Sliced, Diced' Mortgages More Likely to Default, Offit Says

Most of the 5.85 million subprime mortgages in the U.S. are in danger of defaulting in the next 12 months because of restrictions on changing terms of the loans, according to Offit Capital Advisors.

About 80 percent of the loans are in bonds that ``slice and dice'' rights to a mortgage's interest or principal in multiyear segments, said Todd Petzel, chief investment officer for the New York-based firm, which manages $5 billion. Lifting restrictions on loan modifications spelled out in the securities requires the agreement of everyone who has invested in them, Petzel said.

``If you could get all the investors in the same room, there's no limit to the modifications that could be made to a loan, but that's not likely to happen,'' Petzel said. ``Once you cut up a pig into pork chops and loins and hams it's nearly impossible to put the pieces back together.''

Anti-foreclosure legislation in the U.S. House and Senate asks lenders to voluntarily reduce mortgage principal and banking regulators are urging lenders to modify loan terms to stem the worst surge of foreclosures in seven decades. About half of the subprime adjustable mortgages in securities had payments delinquent for more than 60 days or was in foreclosure, according to a report on the Federal Reserve's Web site.

The collapse of the subprime market that began last year caused at least $380 billion of asset writedowns and credit losses and damaged the economy. Measured annually, U.S. economic growth probably will reach a seven-year low of 0.9 percent in 2008, Fannie Mae, the world's largest mortgage buyer said in a May 8 forecast.

`All Jammed Up'

``We're suffering from a hangover that comes from having the credit markets all jammed up,'' said Steve Van Order, a debt strategist at Calvert Asset Management in Bethesda, Maryland, which oversees $10 billion in bonds. ``We're a credit-dependent economy, and that mechanism hasn't been working right.''

There were 5.85 million subprime mortgages in the fourth quarter, according to the Mortgage Bankers Association in Washington. Of those, 104,215 were modified by permanently altering the terms of the contract, according to Hope Now Alliance in Washington, a voluntary coalition of mortgage companies created by U.S. Treasury Secretary Henry Paulson.

The terms of most mortgage-backed securities prohibit reducing a loan's principal by more than 5 percent, Offit Capital's Petzel said. That's not enough, in most cases, to avoid a foreclosure, he said.

``New layers of wealth will be eroded from both consumers and from the balance sheets of still fragile financial institutions'' if foreclosures continue to rise, he said today in a note to clients.

The technology exists to reconstitute whole loans from the various instruments that own pieces of them and repackage them as new bonds, said Van Order. The main obstacle is the lack of agreement on how the mortgages will perform, he said.

``People were in agreement, when they invested in these securities, on how these loans would likely behave, and of course it turned out they all were wrong,'' Van Order said. ``We don't yet have enough of a consensus on the surviving loans to reverse- engineer the securities.''