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Rating agencies to cut subprime bond ratings

Standard and Poor's blames 'liar loans' for excessive delinquencies; situation will worsen before it gets better, say analysts.

By Les Christie, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- Standard and Poor's Rating Services said Tuesday it was putting 612 securities backed by subprime mortgages on "CreditWatch negative" and that it expected the majority to soon be downgraded because of high delinquency and foreclosure rates.

In a similar move Tuesday, Moody's Investors Service downgraded 399 securities and placed an additional 32 securities on review for possible downgrade, Reuters reported. The negative rating actions affect securities with an original face value of over $5.2 billion, representing 1.2% of the dollar volume and 6.8% of the securities rated by Moody's in 2006 that were backed by subprime first lien loans.

S&P based its concerns on past performance but said it expects the loans involved will continue to lose money - and that problems will intensify.

Starting almost immediately, S&P will begin to lower ratings, which now range from A+ to BB, to as low as CCC. Many of the loans affected are in the portfolios of major Wall Street players such as Bear Stearns, Citigroup, JP Morgan, Merrill Lynch and Morgan Stanley.

The securities flagged by S&P, all backed by U.S. subprime mortgages, represent a little more than 2 percent of the more than $565 billion in U.S. residential mortgage-backed securities rated during the 15 months ended Dec. 31, 2006.

According to an S&P press release, the agency took the step because of high delinquencies, mostly stemming from lax underwriting standards in effect when the loans were originally made.

According to the ratings agency, vintage-2006, subprime loans have accumulated delinquencies far in excess of historical norms and at much higher rates than the agency initially anticipated.

The implications for the housing markets are negative. S&P is predicting more months of home price declines before any rebound. That, combined with the large number of subprime adjustable rate mortgage (ARM) loans due for an increase in interest rates, spells big problems for many subprime borrowers.

According to the S&P report, 75 percent to 80 percent of the loans identified for a rating downgrade will undergo some type of upward payment adjustment during the next 18 months, increasing monthly payments for subprime borrowers, many of whom will not be able to afford them.

Falling home prices and tightened underwriting standards will add to the pain by making it more difficult for borrowers to refinance out of unaffordable ARMs.

Subprime loans get new standards.

Another factor adding to the poor performances of these loans was that many of them were so-called "liar loans" in which claims by applicants about income, assets and employment were unsubstantiated. S&P cited an analysis made by the Mortgage Asset Research Institute, an information provider to the mortgage and financial services industry, which found that there had been a big jump in misrepresentations on credit applications.

The chef economist for S&P, David Wyss, has predicted a drop of 8 percent nationwide in the median price of a U.S. home from the peak in 2005 to the bottom late in 2007 or early 2008. Without adjusting for inflation, the loss will register at more than 10 percent.

The prices of homes covered by these subprime mortgages will fare even worse, S&P said, with a decline of 22 percent.  Top of page