JPMorgan Sees Subprime Plunge - TheStreet

JPMorgan Sees Subprime Plunge

An analyst says the riskiest index could hit drop another 33%.
Author:
Publish date:

The sturm and drang that has beset the esoteric universe of securities tied to borrowers with shaky credit quality may be far from over.

Securities backed by subprime and so-called collateralized debt obligations -- which are pooled investments consisting of bonds, mortgages and other debt -- have been on steady decline since this spring. The selloff has been accelerated by recent downgrades of those hard-to-parse securities by Moody's Investors Service and Standard & Poor's.

But more pain may be on the horizon over the next 18 months if pricing levels reset and investors continue to unload the pieces of the CDO components that have fallen into distress.

According to Chris Flanagan, global head of ABS and CDO research at

JPMorgan Chase

(JPM) - Get Report

, pricing in the ABX -- used to hedge bets on mortgage-related securities -- is on the way to making new lows.

"We're on the cusp of a serious pullback in liquidity for this market," Flanagan commented during a midmorning conference, "Subprime Meltdown: Current thoughts on ABX pricing." He was reiterating comments he made yesterday about the troubled subprime market.

Flanagan says pricing on the riskier portions of CDO securities are still overvalued. Junk-rated securities could approach values of around 30 cents on the dollar, he said. Earlier this week, the riskiest tranches of debt measured by the ABX hit all-time lows of about 45 cents on the dollar.

Although Flanagan is not expecting widespread subprime contagion, he sees subprime resolution taking longer.

A spokesman for JPMorgan declined to make Flanagan available for additional comment.

Downgrades from

Moody's

(MCO) - Get Report

and

McGraw-Hill

(MHP)

subsidiary S&P have caused a wave of CDO securities to float back onto the marketplace. Pensions and insurance plans are allowed to own the higher-rated tranches of these pooled deals but are restricted from holding portions that fall below investment grade. So the recent downgrades have made them sellers.

CDOs have been a big fee generator for banks and brokerages. Various parties made money by originating subprime mortgages, pooling these securities and selling them off as bonds to investors.

But subprime has hurt the likes of

Bear Stearns

(BSC)

, which said this week that two highly-leveraged hedge funds have been estimated to be essentially worthless. Earlier, a

UBS

(UBS) - Get Report

hedge fund, Dillon Read Capital, collapsed on subprime-related bets.

Investors now are waiting for the next shoe to drop, which could rear up in so-called Alt-A loans and other mortgage loans provided to borrowers with low income or no documentation of their income.