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Global losses from sub-prime may reach $400bn

Financial markets’ losses from the falling value of sub-prime mortgage assets may reach $300-400bn worldwide, representing a default on 30–40 percent of global sub-prime debt, according to Mike Mayo, analyst at Deutsche Bank.

Wall Street’s largest banks and brokers will be forced to write down as much as $130bn because of the slump in sub-prime related debt, according to Mayo. The remainder will come from smaller banks and investors in mortgage-related securities.

Citigroup, Merrill Lynch and Morgan Stanley led more than $40bn of write-downs in the third quarter, as record US foreclosures sunk asset prices. Approximately $1.2tn of the $10tn of outstanding US home loans are considered to be sub-prime, Mayo said in a note last week.

Latest estimates of losses due to directors and officers (D&O) insurance claims relating to the crisis range from $3bn, a figure put out by Bear Stearns analyst David Small earlier this year, to $2bn in 2007 alone, according to broker Guy Carpenter. Kevin Griffiths, head of global casualty specialty practices at Guy Carpenter, recently estimated that 2007 filed claims alone would reach $2bn for the D&O sector, which the firm said would be “an ‘incubation’ year”, with errors and omissions (E&O) losses “relatively contained”.

Griffiths predicted: “We expect losses to rise significantly higher in 2008 and 2009, due to increased stock market volatility and put/call ratios, litigation tendencies and an ever-lengthening list of sub-prime market casualties.”

In a recent report, broker Willis Group cited a comment from law firm Ledbetter & Associates, who consider the current level of sub-prime related lawsuits to be “just the tip of a huge iceberg”.

The report added, that although the D&O and E&O markets are still soft, “The loss potential of the sub-prime credit crunch has caused the insurance carriers (and reinsurers) to sound the alarm. Management and professional liability underwriters are seeking extensive information about an insured’s potential exposure not just to sub-prime loans but to the collateralised mortgage obligations and collateralised debt obligations in general.”

Willis added: “Underwriters are also concerned, perhaps reasonably, with potential bankruptcies and the following blame game that could result in non-indemnifiable claims. There is speculation that the next wave of A-Side claims (non-indemnifiable claims against executives) could stem from the mortgage market meltdown. In the future, profitability for A–Side insurance may no longer be a foregone conclusion.”

Moody’s analyst Timour Boudkeev recently stated that the expected insurance losses arising from sub-prime for European insurers are “ a fraction of that posted for the UK floods this year, which had an impact of barely a couple of points on combined ratios”.

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