mortgage-backed securities (CMBS), and loans warehoused for inclusion in CMBS--have also eroded. When we analyze nonprime MBS from a "hold-to-maturity" perspective, the write-downs that financial institutions have already taken appear to cover the majority of projected losses on the wider group of MBS mentioned above. Focusing on the tiered structure of MBS shows that much greater amounts of estimated losses will penetrate the highly rated tranches of ABS CDOs and second-lien RMBS than the other segments of MBS, including subprime RMBS. But current market forces are such that an increasing proportion of nonprime MBS are being marked to prevailing low values. For example, half of the ABS CDOs issued from 2005 through 2007 have already reached event-of-default triggers that accelerate payments or lead to termination of the CDO and liquidation of the underlying securities. The financial industry raised a huge amount of capital over the past year to compensate for securities losses. The present market conditions are less favorable, and financial institutions face this next wave of write-downs with reduced opportunities to raise additional capital. The success in future capital raising, through issues or asset sales,
Standard & Poors RatingsDirect | September 17, 2008

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to compensate for additional securities write-downs, will be the key factor driving the credit ratings on many global financial institutions in the second half of 2008.
Write-Down Estimates Have Increased

A half year ago we headlined our calculation for write-downs in the report "Subprime Write-Downs Could Reach $285 Billion, But Are Likely Past The Halfway Mark," published March 13, 2008, on RatingsDirect. When we run the same calculation today as laid out in that article on the ABS CDO and subprime RMBS segments (excluding second-lien RMBS), the estimate grows to $378 billion, due to an increase in projected losses on the loans backing the securities and a continual drop in market values. Aiming the analysis at a wider range of MBS that have lost value since summer 2007 expands the potential for write-downs to well over $500 billion. The market is still searching for an equilibrium price on trillions of dollars of structured securities, in particular at the higher end of the ratings spectrum. In contrast to our write-downs estimate in the March report, this article introduces a detailed "hold-to-maturity" estimate of losses on the wider group of structured securities. We feel this better assesses the underlying economic value of the securities than current market values, which may reflect significant risk premiums for illiquidity and uncertainty. The gap between projected cumulative losses on a hold-to-maturity versus a market valuation approach is significant for many MBS, in particular at the higher end of the ratings spectrum. Our hold-to-maturity estimate of ultimate losses for the wider range of MBS is $437 billion and $482 billion including leveraged loans. The erosion of the creditworthiness of financial guarantors (the monoline bond insurers, or monolines) has increased total write-downs for banking groups. A material portion of the MBS risk that banks and broker-dealers transferred to the monolines has, in effect, returned to the banks and brokers. By our estimation, up to 15% of the write-downs through the first half of 2008 are in the form of valuation reserves against coverage they purchased from the monoline industry, which has been hurt significantly by its entry into the business of guaranteeing MBS earlier this decade. Due to doubts about the capacity of monolines to cover their guarantees, many financial institutions are commuting insurance contracts (typically in the form of credit default swaps) on ABS CDOs and other MBS for cash payouts that are a fraction of the drop in value of the underlying securities.
Unwinding Lehman's Trades Will Further Depress The Market Values Of MBS
Lehman Brothers' collapse will likely place further downward pressure on MBS values. While the Sept. 14, 2008, Chapter 11 filing only included the U.S. holding company Lehman Brothers Holdings Inc. (LBHI), the group's major international operating entities in the U.K., Japan, and Germany have been placed under various forms of administration by the financial authorities of their respective countries. We believe that many trades between Lehman's broker-dealer subsidiaries and their counterparties technically are in default due to the Chapter 11 filing--even if the operating subsidiaries remain solvent and functioning. This has or will lead to the unwinding of many trades. The acquisition of Lehman's U.S. trading operations by Barclays PLC (AA-/Watch Neg/A-1+) will limit only moderately the impact of this. The primary objective of financial authorities around the globe now in control of Lehman group's entities is for an orderly resolution and quick return of cash, stock, and other securities to Lehman customers. In the U.S., the Securities Investor Protection Corporation, a government regulatory organization that works closely with the SEC, made a statement to this effect on the day LBHI filed for bankruptcy protection.
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The demise of Lehman means that the market loses a leading investor and trader of MBS and other structured securities. This troubling development comes when most banks and brokers are trying to shrink risk assets and reduce their MBS holdings. To the extent that Lehman is forced to sell securities in an unfavorable market environment when closing trades and paying maturing debts, downward pressure on the market values of MBS will increase. Lehman does not have material holdings of ABS CDOs, however, and the Lehman group had reduced materially its balances of other nonprime MBS since the summer of 2007. Approximately half of Lehman's MBS is European RMBS, which have not lost value to the same extent as U.S. RMBS. This is a factor that may limit the impact of the winding down of Lehman specifically on MBS prices. Lehman's $33 billion global commercial real estate portfolio, in contrast, is substantial, and is dominated by whole loans and equity positions. These will be difficult to sell. Lehman holds relatively little CMBS, and most is in Europe.
Losses Have Spread Beyond Subprime

In our view, the decline in the U.S. housing market is thus far at the root of the losses roiling the global financial sector. U.S. house prices already have dropped 18% from their July 2006 peak (according to the S&P/Case-Shiller Home Price Indices), the largest decline since the 1930s. Housing starts and home sales continue to slow. While there are some signs that these trends are starting to bottom out, their impact on the performance of several segments of mortgage finance has been devastating, particularly when coupled with the pressure of a slowing economy. As in the subprime segment, the performance of Alt-A loans made during the last two to three years of the credit boom is much worse than that of prior vintages. Similarly, prime mortgage loans granted toward the end of the credit boom also are showing signs of deterioration. (See "U.S. Home Prices Continue To Plunge, But How Low Can They Go?" published Sept. 16, 2008.) Since we published the March report, Standard & Poor's has raised its lifetime loss projection for all segments of MBS (see table 1). The increases in loss assumptions on Alt-A and prime jumbo RMBS are proportionally greater than those for subprime RMBS.
Table 1 Loss Assumptions For Selected U.S. MBS Segments By Vintage (%) Subprime RMBS Fixed-rate Alt-A Option adjustable-rate mortgage Alt-A Short-reset hybrid Alt-A CES HELOC RMBS Prime jumbo RMBS CMBS
N.A.--Not available. Source: Standard & Poor's.
2005 2006 2007 Loss severity 10.5 23.0 27.0 50 N.A. N.A. N.A. 18.5 6.9 0.3 2.1 4.8 11.0 12.2 46.2 22.6 0.8 2.5 6.7 14.7 15.0 57.1 37.9 1.2 2.8 35 40 40 100 100 25-30 34
The broad European mortgage sector--both loans and MBS--to date has not experienced the same erosion in quality as the U.S. market. In Europe, mortgage loans have not deteriorated materially in performance, and MBS and covered bonds backed by mortgages have held their values better than U.S. MBS. Nonetheless, certain European markets--notably the U.K., Spain, and Ireland--are starting to weaken in our view, and the growing housing market

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pressures in several European countries will be a negative credit factor for banks for the next two to three years.
A Rising Tide Of Write-Downs

Our estimate of write-downs on a like-to-like basis, focusing only on subprime RMBS and ABS CDOs, has increased to $378 billion, up from $285 billion in March. This is due to the increase in projected losses on subprime mortgage loans and the persistent drop in market values of MBS in 2008. The decline in the ABX indices and consequent widening of implied spreads both illustrates and exacerbates the pressure on valuations of subprime RMBS and ABS CDOs (see chart 1). Launched in January 2006, the ABX tracks the performance of a relatively small basket of credit default swaps (CDS) based on U.S. residential subprime securities. CDS, which act like insurance contracts, allow buyers and sellers to trade risk. The swaps can offer protection if the securities are not repaid as expected, in return for regular insurance-like premiums. A decline in the ABX (a widening of implied spreads) generally signifies market sentiment that subprime mortgage credit risk is increasing. Likewise, an increase in the ABX (a narrowing of implied spreads) typically signifies market sentiment that subprime mortgage risk is declining. The ABX has been one of the primary benchmarks for the valuation of subprime RMBS and ABS CDOs invested in subprime RMBS.
Chart 1
On July 30, 2008, Standard & Poor's revised upward its expectations of default frequency and loss severity for the
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recent vintages of subprime RMBS (see "Standard & Poor's Revises U.S. Subprime, Prime, And Alternative-A RMBS Loss Assumptions."). To update our estimate, we applied the revised estimates to the original issuance and outstanding balances of subprime RMBS (see table 2).
Table 2
U.S. Subprime RMBS: Projected Losses By Vintage

(Bil. $) Vintage 2005 2006 2007* Total Original issuance 458 466 276 1,200 Amount originally rated 'AAA' 366 373 221 960 Estimated total outstanding 321 326 276 923 Loss assumption (% from table 1) 10.5 23 27 -Projected losses on original issuance 48 107 75 230
*Issued through September 2007. Source: Standard & Poor's.
Our estimate only covers securities that Standard & Poor's rates. Adding unrated securities could increase the total value of the amounts by up to 15% and would boost the projected lifetime loss by the same proportion. On the other hand, the estimate does not take into account in the positive offsetting factors of excess spread, which can be a material factor, and overcollateralization (OC) in the subprime RMBS themselves. Our calculation shows a lifetime loss of $230 billion, of which $182 billion is from the 2006 and 2007 vintages due to the projected greater deterioration of the subprime loans from those years. At origin, we rated 'AAA' approximately 80%, or $960 billion, of the $1.2 trillion in subprime RMBS issued 2005 through 2007, and 'AA+' and lower $240 billion in subordinated tranches. Without taking into account the OC and excess spread, the projected $230 billion in lifetime losses in the underlying pools would extinguish most of the $240 billion in original issuance of subordinated tranches but would not reach the 'AAA' subprime RMBS from a "whole-segment" perspective. From this big-picture perspective the 'AAA' tranches would not suffer any losses through to the maturity of the securities. But structured MBS are not identical. The performance of specific securities depends on portfolio composition (geography and loan type), the degree of subordination, and the existence and amount of OC and excess spread. The year and quarter of origination of the subprime loan collateral is the primary determining factor in the potential for loss. Depending on these security-specific factors, some 'BBB' rated subprime RMBS could pay full interest and principal through to maturity, and some 'AAA' rated RMBS could default.
Alt-A Segment Risk Is Increasing

Much like that of subprime loans, the performance of Alt-A loans made during the last few years of the mortgage credit boom has deteriorated significantly. Alt-A loans are first-lien residential mortgages that generally conform to traditional prime credit guidelines but do not qualify as prime-quality conforming loans under standard underwriting programs due to high loan-to-value ratios, or insufficient or irregular loan documentation, occupancy status, or property type. We recently increased our loss assumptions for Alt-A loans from 2006 and 2007. Subsegments of Alt-A RMBS display different degrees of deterioration: the lifetime loss assumptions for the short-reset hybrid and option

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adjustable-rate (negative amortization) mortgage subsegments of Alt-A RMBS are more than double the projected loss rate for fixed-rate Alt-A loans. Although transactions involving these riskier segments typically have higher credit enhancement than for other Alt-A RMBS, they have generally incurred much larger write-downs, which reflect lower coverage of projected/pipeline losses. We project a lifetime loss of $79 billion on the underlying Alt-A loans issued from 2005 through 2007, a total that slightly exceeds one-third of the dollar amount of subprime RMBS losses projected for the same three years (see table 3). As with the subprime RMBS, we exclude Alt-A loans in unrated transactions and the potential offset of OC and excess spread. While from our calculation Alt-A is a risky segment, we do not believe it poses the same magnitude of damage to the industry as does subprime RMBS.
Table 3
U.S. Alt-A RMBS: Projected Losses By Vintage

(Bil. $) Vintage 2005 2006 2007 Total Original issuance 362 427 345 1,134 Amount originally rated 'AAA' 334 400 329 1,063 Estimated total outstanding 253 299 345 897 Loss assumption (%)* 4.0 7.3 9.8 -Projected losses on original issuance 14 31 34 79
*Average loss assumption weighted by original issuance for the three subsegments: fixed-rate, option adjustable-rate, and short-reset hybrid. Source: Standard & Poor's.
The layer of subordinated Alt-A securities under the 'AAA' tranche is much thinner than that of subprime RMBS. We rated 'AAA' at origin approximately 94%, or $1.06 trillion, of Alt-A securities issued 2005 through 2007, and 'AA+' and lower $70 billion in subordinated tranches. Subordinated tranches rated 'AA+' and lower at origin are at risk of default, while securities that we rated 'AAA' at origin are largely protected by the subordination (and excess spread and OC) and should pay in full to maturity under the new loss assumptions. But as with subprime RMBS, the performance of specific securities will vary greatly depending on portfolio composition, excess spread, and OC.
Negative Home Equity Leads To Second-Lien RMBS Defaults

Displaying extremely high delinquency and loss rates are two smaller segments that are characterized by the second-lien position of the mortgage collateral--closed-end second-lien (CES) and HELOC RMBS. The high loan-to-value ratios of second-lien loans, combined with the significant drop in U.S. house prices, resulted in a high proportion of negative home equity in these two segments. Borrowers with negative home equity have proved more likely to default on second-lien loans in this downturn than in prior slumps. We increased our loss assumptions on both CES and HELOC RMBS in July 2008. Applying the loss assumptions to the original issuance of the 2005-2007 vintages results in projected losses of approximately $50 billion for the two segments combined (see tables 4 and 5).
Table 4
Closed-End Second-Lien RMBS: Projected Losses By Vintage

(Bil. $) Vintage 2005 Original issuance Loss assumption (% from table 1) Projected losses on original issuance 11 18.5 1.9
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Table 4
Closed-End Second-Lien RMBS: Projected Losses By Vintage(cont.)

2006 2007 Total
Source: Standard & Poor's.
43 28 81
46.2 57.1 --
19.8 15.7 37.5
Table 5
HELOC RMBS: Projected Losses By Vintage

(Bil. $) Vintage 2005 2006 2007 Total
Original issuance Loss assumption (% from table 1) Projected losses on original issuance 30 6.9 2.1 25 13 69 22.6 37.9 -5.7 5.1 12.9
Note that the HELOCs that served as collateral for RMBS issued in 2005-2007 represent a small proportion--less than 10%--of the total of HELOCs outstanding in the U.S. financial industry. Banks' on-balance-sheet HELOC loans represent a significantly larger concentration of risk from a systemwide perspective than do HELOC RMBS. The U.S. financial industry has already charged off a substantial amount of delinquent HELOCs, with more to come as the housing slump deepens.
CMBS Remains Resilient

The relatively resilient performance of the CMBS segment contrasts with the erosion in quality of residential MBS segments. Although recent CMBS vintages display some signs of softening, the class as a whole is much less vulnerable to the decline in market conditions in the U.S. and Europe. The projected loss assumptions for the loans backing the 2005-2007 vintages of CMBS are 2%-3%, significantly lower than the loss assumptions on nonprime RMBS from the same years. Our estimate for projected losses for U.S. CMBS originated in those three years is only $14 billion compared with $562 billion in total issuance (see table 6). The average credit enhancement for CMBS from 2005-2007 is 12%-13%--double that of Alt-A RMBS issued the same years.
Table 6
CMBS: Projected Losses By Vintage

(Bil. $) Vintage 2005 2006 2007 Total
Original issuance Loss assumption (% from table 1) Projected losses on original issuance 154 2.1 3.2 188 220 562 2.5 2.8 -4.8 6.0 14.2

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ABS CDOs Are Likely To Rack Up Heavy Losses

In our view, CDOs remain a major source of risk of structured securities. The absolute amount of projected losses for ABS CDOs greatly exceeds that for subprime RMBS from both a mark-to-market and hold-to-maturity perspective. We believe this is due to at least the following factors: ABS CDOs purchased most of the subordinated tranches of subprime RMBS issued in 2006 and 2007. In particular, ABS CDOs purchased virtually the entire issuance of 'BBB' and 'A' rated mezzanine subprime RMBS from those two years. Projected losses on subprime loans from 2006 and 2007 will hit the great majority of subordinated RMBS from those two years. ABS CDOs created over $75 billion in additional mezzanine positions by synthetically referencing 'BBB' and 'A' rated subprime RMBS from those years. The synthetic exposures amplify the impact of mezzanine subprime RMBS defaults on ABS CDOs. ABS CDOs purchased half of the subordinated tranches of Alt-A issued in 2005 through 2007. Projected losses on Alt-A loans from 2006 and 2007 will hit the great majority of subordinated Alt-A RMBS of those two years. ABS CDOs invested in other ABS CDOs--the so-called "inner CDOs"--typically the mezzanine variety, will suffer a high rate of default with limited recoveries. A significant proportion of ABS CDOs include event-of-default (EOD) clauses that are forcing acceleration or liquidation of the underlying securities in an illiquid market. As a result of all these factors, ABS CDOs generally have suffered greatly. Negative rating actions continue; as of Sept. 8, 2008, we lowered one or more times more than 78% of the ratings on CDOs of ABS issued in 2005 through 2007 as a result of stress in the residential mortgage market. Valuations of ABS CDOs have dropped over the past six months, in step with the decline in value of the underlying mezzanine subprime RMBS and Alt-A securities that constitute a material proportion of the collateral. Our current estimation of average percentage write-downs are 70% for high-grade and 85% for mezzanine ABS CDOs (see table 7). These represent an approximation of the average percentages by which financial institutions have reduced or will reduce the initial carrying value of high-grade and mezzanine ABS CDOs originated 2005-2007 (based on disclosed and estimated data). During the course of 2008 such valuations have tended to converge downward toward these percentages, although differences across financial institutions still persist.
Table 7
ABS CDOs: Average Percentage Write-Downs By Vintage And Subsegment

(Bil. $) 2005 2006 2007
High-grade 20 70 70
Mezzanine 30 85 85
CDO Squared 30 85 85
Applying these percentages yields an estimate of total write-downs of ABS CDOs of $309 billion (see table 8). The estimate for subprime RMBS plus ABS CDOs is $378 billion (see table 9). This estimate eliminates the double counting of risky mezzanine subprime RMBS purchased by ABS CDOs: approximately 70% of the subordinated tranches of subprime RMBS issued from 2005 through 2007 were purchased by ABS CDOs.
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Table 8
ABS CDOs: Estimated Write-Downs By Vintage

(Bil $) Vintage High-grade Mezzanine CDO Squared Other* Total outstanding Estimated write-downs (based on % from table 7) 2005 52 29 7 12 99 21 2006 2007 Total 92 82 226 87 81 197 9 18 34 32 34 78 220 216 535 146 142 309
*Commercial real estate (CRE) plus CUSIP CMBS. Issued through September 2007.
Table 9
Subprime ABS: Estimated Write-Downs

(Bil. $) Subprime RMBS outside of ABS CDOs ABS CDOs Total
69 309 378
EOD Clauses Force Sales At Depressed Values

We believe that one factor contributing to the severe market devaluation (and the convergence in valuation) of ABS CDOs is the presence of event-of-default (EOD) clauses that, when triggered, allow the controlling investors to accelerate payments to the most senior securities or to terminate the CDO and liquidate the portfolio collateral. The credit deterioration of recent vintage RMBS, either through direct holding or from other CDO transactions that in turn are collateralized by RMBS, has triggered EODs on a substantial proportion of ABS CDOs. By Sept. 8, 2008, Standard & Poor's had received EOD notifications from over $235 billion of cash flow and hybrid ABS CDOs, which represents over 50% of the highest risk CDO segments, namely the high-grade CDOs, mezzanine CDOs, and CDOs squared issued in 2005 through 2007. Of the over $235 billion, more than $50 billion had already been liquidated by the end of August, meaning that the CDOs had been terminated and the underlying collateral sold. While the sales of the underlying assets are sometimes to the owner of the CDO, the termination and sale forces a valuation of the underlying RMBS under the current depressed market conditions. As the CDOs with EOD clauses work their way through the successive stages of notification, acceleration, notice of liquidation, and final liquidation, further forced sales into an illiquid market will exert continued pressure on valuations of the RMBS collateral and of the CDOs themselves. We expect that roughly half of the cases of EOD notification will end in liquidation.
A Hold-To-Maturity Estimate Assesses Economic Value

In an effort to better estimate the loss in underlying economic value of MBS, we apply a hold-to-maturity approach to all nonprime segments of MBS. Our hold-to-maturity estimate of ultimate losses for the wider range of MBS is $437 billion--and $482 billion including leveraged loans (see table 10). This estimate is the sum of the cumulative projected losses in the nonprime MBS segments, with ABS CDOs representing well over half of the projected total.

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Table 10
All Nonprime MBS Segments: Estimated Losses On A Hold-To-Maturity Basis

(Bil. $) ABS CDOs Subprime RMBS outside of ABS CDOs CES Alt-A RMBS outside of ABS CDOs CMBS HELOC RMBS Total Leveraged loans Total including leveraged loans
264 69 37 40 14 13 437 45 482
We projected ABS CDO losses by taking our assumptions for loss rates on subprime and Alt-A RMBS by vintage and tranche rating level and applying them to the specific securities that compose ABS CDOs. The result of this calculation is a cumulative loss of $264 billion with a higher loss rate on mezzanine CDOs and CDOs squared and a relatively lower rate on high-grade CDOs. To this we add a total of $173 billion in estimated losses on the other nonprime MBS segments. We eliminate double counting of the subprime and Alt-A RMBS purchased by ABS CDOs--this is why for subprime RMBS in particular the projected losses are only $69 billion. Most of the losses from subprime RMBS are borne by ABS CDOs. The fact that total write-downs through the first half of 2008 fall short of the hold-to-maturity estimate clearly points to heavy additional write-downs as the downturn deepens. We are making our estimates for securities write-downs and for projected losses from a hold-to-maturity perspective in the context of a slowing global economy, tighter credit market conditions, and widening spreads on all classes of debt--including for corporate and some government bonds. In particular, estimating the future market value of securities in such a turbulent and uncertain environment is subject to a wide margin of error. We believe that global systemwide write-downs of all debt securities to currently depressed and declining market values could easily double our $378 billion estimate for potential write-downs of subprime RMBS and ABS CDOs only. Market valuations may reflect significant risk premiums for illiquidity and uncertainties with respect to the assumptions of losses for different segments and vintages. We believe that the market is still searching for an equilibrium price on trillions of dollars of structured securities, in particular at the higher end of the ratings spectrum. The gap between projected securities losses on a hold-to-maturity and a market valuation approach is significant for many MBS that have retained their 'AAA' ratings.
The Industry Moves From Write-Downs To Loan Losses

The wider the group of securities one includes in the base of analysis, the higher the global estimate for potential write-downs (and the less fitting the "subprime" label). The term "subprime" has served as a catchall for an ever-wider base of assets as the downturn in the global financial sector has deepened. Many observers now include commercial loan loss provisions in the total for write-downs. These also are substantial: The largest 30 commercial banking groups took over $180 billion in loan loss provisions from July 2007 through June 2008.
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Perhaps the broadening of the subprime label to include most classes of bank assets in a wider range of countries is fitting--we just need a better name for this slump. The wider pool of affected assets reflects a second phase of the downturn in the credit cycle. In this "post-write-downs" phase, we expect that balance sheet loan losses and lower business volumes will dominate, as opposed to the market value write-downs of securities in the first phase. Right now, write-downs of MBS and other securities will remain significant, while on-balance-sheet loan losses will continue to climb. Unfortunately, the first stage is not over yet, and significant further write-downs are in store for global banks. The overlap of these two stages--additional securities write-downs and rising loan losses--in the second half of 2008 may prove to be the most difficult test yet for the battered global financial sector.
Additional Contact: Financial Institutions Ratings Europe; FIG_Europe@standardandpoors.com

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September 17, 2008

Standard & Poors RatingsDirect | September 17, 2008

Write-Down Estimates Have Increased

Losses Have Spread Beyond Subprime

Standard & Poors RatingsDirect | September 17, 2008

A Rising Tide Of Write-Downs

U.S. Subprime RMBS: Projected Losses By Vintage

*Issued through September 2007. Source: Standard & Poor's.

Alt-A Segment Risk Is Increasing

Standard & Poors RatingsDirect | September 17, 2008

U.S. Alt-A RMBS: Projected Losses By Vintage

Negative Home Equity Leads To Second-Lien RMBS Defaults

Closed-End Second-Lien RMBS: Projected Losses By Vintage

Closed-End Second-Lien RMBS: Projected Losses By Vintage(cont.)

19.8 15.7 37.5

HELOC RMBS: Projected Losses By Vintage

CMBS Remains Resilient

CMBS: Projected Losses By Vintage

Standard & Poors RatingsDirect | September 17, 2008

ABS CDOs Are Likely To Rack Up Heavy Losses

ABS CDOs: Average Percentage Write-Downs By Vintage And Subsegment

ABS CDOs: Estimated Write-Downs By Vintage

Subprime ABS: Estimated Write-Downs

EOD Clauses Force Sales At Depressed Values

A Hold-To-Maturity Estimate Assesses Economic Value

Standard & Poors RatingsDirect | September 17, 2008

All Nonprime MBS Segments: Estimated Losses On A Hold-To-Maturity Basis

264 69 37 40 14 13 437 45 482

The Industry Moves From Write-Downs To Loan Losses

Standard & Poors RatingsDirect | September 17, 2008

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