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Near $1 Trillion in Losses Projected

Near $1 Trillion in Losses ProjectedIMF report projects $945 billion in losses

April 9, 2008


A report from the International Monetary Fund suggests losses triggered by the subprime meltdown could near $1 trillion. The losses will likely be more than double the losses suffered from the Asian crisis and more than three times the losses generated from the savings and loan crisis.

The findings were outlined in IMF Global Financial Stability Report — Containing Systemic Risks and Restoring Financial Soundness.

Prime borrowers are in a better position to withstand home prices declines because of their equity cushion. The average equity for prime borrowers is around 50 percent, while the average equity for subprime borrowers is less than 5 percent.

“Going forward, however, if home prices continue to fall, and other macroeconomic fundamentals weaken, there is a risk of higher defaults on prime mortgages, especially on recent vintages,” IMF wrote. “Reflecting the deterioration in the underlying collateral, prices have continued to slide on nonagency securitized mortgages.”

Losses on $300 billion in unsecuritized U.S. subprime loans outstanding are projected to reach $45 billion, while losses on the $600 billion in unsecuritized Alt-A loans are expected to total $30 billion. Unsecuritized prime loans of $3.800 trillion are expected to generate losses of just $40 billion, and prime RMBS of $3.800 trillion are projected to generate no losses.

IMF estimated aggregate losses on U.S. residential mortgages and securities, including prime and subprime, will reach $565 billion.

While commercial mortgage performance has held up so far, widening spreads on commercial mortgage-backed securities to near-record levels suggest that defaults and loss rates on recently-originated commercial loans could be the worst ever.

But several factors indicate the commercial sector should fare better than the subprime sector. One reason is that the share of commercial mortgages that are securitized is much less than the share of subprime loans that were securitized — leaving investors less detached from the loan pools. In addition, payment resets are rarer on commercial loans than on subprime loans. Another factor is the requirement of audited financial statements for commercial borrowers, reducing the risk of fraud.

Commercial mortgage-backed securities outstanding of $940 billion are projected to generate losses of $210 billion, and $2.400 trillion in unsecuritized commercial real estate were forecast to produce $30 billion in losses.

In all, including corporate loans and consumer loans, total securitized and unsecuritized losses were forecasted at $945 billion.

The report compared the $945 billion in expected losses from the current U.S. subprime crisis to the savings and loan crisis in the late 1980s, which produced around $275 billion in losses, and the Asian banking crisis of the late ’90s, which resulted in around $400 billion in losses.

The latest crisis has been compounded by the degree of leverage taken on by a variety of institutions, including banks, monoline insurers, government-sponsored enterprises and hedge funds.

“What began as a fairly contained deterioration in portions of the U.S. subprime market has metastasized into severe dislocations in broader credit and funding markets that now pose risks to the macroeconomic outlook in the United States and globally,” the report said.

Among numerous recommendations by the IMF were ratings systems reforms, strengthened oversight of mortgage originators and quick identification of potential writedowns.

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