A long-expected downgrade of bonds backed by risky subprime mortgages will probably have a minimal impact on pension funds, foundations, banks and other institutional investors in the state – at least for now.
Moody’s Investors Service on Tuesday cut ratings on 399 subprime-mortgage bonds made last year worth $5.2 billion.
Standard & Poor’s, also on Tuesday, said $12 billion out of $565.3 billion in subprime bonds issued from late 2005 through 2006 are in line to face a downgrade.
“The Denver Foundation does not have any such investments in its portfolio, and we are not aware of any other local foundation that does,” said spokeswoman Rebecca Arno.
The Colorado Public Employees’ Retirement Association, which reported a $38.8 billion portfolio at the end of last year, doesn’t list any risky mortgage- backed debt issues among its top 10 fixed-income holdings.
State-chartered community banks aren’t allowed to hold high-risk debt issues in the first place and should see little impact, said state banking commissioner Richard Fulkerson.
“If a mortgage-backed security is downgraded to junk status, a bank won’t be able to hold it in its portfolio,” Fulkerson said.
Some hedge funds, however, were heavily invested in the new hot potato of the investment world, including the Galena Street hedge fund, which was managed out of Denver.
The $300 million hedge fund cashed out its mortgage-backed holdings last week in the face of heavy investor demands.
Such forced sales push down prices for the thinly traded subprime-mortgage bonds, already under stress because of rising foreclosures.
Subprime-backed bonds are down 30 percent to 70 percent in value, and most of those losses aren’t being recognized by owners of those rapidly depreciating securities, said Lou Barnes, a Boulder mortgage banker who closely follows the debt markets.
Tuesday’s downgrades and the others expected to follow could force institutional investors to sell holdings that aren’t what they thought they were.
Barnes said subprime loans were packed into securities, called collateralized debt obligations, or CDOs, that were given higher investment ratings.
Bad subprime loans could bring down the highly structured securities, causing a wider panic in credit markets.
Investors would probably run from funding additional mortgages, further stressing an already- sluggish housing market. Funding the high-yield bonds needed to support a spate of recent corporate acquisitions would also become more difficult.
A more benign scenario has the bad loans made in 2005 and 2006 working through the system, with casualties limited to specific pockets, Barnes said.
Older, “seasoned” mortgage loans would perform as expected, and new loans made under tighter guidelines would face fewer defaults.
Right now, it remains too early to know what scenario will play out, Barnes said.
Staff writer Aldo Svaldi can be reached at 303-954-1410 or asvaldi@denverpost.com.
