s&p subprime global

8/3/2019 S&P Subprime Global

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Global Financial Institutions EyeAnother Wave Of Write-Downs AsU.S. Housing Woes SpreadPrimary Credit Analyst:Scott Bugie, Paris (33)1-4420-6680; [email protected]

Secondary Credit Analyst:Nick Hill, London (44) 20-7176-7216; [email protected]

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

September 17, 2008

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Global Financial Institutions Eye Another WaveOf Write-Downs As U.S. Housing Woes SpreadThe 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. Thelosses 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 InPerspective," 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 toprevailing 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,

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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 arecommuting 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.



Global Financial Institutions Eye Another Wave Of Write-Downs As U.S. Housing Woes Spread


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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 isEuropean 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. Whilethere 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

(%) 2005 2006 2007 Loss severity

Subprime RMBS 10.5 23.0 27.0 50

Fixed-rate Alt-A N.A. 4.8 6.7 35

Option adjustable-rate mortgage Alt-A N.A. 11.0 14.7 40

Short-reset hybrid Alt-A N.A. 12.2 15.0 40

CES 18.5 46.2 57.1 100

HELOC RMBS 6.9 22.6 37.9 100

Prime jumbo RMBS 0.3 0.8 1.2 25-30

CMBS 2.1 2.5 2.8 34

N.A.--Not available. Source: Standard & Poor's.

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 mortgageloans 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 ofsubprime 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. $)

VintageOriginal

issuanceAmount originally

rated 'AAA'Estimated total

outstandingLoss assumption (% from

table 1)Projected losses on

original issuance

2005 458 366 321 10.5 48

2006 466 373 326 23 107

2007* 276 221 276 27 75

Total 1,200 960 923 -- 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. $)

VintageOriginal

issuanceAmount originally rated

'AAA'Estimated total

outstandingLoss assumption

(%)*Projected losses on original

issuance

2005 362 334 253 4.0 142006 427 400 299 7.3 31

2007 345 329 345 9.8 34

Total 1,134 1,063 897 -- 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 Original issuance Loss assumption (% from table 1) Projected losses on original issuance

2005 11 18.5 1.9





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Table 4

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

2006 43 46.2 19.8

2007 28 57.1 15.7

Total 81 -- 37.5

Source: Standard & Poor's.

Table 5

HELOC RMBS: Projected Losses By Vintage

(Bil. $)


2005 30 6.9 2.1

2006 25 22.6 5.7

2007 13 37.9 5.1

Total 69 -- 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. $)


2005 154 2.1 3.22006 188 2.5 4.8

2007 220 2.8 6.0

Total 562 -- 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 suffera 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 table7). 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. $) High-grade Mezzanine CDO Squared

2005 20 30 30

2006 70 85 85

2007 70 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 92 87 9 32 220 146

2007 82 81 18 34 216 142

Total 226 197 34 78 535 309

*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 69

ABS CDOs 309

Total 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 264

Subprime RMBS outside of ABS CDOs 69

CES 37

Alt-A RMBS outside of ABS CDOs 40

CMBS 14

HELOC RMBS 13

Total 437

Leveraged loans 45

Total including leveraged loans 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 arelatively 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 forglobal 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; [email protected]





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