Subprime Mortgage Derivatives Extend Decline on Moody's Review
By Jody Shenn and Shannon D. Harrington
Feb. 22 (Bloomberg) -- The perceived risk of owning low- rated subprime mortgage bonds rose to a record for a fifth day after Moody's Investors Service said it may cut the loan servicing ratings of five lenders.
An index of credit-default swaps linked to 20 securities rated BBB-, the lowest investment grade, and created in the second half of 2006 fell 4.6 percent to about 75 today, traders said. The index is down 23 percent since being formed last month, meaning an investor would pay more than $1.1 million a year to protect $10 million of bonds against default, up from $389,000 in January.
Moody's said late yesterday that it may cut the so-called servicer ratings for affiliates or units of lenders including Irvine, California-based New Century Financial Corp., the second- largest lender to subprime borrowers. Declines in the ABX-HE-BBB- 07-1 index accelerated this month as New Century and HSBC Holdings PLC, the biggest lender, said more of their loans were going bad than they expected.
``I do not think it is surprising we have trouble in this sector of the market; I think the surprise is the speed at which it has unfolded in the last couple of months,'' said Mary Miller, director of fixed-income at Baltimore-based T. Rowe Price Group Inc., which manages about $335 billion in assets.
Credit-default swaps on mortgage bonds make payments to buyers if the securities aren't repaid as expected.
London-based HSBC today said Bobby Mehta stepped down as head of its North American unit and as chief executive officer of HSBC Finance Corp. after the company earlier this month said it was setting aside 20 percent more than analysts estimated to cover loan losses.
Moody's Review
Moody's said it also may reduce the ratings of affiliates or units of Ameriquest Mortgage Co., Accredited Home Lenders Holdings Co., Winter Group and NovaStar Financial Inc. Kansas City, Missouri-based NovaStar this week reported a surprise fourth-quarter loss of $14.4 million, and said it won't make much money on its mortgage investments for the next five years.
Servicer ratings affect how much protection for investors ratings firms require when mortgages are packaged into bonds. Weaker servicing operations at the five companies may hurt existing securities, Moody's said.
Subprime mortgages are given to people with poor or limited credit records or high debt and typically have rates that are at least two or three percentage points above safer prime loans. The level of delinquencies on subprime mortgages made last year is the highest ever for such loans at a similar age, according to New York-based Bear Stearns Cos.
`Going to Zero'
New series of ABX indexes are created every six months by a group of securities firms including Bear Stearns, Deutsche Bank AG, and Goldman Sachs Group Inc., and London-based Markit Group Ltd. They indicate prices for default swaps linked to 20 bonds, not prices for swaps on each.
Besides bondholders, stock investors have used ABX contracts as a way to bet on the declining fortunes of subprime mortgage companies or the housing market.
The BBB- rated portions of ABX contracts are ``going to zero,'' said Peter Schiff, president of Euro Pacific Capital, a hedge-fund manger in Darien, Connecticut. ``It's a self- perpetuating spiral, where as subprime companies tighten lending standards they create even more defaults'' by removing demand from the housing market and hurting home prices, he said.
Schiff said he has steered his clients to invest in the U.S. Residential Real Estate Hedge V fund, which has $17 million in bearish bets through ABX contracts. The fund has made about 50 percent this year, said Andrew Lahde, head of Ladhe Capital Management in Santa Monica, California and manager of the fund.
