Talk of an economic rebound during a week that saw the Federal Reserve ramp up its efforts to stave off a recession may seem a bit premature, but some market participants are not ruling out the return of jumbo prime loans later this year.

To be sure, any comeback will be slow developing and depend greatly on whether housing prices continue to decline, sources said. The market will of course also be significantly smaller than it was before the housing bust.

Glenn Costello, co-head of Fitch Ratings' U.S. RMBS group, said that this sector will be "less than half of what it was last year."

As the credit crunch spiraled out of control last summer, investors fled to the comfort of loans backed by Freddie Mac and Fannie Mae. The market for all other types of residential mortgages had essentially evaporated.

For investors, the flight to quality had more to do with the worsening housing market, in which foreclosures soared and home prices declined, than any significant uptick in prime loan defaults. Mark Fleming, chief economist for First American CoreLogic, which provides mortgage risk management and fraud protection technology, called the prime jumbo market the one segment that "has been sort of caught up in the process," and said that the investors' flight away from it "was the least warranted from a performance perspective."

"The spreads for prime jumbo really responded to the market psychology rather than any reality of credit performance in that space," he said. "So if there is a market that should come back first it is prime jumbo for sure."

The toll the summer credit crunch took on the prime jumbo market was evident in the Senior Loan Officer Opinion Survey released in October by the Fed. Approximately 45% of the respondents said that origination of the nonconforming prime loans had declined, while 35% reported a drop in the number of prime mortgage loans that had been securitized.

Sources agree that the prime jumbo market, like all sub-segments of MBS, will begin its comeback when investor confidence is restored. "There's economics, numbers, math and then there's psychology," Fleming said. "In asset markets it seems that psychology plays a very large role in price formation during times of volatility and in regular times."

The push to win back the confidence of investors has already begun, according to Fleming. He noted much-publicized developments such as the tightening of credit standards, changes in the profile of originated loans and the efforts made by the rating agencies to improve their business practices.

"The ability to properly evaluate the risk on all securities is being called into question because of what happened to subprime," Fleming said. This has left many investors unaware that the credit performance of jumbo prime has not actually been weakened because of the broader market troubles.

"If you took a survey of investors, many of whom are foreign, I don't know if they would necessarily recognize that fact," he said. "I mean, the fact that the spreads have widened the way they have indicates that they don't."

Art Frank, director and head of MBS research at Deutsche Bank Securities, said that investors will have to see that defaults and credit losses on prime jumbo loans are not escalating like their subprime counterparts before dipping their toes in the water again.

"It's quite possible that the jumbo prime market comes back to some degree at wider spreads than a year ago," he said "I don't think we're going to undo the whole second half of the 2007 experience, but I can see as we get later in the year the possibility of the jumbo prime market coming back."

There is going to be pent-up demand for these asset classes, Fleming added. "It's only a matter of time before investors decide this is again the place where they want to put their money relative to other options," he said.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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