THE BANK of England reported this week that UK banks may have incurred up to £2.1bn of mark to market losses as a result of the frozen market in commercial mortgage backed securities.
In its Financial Stability Report for April, the Bank said that UK banks held £16bn of highly rated CMBS. Assuming marks based on secondary market prices of 90%-95% of par results in writedowns of up to £1.6bn. Meanwhile a rough estimate of losses incurred by the inability to securitise loans in the pipeline increases the total by another £500m.
The Bank estimates that direct lending against commercial property will result in £0.8bn of writedowns in a baseline scenario, rising to £5.1bn in a worst case scenario where default rates rise to 10%.
Encouragingly, the report argued that "market prices [for securitisations] are likely to overstate significantly banks’ losses as they will reflect factors such as illiquidity and uncertainty". After years of underpriced risk, "prices in at least some credit markets appear now to have overshot during the correction phase".
The report also makes several recommendations to improve financial stability and restore confidence. Chief among these are a call for improved and standardised disclosure on exposures to structured and leveraged finance.
The Bank said: "There is also a case for some greater degree of coordination of the timing of announcements."
One way to improve disclosures would be to reveal the assumptions underpinning valuations and the range of uncertainty around estimates. The report also calls for accounting standards setters to provide "authoritative guidance on the valuation of financial instruments when markets are no longer active and on what constitutes an active market".
The Bank endorses the recommendations of the Financial Stability Forum and the initiatives undertaken by the European Securitisation Forum on disclosure by issuers of structured products, including standardisation, regular collateral updates, and transparency about underwriting standards.
Rating agencies should increase differentiation between structured finance ratings and single name ratings, a move that now seems inevitable.