Ratings agency downgrades subprime mortgage bonds
Hours after Standard & Poor's warned it may cut the credit rating of more than $12 billion US in bonds backed by risky home loans, another agency downgraded its rating on hundreds of similar securities.
Both S&P and Moody's Investors Service said they made the moves because borrowers are missing mortgage payments at levels much higher than anticipated.
The concern is significant because the bonds— many sold by some of Wall Street's biggest banks— represent a principal source of financing for the housing market. Lower ratings for mortgage-backed bonds could cause a domino effect that might ultimately strangle what until this year was a major propellant of home prices: easy access to money.
Moody's lowered its rating on 399 of the bonds, known as residential mortgage-backed securities, and said it may downgrade 32 more. All of the bonds were issued in 2006.
Earlier Tuesday, Standard & Poor's Ratings Service, the credit-rating division of McGraw-Hill Cos., said it may slash its rating on 612 classes of mortgage-backed bonds issued by such banks as Citigroup Inc., Bear Stearns Cos., Lehman Brothers Holdings Inc., Morgan Stanley, Merrill Lynch & Co. and JPMorgan Chase & Co.
S&P said the cuts could begin "in the next few days."
Many of the bond sellers on S&P's watch list are the same as those that were downgraded by Moody's later in the day.
The ratings services are focusing on bonds backed by subprime mortgage debt, or loans to people with spotty credit histories. Subprime borrowers collectively have missed a lot more payments on loans amid higher interest rates and a slowdown in the economy.
S&P adjusted its method for rating subprime mortgage-backed bonds to assume more missed payments and mortgage fraud. The ratings agency said it now has enough data to examine how loans issued during this period will perform.
S&P said it is now drawing a stronger correlation among different levels of risk. If one level of credit begins to show cracks, the next level up needs to demonstrate it is better-protected from default risks to maintain its rating.
The subprime mortgage industry has deteriorated more drastically than expected, S&P said, and it does not expect poor credit performance to improve soon. Subprime lenders adopted more lenient lending standards during the housing run-up, S&P said, and many home buyers painted a false picture of their credit when they borrowed money.
S&P's review also affects collateralized-debt obligations, which are complex securities that splice a lot of different kinds of debt into layers of risk.
The subprime mortgage market began collapsing in February when HSBC Holdings PLC and New Century Financial Corp. reported mounting payment defaults had choked a lot of value from the banks' loan portfolios.
Dozens of subprime lenders have since gone bankrupt as banks have become more reluctant to put money behind risky mortgage loans.
S&P chief economist David Wyss said he expects aneight per cent decline in home prices between 2006 and 2008. Lower home prices can exacerbate credit problems because people having trouble repaying their loans cannot tap the equity in their homes for as much cash.