Moody's Piles On

Brokerage stocks got hit hard Tuesday after the big ratings agencies finally took action on the sinking subprime mortgage market.

Tuesday morning, Standard & Poor's placed about $12 billion worth of residential mortgage-backed securities on watch for a possible downgrade, citing rising increasing losses tied to subprime mortgages. Later Tuesday, Moody's Investors Service downgraded 399 residential mortgage-backed securities, citing "higher-than-anticipated" rates of delinquency.

The downgrades hardly came as a surprise, given that dozens of lenders to consumers with poor credit histories went belly-up this spring as defaults and delinquencies spiked. The biggest casualty was New Century, which once billed itself as "a new shade of blue chip" and issued billions of dollars worth of loans to homebuyers with poor credit histories.

Moody's didn't comment on the timing of the ratings decision. S&P says it had been monitoring the residential mortgage-backed securities since the end of 2005, but there hadn't been enough "seasoning" to indicate future credit trends of the securities.

"The patterns were emerging a few months ago, but now they have gotten more clear and the data has gotten robust enough" for the ratings firm to take action, says Scott Mason, director in the RMBS group at Standard & Poor's.

Wall Street took the news badly anyway, with Lehman Bros.(LEH Quote) dropping 5% and Bear Stearns (BSC Quote) sinking 4%. Other big brokerages dropped 2% or so.

The ratings moves could hurt the firms, because Wall Street has made barrels of money in recent years by packaging loans together and reselling them as securities.

There is "further uncertainty over who's involved in what in terms of subprime and how deep it will go," says Matt Kelmon, president of the Kelmoore Funds in Palo Alto, Calif.

Yet while brokers have been the worst performing financial group this year, the selloff could present a "buying opportunity," Kelmon says.

The brokers "never achieved a rich valuation," he says. "Earnings continue to come in strong," and the firms for the most part aren't trading at the high end of several key metrics.

S&P said the actions are being taken because of "poor collateral performance, our expectation of increasing losses on the underlying collateral pools and the consequent reduction of credit support," among other factors.

The subprime mortgage securities represent about 2.13% of the $565.3 billion of the U.S. residential mortgage-backed securities industry rated by S&P between the fourth quarter of 2005 and the fourth quarter of 2006, the firm said.

S&P is also reviewing the ratings of collateralized debt obligations where the underlying portfolio contains any of the affected securities subject to these rating actions.

Moody's downgraded 399 residential mortgage-backed securities and placed an additional 32 mortgage securities under review. The New York ratings firm said the securities were issued last year and were backed primarily by first-lien adjustable and fixed-rate subprime mortgages.