May 3 (Bloomberg) -- Moody's Investors Service, Standard & Poor's and Fitch Ratings understate the risks of subprime mortgage bonds, putting funding for the U.S. housing industry at risk, according to a study to be released today.
The ratings companies can't evaluate the probability of losses because home loans that back the debt have constantly changing underwriting standards, according to the study by Joshua Rosner, a managing director of investment research firm Graham Fisher & Co. in New York, and Joseph R. Mason, an associate finance professor at Drexel University in Philadelphia.
S&P, Moody's and Fitch are also not impartial examiners of credit because they help design the securities, according to Rosner and Mason. Their 84-page study, ``Where Did the Risk Go? How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions,'' is to be presented today at the Hudson Institute in Washington.
``The senior levels of these structures are probably not as safe and secure as the ratings companies have said, as investors would assume, or as regulators are counting on,'' Rosner said in an interview. Whether top-rated classes of such securities are downgraded ``depends on home price appreciation. It's a strong possibility that there could be downgrades.''
Subprime mortgage bond prices are falling as late payment by borrowers with poor credit, reached a four-year high of 13.3 in the fourth quarter, according to the Mortgage Bankers Association trade group in Washington. Losses may exceed a record set in 2000 of about 6 percent, according to New York-based Moody's.
Yields on typical floating-rate BBB rated bonds backed by subprime mortgages rose to a record 5.5 percentage points over the one-month London interbank offered rate in mid-April from about 1.5 percentage points in early February, according to RBS Greenwich Capital Markets. Bond prices move inversely to yields.
Some of the $450 billion in subprime mortgage-backed debt sold last year has lost more than a third of its value, according to Merrill Lynch & Co. Bond investors may lose as much as $75 billion on securities made up of millions of mortgages to people with poor credit, Newport Beach, California-based Pacific Investment Management Co., manager of the world's biggest bond fund, said last month.
Rosner and Mason, who in February published a study titled ``How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruption,'' say that mortgage pools can't be assessed for risk in the same way as corporate bonds because mortgage pools are static and don't alter their holdings when market conditions change.
In addition, mortgage bonds are traded ``over the counter,'' the report said, so there's no transparency for bond prices, making ``the rating the chief mechanism of monitoring and evaluating risk.''
The ratings companies are beginning to cut ratings on mortgage-backed securities issued in the past two years. On April 30, S&P cut credit ratings on a record 253 of bonds backed by U.S. mortgages in the first quarter.
