S&P Drops $534 Billion Bombshell

The bad numbers get bigger all the time. This eyepopping $534 billion figure for the amount of debt that Standard and Poor’s plans to either downgrade or put on negative watch was released a couple of hours ago after the exchanges were closed (sorry, I saw it but was unable to post till now). The markets already gave up their quick spell of cheer from the Fed’s 50 basis point cut due to further bad news on the bond insurer front. The continuing drumbeat of grim developments on the credit front is a reminder that the underlying problem is one of solvency, and in the vast majority of cases, lower interest rates will not turn bad debts into good ones.

S&P was also so kind as to estimate that these moves could increase bank losses, now at roughly $130 billion, to $265 billion. That may test the patience and/or confidence of our friendly junkies, um, sovereign wealth fund rescuers.

Needless to say, expect a rough ride in the markets tomorrow. The Fed is running out of firepower.

From Bloomberg:

Standard & Poor’s said it cut or may reduce ratings on $534 billion of subprime-mortgage securities and collateralized debt obligations, the most sweeping action in response to rising since home-loan defaults.

The downgrades may extend bank losses to more than $265 billion and have a “ripple impact” on the broader financial markets, S&P said in a statement today. The securities represent $270.1 billion, or 47 percent, of subprime mortgage bonds rated between January 2006 and June 2007. The New York-based ratings company also said it may cut 572 CDOs valued at $263.9 billion.

The reductions may increase losses at European, Asian and U.S. regional banks, credit unions and government-sponsored enterprises such as Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks, S&P said. Many of those institutions haven’t written down their subprime holdings to reflect a drop in market values and these downgrades may force them to recognize losses, S&P said.

“It is difficult to predict the magnitude of any such effect, but we believe it will have implications for trading revenues, general business activity, and liquidity for the banks,” S&P said. The ratings company will start reviewing its rankings for some banks, especially those that “are thinly capitalized,” it said.

S&P downgraded $50.1 billion of subprime-mortgage securities, none rated higher than A+. More than 69 percent of the AAA rated subprime securities from 2006 and 46 percent from the first half of 2007 were placed on review.

“This one, I didn’t see coming,” said Mark Adelson a consultant at Adelson & Jacob Consulting LLC in New York, and a former asset-backed bond analyst at Nomura Securities.

Some of the largest global banks have already taken “significant” losses and they aren’t likely to have more writedowns, S&P said. CDOs repackage assets into new securities with varying degrees of risk, from AAA grade to unrated classes. Subprime loans are made to people with poor credit.

Under accounting rules, many smaller banks haven’t been required to write down their holdings until the credit ratings fell, enabling them to avoid the losses at bigger competitors including Citigroup Inc., Merrill Lynch & Co. and UBS AG. The world’s largest banks have reported losses exceeding $133 billion related to mortgages, CDOs and high-yield, high-risk loans, according to data compiled by Bloomberg.

“If you’re holding a AAA piece and it’s now downgraded to AA, you might have to write it down, even if you’re holding it for an investment,” Gary Gordon, a bank stock analyst at Portales Partners LLC in New York, said. “The longer it goes on and the higher the credit rating of the instrument downgraded, the wider the pain.”