S&P May Cut $12B of Subprime-Related Debt

Standard & Poor's may cut $12 billion of subprime-related debt on expectations for an 8 percent drop in U.S. home prices and more defaults on home loans, the rating company said Tuesday.

The classes of affected securities include 612 residential mortgage debt backed by U.S. subprime loans. S&P also announced changes to its rating methodology and is reviewing its ratings of collateralized debt obligations, S&P said in a statement.

The projected fall in home prices would exceed the record 6.5 percent drop between 1991 and 1992, making subprime loans issued in late 2005 and 2006 particularly vulnerable, David Wyss, chief economist at Standard & Poor's in New York, said on a conference call. Subprime loans are extended to borrowers with spotty credit histories.

"The housing market is doing poorly," said Wyss, who also expects a 10 percent drop in housing starts.

"The levels of loss continue to exceed historical precedents and our initial expectations," S&P said in a statement. "At this time, we do not foresee the poor performance abating."

The benchmark ABX 07-1 BBB-minus index dropped 6.5 points to 49 points, a record low, after S&P's rating action. The $12 billion in affected debt represent 2.13 percent of the $585.3 billion in U.S. RMBS rated by S&P last year.

S&P said it underestimated loss rates of the subprime loans that back CDO debt structures. The situation will get worse before it improves, the rating company said.

"This could be important," said Lou Brien, a strategist with DRW Trading Group in Chicago. "Keep an eye out for the other rating agencies to follow suit."

Moody's Investors Service on June 27 said it also expects to downgrade more subprime-related CDOs in the next two years than it did in 2006.

Fitch Ratings said on June 22 that it may cut its CDO manager rating on Bear Stearns Asset Management, part of Bear Stearns Cos.' (BSC.N), after Bear Stearns Cos. Inc. (BSC.N) said it would provide up to $3.2 billion in financing for a struggling hedge fund it manages.

CDOs are a rapidly growing class of securities created by packaging together bonds, including risky subprime loans, junk or high-yield bonds and high-grade debt, to help diversify risk.

"On a macroeconomic level, we expect that the U.S. housing market, especially the subprime sector, will continue to decline before it improves, and home prices will continue to come under stress," S&P said.