S&P Counts the Dead Bodies

Standard & Poor’s latest report on the cost of mortgage losses to the financial sector does a good job of totaling up the dying bodies to date killed by securities backed by tainted, exotic loans. The tally is frightening, but what may be scarier are the good old fashioned foreclosures yet to come.
S&P upped its estimate of losses on risky loans backing U.S. mortgage securities to as much as 40 percent. S&P expects Alt-A loans from 2005 to post losses of 10 percent, up from its previous estimate of 7.75 percent, according to Reuters.
Losses among securities backed by U.S. home loans could reach.$260 billion to $375 billion. About $1.7 trillion in so-called private-label mortgage securities remain outstanding, down from the $3.7 trillion issued since 2004.
Loss severities, which include the costs to foreclose and liquidate a home and declines in property value, are expected to rise to 70 percent for 2006 and 2007 subprime bonds and 60 percent for Alt-A bonds issued in those years, S&P added. Some severities have already exceeded 100 percent, it said.
S&P said it now forecasts defaults on subprime loans issued in 2005, 2006 and 2007 at 11 percent, 30 percent and 49 percent, respectively.
That’s not the worst of it, but it was bad enough to shake the financial markets today. S&P didn’t attempt to forecast the really bad news which is the impact on mortgage backed securities of the next wave of foreclosures (see It’s the Economy, Stupid). Most of these won’t be exotic loan defaults. They will increasingly consist of conventional, often prime, loans held by borrowers who cannot make their payments due to economic factors, especially lay-offs, and who cannot sell without taking a loss because they owe more than their properties are worth in a depressed housing market.
Unlike option ARMS and many of the other exotics that back the securities the S&P forecast, these “good old fashioned foreclosures” are difficult to forecast because they don’t have recast dates. Once securitized, they are also impossible to identify. They carry lower risk to investors than the exotics.
“We have observed increases in loss severities and we expect them to continue to rise until we reach the trough of the market value decline, which we believe will be in the first half of 2010,” S&P concluded, perhaps optimistically.