No Clear End to Subprime Woes, Says Bond Manager

Will the mortgage industry's current decline reverse itself by January 2008? MBA chief economist Douglas Duncan predicted it will. PIMCO Senior Vice President Jennifer Bridwell said not.

Speaking at the 35th annual Western Secondary Market Conference in San Francisco, Ms Bridwell pointed to the impact of 2008 ARM resets as a serious bump in the road likely to bring more defaults and delay recovery. Mr. Duncan did not openly disagree but suggested that a generally healthy economy would blunt the effect of further subprime woes.

Mr Duncan reminded attendees that the mortgage industry is at the end of "a 30-year shift to funding through the global capital markets" and away from portfolio lenders such as the S&Ls. He said the current tightening of underwriting standards has brought the mortgage industry a 10% decline in production and a 50% decline in securitization. While investors are no longer willing to buy subprime ARMs, he reminded attendees that "subprime is not going away."

"We will see the peak in delinquencies in the next 2 to 4 quarters" and the peak in foreclosures within the next 6 quarters, Mr. Duncan predicted. Instead of blaming exotic loan products, he pointed to local market conditions, particularly to high unemployment in states such as Ohio, Indiana, Michigan, Louisiana and Mississippi.

Giving a bond manager's view of the current situation, Jennifer Bridwell, MBS/ABS product manager for Newport Beach, CA-based PIMCO, said "investor confidence in the non-agency market has been shaken" by the subprime collapse and predicted that the bond market is poised for cumulative losses. "We think there are a lot of downgrades coming" in the wake of subprime resets in late 2008, she predicted, forecasting that the market would not bottom out until 2009.

With world headquarters in Newport Beach, California, as of March 31, 2007 PIMCO had 867 employees handling $687.1 billion in fund-management assets, $280 billion of that in mortgage debt - but none currently in subprime, Ms Bridwell stressed. To get back in the subprime market, investors will want "compensation for risk, wider spreads or both," she said.

The biggest news at this year's Western Secondary Conference may be what didn't happen, as a scheduled "Rating Agency Overview" was canceled at the last minute.

Asked why she thought Moody's and Standard & Poor's had backed out of their Thursday afternoon session, Ms Bridwell said it was no surprise that they wouldn't relish explaining why some ABS/MBS securities rated AA a year ago ended up being worthless today. She pointed beyond the interplay of low interest rates and innovative mortgage products to a combination of porous rating agency methodology and excess liquidity as causes for the current market woes. On the positive side, she said the demand for ABS backed by prime mortgages is "very robust" today.

In May 2006, for the second year in a row, PIMCO (www.pimco.com) marshaled its 11-person team of mortgage experts to monitor local data for key markets, conducted "ride-alongs" with real estate and mortgage brokers in 20 different cities, analyzed high-frequency economic and housing data, and tracked mortgage lending trends and market data to spot changes affecting mortgage lending and credit risk.

By August 2006 PIMCO managing director Scott Simon noted a slowdown in the U.S. housing market but continued to predict that a 5% growth in housing prices for 2006 would continue in 2007, "with stronger gains in the first half of the year and smaller gains through the second half." Mr. Simon pointed to evidence of a more serious downturn in the aggressive price reductions by publicly traded homebuilders under pressure today to control inventories because "equity analysts treat homebuilders like manufacturing companies and frown on excessive inventories." He also noted a worsening affordability picture on both the interest rate and price sides and expressed concern that American homeowners had continued in 2006 to literally use "their house as an ATM machine." At some point, he warned, "people get too far in debt and bring too much consumption forward from savings and the market will stop making these loans." Ms Bridwell reiterated those same concerns. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.bondbuyer.com/ http://www.sourcemedia.com/