Sub-Prime Losses to Grow

Additional increased projections for losses among sub-prime loans by Moody's Investors Service and the flood of mortgage-debt downgrades from Standard & Poor's has sent ripples through the credit market, painting a bleak outlook for the housing market.   
  
As a result, debt investors turned their backs on a stock-market rally and looked to the safety of Treasury bonds. The ABX indexes that track sub-prime-mortgage bonds gave back some of their gains of the past week, and even some bonds backed by high-quality agency mortgages dropped in value.  
  
Moody's reported that it now expects total losses on sub-prime mortgages taken out in 2006 to be between 14% and 18%, though some bundles of sub-prime loans that were used to back securities could see losses as high as 35%. In October the New York ratings firm said it expected average losses on sub-prime loans to range from 6.6% to 15%.  
  
The loss estimates are at the core of many of the problems Wall Street is experiencing. As the outlook for mortgage losses deteriorates, rating services downgrade more bonds. And as the banks that hold mortgage securities ratchet up their own loss estimates, they have been announcing ever-increasing write-downs.  
  
Moody's revision was prompted by rising numbers of sub-prime borrowers who have stopped making payments on their mortgages. It is also driven by the deteriorating outlook for home prices. Home-price declines depress the amounts that can be recovered from defaulted loans after homes are foreclosed upon and sold.  
  
In mid-January, S&P also raised its loss expectations for 2006 sub-prime loans to 19% from an earlier 14% forecast. A loss of 19% suggests that a $1 billion pool of sub-prime loans will have only $810 million left after the loans have either paid off or defaulted. Following the revision of its loss estimates, S&P on Wednesday downgraded, or threatened to downgrade, over 8,000 mortgage securities originally worth $534 billion.  
  
Those downgrades triggered further S&P rating changes yesterday on a few bond insurers that had written financial guarantees on mortgage securities. S&P cut its triple-A financial-strength rating on Financial Guaranty Insurance Co. to double-A and placed the top ratings of MBIA Inc. and XL Capital Assurance Inc. on reviews for downgrades.  
  
Right now, actual losses on 2006 sub-prime loans are slightly above 1%. That might sound like a long way from the double-digit losses being projected. But many analysts say it isn't a stretch.  
  
Delinquency rates among 2006 sub-prime loans are already as high as 27% in some cases. On average, around 17% of sub-prime loans made in 2006 are over 60 days delinquent, in foreclosure or have been foreclosed upon, according to Moody's. Adam Klauber, director of research in the U.S. for Fox-Pitt Kelton Cochran Caronia Waller, says more-bearish investors still believe losses could top 20%, although that is generally thought to be an extreme outcome. Increased losses among sub-prime mortgages could signal that losses will creep up among other classes of borrowers, including those to be considered prime, or the least likely to default.  
  
Such concerns yesterday helped drive prices of some agency mortgage securities lower, while investors dived into Treasury bonds, sending the benchmark 10-year Treasury note up 25/32, or $7.8125 for every $1,000 invested. The 10-year yield dropped 0.09 percentage point to 3.642%, while the yield on the two-year Treasury fell to 2.177%. Treasurys were also aided by a U.S. government report that showed jobless claims jumping to the highest level since October 2005.