No quick end to the subprime shakeout

From the Wall Street Journal:

Ills Deepen in Subprime-Bond Arena
More Downgrades Seen
As Foreclosures Ripple
June 18, 2007; Page C1

few weeks ago, the market for bonds backed by risky home loans looked like it was calming down. Now, problems are quickly mounting.

At Bear Stearns Cos., a group of hedge-fund managers at the Wall Street firm spent the weekend scrambling to line up new investors or lenders to keep afloat their fund, called High Grade Structured Credit Strategies Enhanced Leverage fund. The fund, which invests in many securities that are backed by subprime mortgages, suffered heavy losses in recent months.

On Friday, credit-rating firm Moody’s Investors Service slashed ratings on 131 bonds backed by pools of speculative subprime loans because of unusually high rates of defaults and delinquencies among the underlying mortgages. The ratings company also said it is reviewing 247 bonds for downgrades, including 111 whose ratings it had just lowered. All the bonds were issued as recently as last year.

The latest moves by Moody’s affected around $3 billion worth of bonds, which represent less than 1% of the over $400 billion in subprime mortgage-backed bonds that were issued in 2006. Still, it was the most aggressive action taken yet by any of the ratings companies — which some critics say have been slow to address the housing downturn — and could weigh on the already fragile subprime bond market. Some investors may be forced to sell bonds whose ratings were cut to “junk” from “investment-grade,” and some may have to write down the values of the downgraded bonds in their portfolios.

“The wave of downgrades will continue” among subprime bonds issued in 2006, says Jay Guo, director of asset-backed research at Credit Suisse in New York. The Moody’s downgrades are so far concentrated among bonds backed by “second-lien” loans, which are taken out on homes that have already been pledged as collateral on another mortgage. Second-lien lenders stand at the back of the line; when borrowers default, it is highly unlikely the loans will recover any money.

The housing market continues to deteriorate, and many economists see little hope that it will start to recover before 2008. Home prices are falling in much of the country, particularly in parts of California, Arizona, Nevada and Florida. Lower home prices will lead to more and costlier foreclosures. Meanwhile, lenders are tightening their lending policies, which will make it difficult, if not impossible, for some people to refinance loans when their interest rates reset to higher levels. That would lead to more foreclosures.

Moody’s said second-lien mortgage loans that were bundled into bonds in 2006 “are defaulting at a rate materially higher than original expectations.” It said such loans were originated when underwriting standards were very aggressive, and have deteriorated significantly as the pace of home-price appreciation has slowed. That is what is causing most of the bond downgrades.

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2 Responses to No quick end to the subprime shakeout

  1. HOUSE OF CARDS says:

    Homebuilders’ Index Drops to 16-Year Low
    Monday June 18, 2:18 pm ET
    By Alan Zibel, AP Business Writer
    Sentiment Index for Housing Market Hits Lowest Level in More Than 16 Years, Trade Group Says

    WASHINGTON (AP) — A measurement of industry sentiment about the housing market fell in June for the fourth straight month to the lowest point in more than 16 years.
    Housing developers are being squeezed by tighter lending standards for borrowers trying to get mortgage loans. In response to weak demand, developers are cutting prices and offering buyer incentives to cope with a mounting supply of unsold homes, the National Association of Home Builders said Monday.

    The trade group’s housing market index, which tracks builders’ perceptions of current market conditions and expectations for home sales over the next six months, fell to 28, the lowest reading since February 1991, the NAHB said.

    Wall Street had expected a reading of 30, according to the consensus forecast of Wall Street economists surveyed by Thomson/IFR. Ratings higher than 50 indicate positive sentiment about the market. The seasonally adjusted index has been below 50 since May 2006.

    The continuing slump is bad news for housing developers like Lennar Corp., D.R. Horton Inc., Pulte Homes Inc., Centex Corp. and Toll Brothers Inc., the largest U.S. homebuilders by market value.

    The index has been sliding since March as demand for new housing slumped amid a rise in defaults for borrowers with weak, or subprime, credit.

    “It’s clear that the crisis in the subprime sector has prompted tighter lending standards in much of the mortgage market,” David Seiders, the group’s chief economist, said in a statement, adding that rising interest rates have also eroded demand.

    Home sales will continue to decline in the months ahead, he said, and housing starts are not expected to improve until next year, he said.

    Sales of new homes, which represent about 15 percent of all home sales, surged in April, but median prices fell 11 percent from the previous month as builders slashed prices.

    Mortgage giant Freddie Mac reported last Thursday that 30-year, fixed-rate mortgages averaged 6.74 percent,the highest level in 11 months.

    Meanwhile, the troubled market for homebuyers with weak, or subprime, credit has hampered investors in mortgage securities who bought loans backed by subprime mortgages. Moody’s Investors Service said Friday it downgraded 131 mortgage investments tied to subprime loans.

    Moody’s said the downgrades were a result of a higher-than-expected default rate among second mortgages issued to subprime borrowers last year and stemmed from “an environment of aggressive underwriting.”

    The Mortgage Bankers Association reported last week that the percentage of payments that were 30 or more days past due for subprime adjustable-rate mortgages jumped to nearly 16 percent in the first quarter, the highest number on record. Foreclosure filings, meanwhile, were up 90 percent in May compared with last year, according to industry data firm RealtyTrac Inc.

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