Higher Delinquencies Affect Securities' Investors

New York-In the past few years investor caution has been the order of the day in the residential mortgage marketplace and higher default rates are adding caution to commercial mortgage security investors.

To best assist investors purchasing nonperforming commercial loans earlier this year, Fitch Ratings said it has turned to 30-day delinquencies as an early leading indicator of future commercial mortgage backed securities performance.

"High-profile loans secured by larger properties, which were often not stabilized at transaction issuance, have begun to default," said Susan Merrick, managing director and head of the U.S. CMBS group at Fitch Ratings.

Furthermore, Ms. Merrick said, "Though capital market illiquidity remains problematic, the recent defaults underscore a shift in which the deepening recession has impacted real estate fundamentals such that term risk outweighs balloon risk as an immediate concern."

The rating agency noted it "continues to expect that performance defaults on larger loans will push up the loan delinquency index in coming months, to approximately 3% by year-end 2009."

More specifically, Fitch expects to see pools consisting of many larger assets, such as the 2006 and 2007 vintages, which "are likely to be the largest contributors to delinquencies."

In January alone, Fitch said nearly $1.7 billion of loans were classified as 30 days delinquent.

The same month defaults on three 2007 vintage loans ranging in size from $130 million to $225 million led to a 27 basis point increase for January U.S. CMBS loan delinquencies to 1.15%.

The rating agency said that if 100% of the 30-day delinquencies were added to loans currently tracked in the loan delinquency index, which consist of loans that are 60 or more days past due, the index would gain another 34 bps to end the month at up to 1.49%.

In the residential mortgage backed securities market investors face the same concerns.

For example, Chicago-based Invesco PowerShares Capital Management LLC said the crisis caused mortgage loan performance to deteriorate significantly putting many RMBS holders "under pressure to raise capital and reduce exposure to RMBS markets, resulting in systematic deleveraging" pushing the prices of many residential mortgage backed securities "well below fundamental values implied by conservative cash flow projections."

"We believe that various economic factors have converged to push the prices of many prime and alt-A residential mortgage-backed securities well below their fundamental values," said Bruce Bond, president and CEO of Invesco PowerShares.

"We are hopeful that these exchange-traded funds will provide access and transparency into these markets along with some of the much needed additional liquidity originally intended by the TARP."

Recently the company filed registration statements for two new actively managed exchange-traded funds focused on the non-agency, prime and alt-A residential mortgage-backed securities markets, the PowerShares Prime and the PowerShares Alt-A Non-Agency RMBS Opportunity Fund.

The PowerShares Prime Non-Agency RMBS Opportunity Fund will seek to provide total return by investing, under normal market conditions, at least 80% of its assets in non-agency mortgage-backed securities collateralized by pools of prime residential mortgage loans.

The PowerShares Alt-A Non-Agency RMBS Opportunity Fund assets are at least 80% in non-agency mortgage-backed securities collateralized by pools of Alt-A residential mortgage loans.

Invesco PowerShares said it believes there is "an opportunity for investors to recognize above average risk-adjusted returns by investing in discounted senior and super senior prime and alt-A residential mortgage-backed securities," because these securities should generate current principal and interest income as well as potential capital gains.

Since September 2008 when the U.S. Treasury introduced the Troubled Asset Relief Program, former Treasury secretary Henry Paulson noted, "The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded," which are still clogging up financial markets.

So the goal remains that of creating a program to transition these assets off the books.

Invesco PowerShares believes many of the assets that were originally targeted for purchase by TARP are not particularly "troubled" from a credit perspective, but are depressed in price due to systemic deleveraging.

Invesco PowerShares funds intend to invest primarily in non-agency, residential mortgage-backed securities following three categories based on the risk profile of the borrower and the property, prime, alt-A and subprime.

The company noted that prime residential mortgage loans are extended to borrowers with "a relatively low-risk profile through a strong credit history."

Invesco PowerShares Capital Management LLC opereates 130 domestic and international exchange-traded funds, providing advisors and investors access to an innovative array of focused investment opportunities.

Invesco PowerShares is a wholly owned subsidiary of Invesco Ltd., a global investment management firm.

The funds are subject to management risk. Additionally, there are risks associated with investing in mortgage-backed securities collateralized by prime and alt-A residential mortgage loans.

Housing prices in many states have declined or stopped appreciating, after extended periods of significant appreciation.

As a result of these and other factors, the value of some mortgage-backed securities has been negatively impacted.

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