Subprime Losses Showing Up Earlier Than Expected In Bonds
Dow Jones Capital Markets Report
- April 2007
by Danielle Reed
NEW YORK (Dow Jones)--Losses are showing up in subprime mortgage bonds earlier than expected as the home foreclosure process becomes speedier, according to one research firm.
Investors with exposure to the riskiest asset-backed securities had expected to see some losses as a result of the problems with subprime loans underwritten in 2006, but many reckoned the red ink would start flowing much later as foreclosures can take up to two years to complete.
However, the time period between the first missed payment and the foreclosure sale of the home has shrunk by about four months for many properties backing 2006 subprime mortgage bonds, as compared to recent years, according to San Francisco-based asset-backed bond research and modeling firm Applied Financial Technology.
"When you look at 2006 (subprime) collateral there are losses," said Michael Bykhovsky, president of Applied Financial Technology. Models for projected losses based on home price appreciation and housing affordability among other factors would not have projected these loss rates, said Bykhovsky. "Whenever you see something like that" it's probably worth taking a closer look at the data, he said.
The loss rates on most subprime deals he's examined are still extremely low, around 0.5%, but even these declines wouldn't normally show up in the first 12 months of a bond's life.
In at least some subprime bond deals, there are losses when loans backing the deals are just eight months old. The loss rates of around 0.5% are about triple what he'd normally expect to see when a loan is that age.
One explanation, Bykhovsky said, is that banks in charge of collecting mortgage payments and responsible for handling foreclosure and sale of the properties in question are "just clamping down and processing and liquidating" properties whose loans enter into delinquency and default, he said.
It's a logical reaction for banks to want to sell properties faster in a flat to falling home price environment, since there is little they gain by holding onto a depreciating property, said Mark Adelson, managing director of fixed-income research for Nomura Securities International in New York.
The foreclosure process is long and involved, and - depending on state laws - can take anywhere from six months to two years from the time the first mortgage payment is missed to when the bank sells the property. It's only when the home is sold that potential losses are realized by bond investors. The longer a bank waits to sell a property it owns through foreclosure, the more unpaid interest is accumulating. On top of those expenses, banks expect they'll often have to make some repairs - at a minimum, of a cosmetic nature - to a foreclosed property before it can be sold, Adelson said.
While in a rising home price environment waiting an extra month or two can actually work in a bank's favor, Bykhovsky said, in the current environment, "if you have less of a chance of recovery you have to move very quickly."
