The Financial Times Alphaville blog is a worthy read. On Wednesday, January 16th 2007, it is particularly so. Toomre Capital Markets LLC ("TCM") thanks that site for the significant news that S&P again is in the process of readjusting its structured finance risk models. S&P last adjusted its risk models back at the end of October 2007.

Alphaville relays "In a late press release, S&P announced it was adjusting its cumulative loss measure on 2006 subprime collateral to 19 per cent - up from 14 per cent:

We revised our expected losses for the 2006 vintage subprime collateral to 19% from 14%, as delinquencies continue to rise, and we will recalculate lifetime loss expectations for all vintages of U.S. RMBS. Additional losses are projected to result directly for the additional delinquencies and defaults.

The implications of this small change are significant. Many RMBS are structured on something akin to 70% Senior / 20% Mezzanine / 10% Junk/Equity. As a result, S&P is effectively saying that all of the subordinated debt/equity and close to half of the typical mezzanine will be wiped out. The ratings of the senior classes are also more suspect although they are likely to remain investment grade.

The extreme difficulty though is going to occur in all of the other structured finance vehicles which included RMBS as part of their collateral. In the case of CDOs, many include as collateral one or more mezzanine classes from RMBS. Although the concentrations of mezzanine RMBS classes vary, this change in loss measure assumption implies that effectively all of these type of classes will be impaired to at least some extent. Hence, expect significantly more CDO downgrades to come in the next few weeks and it turn market price pressures on the financial guarantee insurers, SIVs, ABCP and those global financial institutions that own effected RMBS and CDOs.

Looking ahead, Toomre Capital Markets LLC suspects that the markets will witness more write-downs at places like Citigroup, Merrill Lynch, UBS and Morgan Stanley as their inventory is further marked down in value. Several global institutions have exposure to CDOs insured by the financial guarantors like MBIA and Ambac. Whether these insurance contracts are money good is likely to be questioned yet again in coming months. Hence, TCM strongly suspects that there will be more losses and considerable volatility will be ahead for the equity of global financial institutions.