Subprime mortgage bond market in deep freeze

By Nancy Leinfuss and Albert Yoon - Analysis

NEW YORK (Reuters) - Sales of bonds that finance the $1.2 trillion U.S. subprime home loan market have ground to a halt, as delinquencies by borrowers continue to rise and credit rating agencies downgrade the securities.

A lending slowdown in a housing market that is already seeing lower average home prices across the U.S. may spill over into a broader credit crunch and slow economic growth further.

At the heart of problem are borrower defaults on adjustable-rate mortgages (ARMs) as scheduled interest rate increases of as much as 6 percentage points take effect, creating a "payment shock" for home loan borrowers.

In addition, credit rating agencies including Moody's Investors Services also raised forecasts for losses on new bonds, resulting in Wall Street banks choosing to freeze deals in their tracks.

"Moody's and Standard & Poor's finally got it into gear, downgrading hundreds of subprime issues and threatening more to come," Bill Gross, manager of the world's biggest bond mutual fund at Newport Beach, California-based Pacific Investment Management Co., said on the PIMCO Web site on Tuesday.

Only two subprime ARM-backed bonds have been sold in the first three weeks of July, compared with at least a dozen subprime ARM deals in the last week of June alone, according to JPMorgan. Closely held issuers C-BASS and Bayview Financial were the lone sellers of relatively small deals this month.

Rates on $335 billion in subprime ARMs are due to reset in the next 12 months, according to Fitch Ratings and Loan Performance data. The time is also near for borrowers who opted for temporary savings available in interest-only (IO) loans.

"When these loans reset, IO periods are over, what makes you think thing are going to go favorably?" said Evergreen's Morrison. "So the (new issue) market is kind of frozen."