NEW YORK -- Borrowers of almost half of the $500 billion of risky subprime mortgages facing higher interest rates over the next 18 months will have trouble refinancing, J.P. Morgan Chase & Co. said on Friday.
An inability by many homeowners with spotty credit histories to refinance their mortgages would lead to more mortgage delinquencies and defaults, increasing losses in investment portfolios that hold securities backed by the loans.
J.P. Morgan forecasts that by the end of 2008, subprime borrowers with home loans totaling $230 billion will not be able to refinance as they face higher rates, nearly quadruple the expected $60 billion this year.
"We are really heading into the reset storm," said J.P. Morgan analyst Chris Flanagan. "We are on the cusp of that."
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Flanagan, J.P. Morgan's global head of asset-backed securities and collateralized debt obligation research, spoke during a conference call with clients on Friday.
Virtually all subprime mortgages are adjustable-rate loans that offer borrowers low teaser interest rates that then reset at sharply higher rates within two or three years.
Federal Reserve Bank President William Poole said on Friday that problems in subprime mortgage markets — which Fed Chairman Ben Bernanke said on Thursday could add up losses of $50 billion to $100 billion — may have been unavoidable.
While it was widely expected around 2004 that interest rates would rise, it was surprising that adjustable-rate loans were made so extensively to borrowers with shaky credit histories.
"It is difficult to avoid the judgment that these ARM loans were poorly underwritten at the outset," Poole said.
An ABX derivative index, a popular tool used by investors to hedge subprime risks, has posted a series of sharp sell-offs and continues to signal further deterioration in the $565 billion U.S. subprime mortgage market.
The index has plummeted in recent weeks amid mounting losses at several hedge funds and as credit rating agencies slashed or placed under review over billions of dollars of subprime mortgage securities.
The "BBB-" ABX indexes fell to record intraday lows on Friday. The ABX 07-1 index, which is tied to loans made in last year's second half, fell to 42.5 after closing at a record low of 44.86 on Thursday. The ABX 06-2, which references loans made in last year's first half, slid to 46.5 following its close of 50 on Thursday. The newest series, ABX 07-2, was not actively trading on Friday.
Flanagan expects the latest ABX 07-2 index will experience similarly weak performance as the prior two index series.
Flanagan also forecast more rating downgrades of ABS and ABS CDOs over the next six to 12 months.
Standard & Poor's on Thursday cut ratings on portions of 75 ABS CDOs that affected almost $2 billion of debt, which make up less than 1 percent of about $250 billion of synthetic CDOs rated by S&P.
The cuts on Thursday also included 10 CDO tranches that were cut to junk from investment-grade status.
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