Credit Market Fall-Out #8 – Still More Bad News Ahead

With about $0.5T (that is T as in trillion) loans to reset there is still plenty of indigestion to go around according to MSNBC. Also Mr. Lo from MIT admits in the article that that there are still some hedge fund, dealer, and bank casualties ahead of us. This is one of the first times I have seen that mentioned in the financial press. I personally expect there to be several “big name” casualties in this process.

The stricken US subprime mortgage market is likely to suffer further setbacks in the coming months as $500bn of risky home loans sold with initial low "teaser" interest rates are reset at much higher levels, analysts warn.

Over the next 18 months, adjustable-rate home loans sold at the peak of the high-risk lending boom in 2005 and 2006 will be reset. Given a recent tightening of lending standards as banks try to rein in their mortgage exposures, this raises the prospect of further serious losses. Christopher Flanagan, strategist at JPMorgan, estimates up to 45 per cent of borrowers facing resets will not meet criteria to refinance into new home loans.

The mounting problems could force ratings agencies to downgrade billions of dollars of mortgage securities below investment grade, a move that would in turn force many investors to sell their holdings and exacerbate the spiral of losses.

Ratings agency downgrades of subprime-related securities have already gained momentum in recent weeks, helping to push a key derivatives index tracking such securities to record lows. The ABX index tracking 2006-issued subprime bonds rated BBB- fell to a record low of 41 cents on the dollar on Friday, down more than 50 per cent since January.

"There is a possibility that one or two money centre banks and dealers could be a casualty along with hedge funds and institutional investors," said Mr Lo. Even higher-rated securities were unlikely to be immune from losses, Mr Flanagan said. "Losses are going to move up the capital structure to the higher-rated pieces. Hedge funds will continue to feel the pain," he said. (my emphasis)