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Panic over! (almost) - or so says S&P

Put the pistol down. Move away from the ledge. We can talk this through. The worst is all but over. Witness the title of the latest tome from Standard & Poor’s:

More Subprime Write-Downs To Come, But The End Is Now In Sight For Large Financial Institutions

Analysts at the rating agency reckon that while there might well be a bit more painful mark to market-ing to be done for Q1, the magnitude of write-downs taken by the big banks, brokers and insurers for 2007 — put, roughly, at $150bn - “is greater than any reasonable estimate of ultimate loss.”

Most of the write-downs have been on the so-called supersenior tranches of CDOs of subprime ABS. To date, banks have written down their unhedged supersenior CDOs of ABS by more than $65 billion. On an original exposure of about $160 billion, this represents about a 40% discount. However, that discount percentage varies tremendously from institution to institution.

In our view, some of the variation may be based on differences in the specific securities the institution owns, as the securities vary widely in their ultimate loss characteristics. Some of the variables that affect the valuation are whether the exposure was to so-called CDO-squared securities (CDOs that purchased tranches of CDOs) or to the supersenior tranches of high-grade CDOs or mezzanine CDOs; the proportion of the underlying loans that were of 2005 or earlier vintages; how many of the CDOs’ investments were in other CDOs and in subprime residential mortgage-backed securities (RMBS); and the levels of subordination in each structure.

Based on available information, we believe that the largest players can be seen as having undertaken a rigorous valuation methodology to come up with conservative valuations. Citigroup Inc. and Merrill Lynch & Co. Inc., for example, value their high-grade supersenior tranches at 52% and 68% discounts to original exposure, respectively. The broader range of banks values them at only a 30% discount. Similarly, Citi and Merrill value the supersenior tranches of the mezzanine CDOs at 63% and 73% discounts, respectively, whereas the broader range of banks values them at a 48% discount.

There are numerous other variables, such the issue of vintage of the underlying assets and there is still the uncertainty associated with those pesky monolines. But, as S&P sees it, intrinsic value should eventually begin to show through:

If they are held to maturity or if some of the risk premium for illiquidity and uncertainty goes out of market spreads, we believe the CDOs of subprime ABS may indeed see a recovery in value, although the amount is difficult to predict.

At which point the overly conservative approach adopted by the biggest institutions should begin to show dividends. Other market participants might as well jump now:

We believe that the difference between the $150 billion in losses from write-downs in market value disclosed to-date and our global estimate of $285 billion will come not just from additional write-downs at banks, where additional losses should be limited, but from write-downs at hedge funds, monoline insurers, other insurers, and other financial institutions.

This entry was posted by Paul Murphy on Thursday, March 13th, 2008 at 16:06 and is filed under Capital markets. Tagged with . You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.

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Comments

  1. Mar 15   11:40 Posted by Peter Warren [report]

    Correction to the post below the figure for the mortgage pool should read
    $513 million NOT bn.

  2. Mar 15   11:13 Posted by Peter Warren [report]

    Judging by the latest Timesonline report on the Bear Stearns’ melt-down, it may have been Alt-A s that done it.
    If you switch to Mike Mish Shedlock’s post at Minyanville (March 14, 3.51 pm - What brought down Bear?) the AAA ratings of WaMu’s Alt-As look out of kilter. According to Mike’s calculations 92.6% of the $513 bn mortgage pool was rated AAA while full doc was provided on only 11% of the loans and 15% were already in foreclosure or REO (caveat lector - do your own verification).

    The answer to my question below on S&P’s reassurance on subprimes would appear to be no, Alt-As were not included which is technically correct although rising default rates suggest they and their CDOs may fast be going the way of the famous subprimes.

    An S&P spokesman was also interviewed on a Bloomberg video yesterday and as I understood him, he emphasised that S&P were not playing down potential future defaults (on unspecified instruments) and that although the end was in sight we still had a way to go. Too true.

  3. Mar 14   8:07 Posted by Paul Murphy [report]

    Anyone who wants the full S&P reports (two of them), drop me a line - paul.murphy@ft.com

  4. Mar 14   6:30 Posted by Peter Warren [report]

    Good point by anonymous. According to the graph reposted on Alphaville several months ago - Dec?, we ‘knew’ sub-prime resets were due to peak later this year and fall off sharply and thus logically would have been discounted by now. I am not clear whether S&P’s statement concerns write-downs on CDOs and variants covering all RMBS or just sub-primes. Alt-A and Option Adjustable rate resets are due to peak at slightly below current sub-prime levels in 2010 and 2011 although defaults are apparently already higher than anticipated. To what extent have they been discounted? Do the CDOs S&P refers to include them even though they are not strictly sub-prime? Or is subprime now a generic term?

  5. Mar 14   1:56 Posted by Ranger Turtle [report]

    We’re supposed to listen to a company that’s under investigation by the FBI that everythings AllRighteeNow?

    Are you sure they even know what the definition of AAAs is

  6. Mar 13   21:54 Posted by Business, Women in Business, Business Real Estate News » Blog Archive » It’s Safe in the Subprime Pool! [report]

    […] [S&P via FT] […]

  7. Mar 13   20:41 Posted by O fim está próximo « Notícias do mercado [report]

    […] O fim está próximo Ou seja, o fim das baixas contábeis dos papéis “subprime”. Ao menos na avaliação dos analistas da Standard & Poor’s, agência de rating cuja credibilidade anda um pouco prejudicada. Mas parece que existe base analítica para essa opinião. Eles analisaram os balanços de instituições como Citigroup e Merrill Lynch e chegaram à conclusão que os títulos baseados em hipotecas “subprime” estão avaliados de maneira bastante conservadora (FT Alphaville, WSJ MarketBeat, Paul Kedrosky). Mas o relatório lembra que as perspectivas para o mercado imobiliário e para outros segmentos do mercado de crédito permanecem sombrias. […]

  8. Mar 13   20:01 Posted by Alea | #Links [report]

    […] Panic over! (almost) - or so says S&P Put the pistol down. Move away from the ledge. We can talk this through. The worst is all but over. […]

  9. Mar 13   19:22 Posted by Anonymous [report]

    notice its not that “writedowns are over” but “subprime writedowns”.

  10. Mar 13   18:12 Posted by hedgehog [report]

    pegnu: in relation to what ?

  11. Mar 13   18:10 Posted by pegnu [report]

    rumours of bank bailouts I think.

  12. Mar 13   17:45 Posted by Lemmy Caution [report]

    “Citigroup Inc. and Merrill Lynch & Co. Inc., for example, value their high-grade supersenior tranches at 52% and 68% discounts to original exposure, respectively. The broader range of banks values them at only a 30% discount”
    …so who has it right, Citi, Merrills or the broader range of banks? Also, if the “high-grade supersenior” tranches get a 68% discount, imagine the pain on the low-grade junior tranches.

  13. Mar 13   17:36 Posted by Carlomagno [report]

    What’s driving the rally in the DJI? Surely not S&P’s analysis…

  14. Mar 13   17:07 Posted by praxis22 [report]

    Hey, if $236Bn didn’t work, perhaps soothing words will.

  15. Mar 13   16:19 Posted by VP [report]

    “The End Is Now In Sight For Large Financial Institutions”

    Had a good laugh at that; did they intend the double-meaning?

  16. Mar 13   16:07 Posted by pegnu [report]

    utter nonsense :)

This post is closed to further comments.