CORRECTED-UPDATE 1-$469 bln in mortgage bonds in danger-Lehman
(Recasts, adds Lehman mortgage bond holdings)
By Al Yoon
NEW YORK (Reuters) - Money managers may be forced to unload up to $469 billion in residential mortgage-backed securities that were pitched as some of the safest investments, according to one of Wall Street's largest bond firms.
Potential downgrades of the bonds, which represent about 30 percent of outstanding "AAA" securities backed by U.S. mortgages, would force a sale, Lehman Brothers said in a report dated Monday.
The Lehman study comes amid heightened worry that eroding credit in mortgages, especially so-called "Alt-A" loans that required less proof of income or assets, will cause losses to even the safest portions of the bonds. Standard & Poor's is reviewing ratings on mortgage bonds after revising its loss projections higher in July.
Lehman Brothers Holdings Inc LEH.N itself had about $15 billion of "RMBS" on its balance sheet as of the end of May. It also had another $10 billion of home loans, servicing and related assets.
"Valuations in the residential credit sector continue to languish as concerns about forced asset sales from banks, broker/dealers, and structured vehicles dominate," Lehman analysts Rahul Sabarwal and Madhuri Iyer said in the report. Rating downgrades are imminent, they added.
Rates of increase in delinquency for many Alt-A and prime jumbo U.S. mortgages in July outpaced those on the subprime loans that helped spark the housing crisis, S&P reports showed on Friday.
The erosion may open a new chapter of the credit crisis by hurting a more conservative class of investors that avoided more complex mortgage products -- like collateralized debt obligations -- that have caused the worst of the write-downs for banks around the world since 2007.
Many of the securities are products of Wall Street mortgage fundings during the housing boom that took market share from Fannie Mae (FNM.N) and Freddie Mac (FRE.N) "agency" programs and were used to finance risky loans. But most of each bond was still rated "AAA" since junior investors agreed to shoulder greater risks.
Downgrades to "AAA" bonds could be especially harsh for mutual fund money managers who are prohibited from holding securities rated below the top tier, the analysts said.
Those money managers may sell $64 billion of their $225 billion in "AAA" non-agency mortgage bond holdings as downgrades occur, they said.
Other holders, including the Wall Street dealers, insurance companies and banks, have more flexibility in dealing with the downgrades and are less apt to sell, they said. Coping with higher capital requirements and funding costs that would follow downgrades is probably preferable to the severe loss that would be realized on a sale of the bonds, they said.
But downgrades would likely add to mark-to-market losses for banks if other investors liquidate assets, they said.
After a year of mortgage market turmoil, "AAA" rated non-agency bonds are trading at 40 percent discount to their par value, they said. Lower-rated bonds already heavily tagged by downgrades are valued even lower, an investor said.
Commercial banks have about $110 billion of their $380 billion in "AAA" non-agency bonds at risk, Lehman calculated. Non-U.S. investors hold $413 billion in the debt, and $118 billion is "at risk," they found.
Fannie Mae and Freddie Mac, the largest providers of funding for U.S. mortgages, hold non-agency MBS but downgrades do not affect requirements on their capital.
(Additional reporting by Dan Wilchins; Editing by Dan Grebler)
