S&P Says Mortgage Freeze Plan May Cause Downgrades (Update3)

By Pierre Paulden


Dec. 6 (Bloomberg) -- U.S. Treasury Secretary Henry Paulson's plan to freeze some subprime mortgage rates in an effort to stop a wave of foreclosures may lead to ratings cuts on some mortgage bonds, Standard & Poor's said.

``Simply freezing interest rates on some U.S. first-lien subprime mortgage loans would have a negative impact'' on ratings of some residential mortgage-backed securities, analysts at New York-based S&P wrote in a report today. S&P said modifications to the loans will mean reduced payments available to investors from creditworthy borrowers.

The proposal comes as the number of Americans who fell behind on their mortgage payments rose to a 20-year high in the third quarter, according to the Mortgage Bankers Association. Adjustable-rate mortgages account for 70 percent to 80 percent of securitized subprime mortgages from 2005 through the first half of this year, S&P said in its report.

Paulson and regulators reached an agreement with lenders that will fix interest rates on some loans for five years, President George W. Bush said today.

The U.S. plan may ``help stabilize mortgage default rates and mitigate the risk of future downgrades of highly rated tranches,'' said Glenn Costello, a managing director in the residential mortgage-backed securities group at Fitch Ratings in New York. ``However, the implications for the lower-rated tranches of these transactions are unclear at this time.''

Lower-rated mortgage bonds rely more on additional interest from higher rates, Fitch said in a report today. If a substantial number of borrowers are eligible for modification and accept its five-year fixed rate, defaults and losses may both fall, the report said.

Credit-Default Swaps

An ABX index of credit-default swaps tied to 20 subprime- loan bonds rated AA when created in the second half of 2006 climbed 3.8 percent to 48.5, according to Deutsche Bank AG. The ABX-HE-AAA 07-1 index tied to originally top-rated bonds backed by the same loan pools rose 1.3 percent to 78.25, while the BBB- 07-1 index was little changed at 19.

S&P, the largest ratings company, said bondholders may benefit from mortgage modifications if they result in fewer foreclosures.

Keep Their Homes

``Standard & Poor's supports appropriate loss mitigation strategies to prevent foreclosures and allow subprime borrowers to remain in their homes,'' the unit of McGraw-Hill Cos. said.

``In certain instances, the negative effects may outweigh the positive benefits,'' S&P said.

Moody's Investors Service said the plan may help bond investors.

``The criteria for modifications appear to be reasonable,'' said Claire Robinson, a senior managing director at Moody's in New York. ``Overall it's a positive step for investors.''

The share of all home loans with payments more than 30 days late, including prime and fixed-rate loans, rose to a seasonally adjusted 5.59 percent, the highest since 1986, according to a report today from the Washington-based bankers trade group. New foreclosures hit an all-time high for the second consecutive quarter in a survey that goes back to 1972.