During 1999 and the first half of 2000, the ABS market has grappled with severe credit difficulties among issuers of subprime residential mortgages. Not only have senior-subordinated deals issued by the weakest firms suffered from genuinely higher credit risk, but even senior tranches of "wrapped" (insured) deals have seen their spreads widen due to the market's judgment of "guilt-by-association." Tiering among various issuers has become pronounced: triple-A-rated tranches of deals issued by financially distressed companies trade roughly 20 basis points behind similar tranches from financially strong issuers, such as Equicredit Corp. and Saxon Mortgage Corp. Nonetheless, within the wide variety of available issues, good investment values can be found.
Higher defaults rates by weaker mortgagors and faster prepayment rates by stronger mortgagors in subprime pools than had been expected at issuance set off this turmoil in the subprime market. With the debt service burden of all consumers at a 12-year high in the first quarter, it is not surprising that the more marginal customers of these subprime lenders have had trouble meeting repayment schedules. At the same time, borrowers who do maintain their payment schedules are often offered the opportunity to refinance at a lower rate. While this is attractive for the borrower, it reduces issuers' cash flow, forcing some to file for bankruptcy protection. The bankruptcy itself causes further deterioration in servicing performance as staff morale and commitment decline, diminishing efforts at collection on slow-paying loans and worsening the default rates. In other instances, troubled issuers have been taken over by healthier institutions.