Sub-prime slump sours bond ratings
Two major bond-rating firms, which critics say responded too slowly to the sub-prime mortgage meltdown, said Tuesday that they were cutting ratings or considering downgrades on billions of dollars in debt backed by risky home loans.
Standard & Poor’s and Moody’s Investors Service said they made the moves because homeowners were missing payments on sub-prime mortgages at much higher levels than anticipated. The firms blamed lenient lending standards during the housing run-up. S&P; also said many borrowers painted a false picture of their credit when they borrowed money.
The current weakness in home values was also a factor in the rating moves, the firms said. S&P; chief economist David Wyss said he expected an 8% decline in home prices from 2006 to 2008. Lower home prices can exacerbate credit problems because people having trouble repaying their loans have less home equity available to tap for cash.
Moody’s said securities backed by mortgages issued by four California-based lenders accounted for 60% of the bonds it downgraded Tuesday.
The four are Brea-based Fremont Investment & Loan, a unit of Fremont General Corp. of Santa Monica that was forced out of the sub-prime lending business by regulators; Anaheim-based Long Beach Mortgage Co., a unit of Washington Mutual Corp.; Burbank-based WMC Mortgage Corp., a unit of General Electric Co.; and bankrupt Irvine-based lender New Century Mortgage Corp.
Moody’s indicated that borrowers last year were defaulting on mortgages issued by these lenders at a higher rate than other sub-prime lenders’ customers.
S&P;, the debt-rating division of McGraw-Hill Cos., said it might slash its ratings on $12 billion of mortgage-backed bonds issued by such Wall Street banks as Citigroup Inc., Bear Stearns Cos., Lehman Bros. Holdings Inc., Morgan Stanley, Merrill Lynch & Co., and JPMorgan Chase & Co. S&P; said the cuts could begin within days. The bonds being reviewed account for 2.1% of the $565 billion of S&P-rated; mortgage bonds issued from late 2005 to 2006.
Moody’s lowered its rating on $5.2 billion of mortgage-backed securities and said it might downgrade others.
Many of the bond issuers on S&P;’s watch list released early Tuesday are the same as those whose securities were downgraded by Moody’s later in the day.
S&P;’s review also affects collateralized debt obligations, which are complex securities that splice debt into new securities with varying amounts of risk.
Amid mounting defaults and a newfound reluctance of banks to put money behind risky home loans, dozens of sub-prime lenders have gone out of business or been sold in distress since late last year.
Investors have criticized S&P;, Moody’s and Fitch Ratings, saying their ratings on bonds backed by mortgages to people with poor or limited credit didn’t reflect the default rate, which is the highest in a decade. Prices of some bonds backed by sub-prime mortgages have declined by more than 50 cents on the dollar in the last few months while their ratings haven’t changed.
An index of the market value of 20 securities backed by sub-prime mortgages fell 7.4% to a low of 51.42, according to Markit Group, which created the gauge. The index has dropped by nearly half since January, reflecting growing expectations of defaults on underlying bonds.
Accurate ratings for mortgage bonds and collateralized debt obligations are important because the securities trade infrequently, making it difficult for investors to immediately value their holdings when market conditions change. Instead, they often rely on sales of similar securities or computer models that use ratings and past performance of the underlying collateral to derive a value for their holdings.
