Mutual funds with large investments in the subprime mortgage market may be in for a bumpy ride.
“[Mutual] funds holding large securities in this market will suffer a hit,” said Joseph Rooney, deputy commissioner for financial regulation for the Maryland Department of Labor, Licensing and Regulation, the state regulatory arm.
With industry analysts projecting more than half a million borrowers defaulting on mortgages from the subprime market and subprime lenders losing lines of credit on Wall Street, the impact may result in fund portfolios reacting to these current market changes.
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“Subordinate trants rated A, AA, and DDD will bear the brunt in this subprime sector,” said Connie Bavely, vice president of mortgage and asset-backed securities for T. Rowe Price.
“As the subprime sector faces more and more problems, like people walking away from loans, the trustee of these securities will sell the properties and if they are not able to recoup the entire loan the loss is absorbed by the lower rated trants, so the lower subordinates can experience the greatest loss,” she added.
Bavely, who said that T. Rowe was negative on the industry and had long ago sold off their interests in the market ? retaining only the more seasoned lenders ? felt that most mutual funds tend to be fairly well insulated because of diverse portfolios “so the impact should be negligible.”
Others economists feel that once the market corrects itself from the boon of subprime lenders and tightens up lending guidelines, the economy should recover.
“Not all subprime mortgages are failing,” according to Peter Morici, an economist at the University of Maryland?s Robert H. Smith School of Business. “The actual failure rate is 15 to 20 percent. We are looking at losses but not catastrophic losses. Individual fund losses could be large, but who that might be is difficult to determine.”
Morici believes there will always be a need for this type of service.
“There will always be a market for subprime loans, but we can expect the industry to regroup and exercise due diligence when loaning money by ensuring that incomes are actually what people report and that appraisals are fair and not inflated,” he added.
