Moody’s Estimates Losses on 2006 Sub-Prime MBS Debt (Residential) At 28-32 Percent

Moody’s has said it intends on reviewing all 2005, 2006, and 2007 sub-prime mortgage bonds, covering some $680B in original loan balances. The projected losses across sub-prime debt issued in 2006 are estimated to be 28-32%.

In 2006, spreads over benchmark rates were roughly 200 basis points for sub-prime (BBB-) debt. By the end of 2008, spreads on BBB debt had shot up to over 20x. See the below file for historical ABS spreads in the US, UK, and Europe.

On the commercial front, 3 weeks ago Moody’s announced that it will begin reviewing some $300B of Commercial Mortgage Backed Securities (CMBS) debt. That figure represents about half of the outstanding CMBS debt rated by Moody’s.

Given the fact that many commercial properties were levered up to 80-90% and beyond in 2006-2007, and many were being purchased at CAP rates of some 5% (or below!), and the required rate of return by investors (market CAP rates) has moved up 1-2% (or more), then all else being equal, the value of those assets have dropped some 16-29%, putting junior or mezzanine tranches in almost most of those assets underwater.

The unfortunate part is that in many, many cases all else is not equal, meaning that underwriting assumptions have changed as well – rental rates are lower, vacancy and leasing commissions are higher, and time to lease up is longer, and exit cap rates are higher. Throw those into the mix when calculating the asset’s new value and the value of many of the assets are now closer to 30-40% off 2006-2007 (1st half), which explains in large part why little to few deals are happening – sellers and buyers have not been able to agree on prices….yet.



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