LAS VEGAS - While the specter of defaults and delinquencies across the lower ends of the home equity ABS credit spectrum disturb more than a few analysts and investors, some are beginning to shift their focus to the credit outlook of the prime and alt-A sectors.

They reason that rating agencies have required enough credit enhancement on subprime bonds to cushion them through a rough credit environment. However, investors in higher FICO loans, particularly those with limited documentation, could be in for an unpleasant surprise.

"I don't want to move up in FICO when I don't have documentation," said Bill Dallas, chairman and chief executive of Ownit Mortage Solutions, at a panel discussion during the ASF 2006 conference here last week. "We are giving people too much capacity to borrow."

Dallas said a consumer's disposable income, regardless of credit score, is pivotal in determining a borrower's ability to pay. And credit enhancement levels, industry members said, may not be enough in the higher credit sectors to cover what may be unforeseen defaults.

Low credit enhancement levels in prime market

"The scariest market to me is the prime market because credit enhancement levels have been so thin," said Scott Eichel, a director at Bear Stearns & Co. "But the rating agencies have been doing a good job in the subprime sector."

Eichel added that subprime bonds, even in the lowest ends of the capital structure, should be able to withstand up to a 10% level of cumulative losses because of structural cushions. In some of the worst environments, cumulative losses were around 8.9%, he said.

Across the credit spectrum, many anticipate that the housing market and mortgage originators will experience the first real pangs from rising interest rates and lower home price appreciation in the next 12 to 18 months.

Dallas, whose origination company was built around an extremely low production cost model, said there are "way too many originators," and those with the lowest cost to produce will survive. Forty-seven percent of audience members voted that credit quality deterioration will hurt originators the most while 32% voted for excess capacity/high cost to originate.

As origination volume begins to fall, 70% of audience members polled felt that large mortgage originators will gain the most market share. Also, 52% believe mortgage banking companies will come out ahead while 30% voted for banks and thrifts.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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