This database monitors the heartbeat of the mortgage security crisis

As markets continue to worry about the health of mortgage-backed securities, Mark Beardsell is monitoring the patient’s vital signs. Beardsell is Director of RiskModel Analytics at Loan Performance. The company manages a gigantic database that tracks the health of the collateral – all of the individual mortgage loans that form the foundation for the various securities held by CDOs and other institutional investors. “We track monthly [the performance of nearly] every loan on every bond that is out there,” he says. [To be exact, Loan Performance covered 90% of the estimated dollars outstanding of non-agency, single family residential, publicly placed mortgage-backed securities through June 2007.]

“I don’t think the collateral performance will come in as bad as everyone thinks today,” he says. In his view, the market is overreacting and some investors are going to clean up over the next 3-5 years as the liquidity mess plays itself out. “A lot of people are going to make money by buying things cheap,” he predicts. Well, maybe. There’s just this one, teensy little problem: No one knows what housing prices will do. “That’s the elephant in the room that determines how this all ends up,” he says.

While Loan Performance’s historical data can’t provide a crystal ball for the future, historical trends are what have the market spooked at the moment. Loan Performance’s loan-level securities database offers loan transparency for primary investors, but for portfolio managers with many instruments it’s impossible to track everything at a micro level. Instead they rely on the rating agencies to assess those bonds. Unfortunately, those ratings didn’t always take into account what would happen to those underlying sub prime mortgages in a market where housing prices flattened or declined. “There was a miss on credit performance in 2006 and 2007 and the market has turned this very quickly into a liquidity crisis,” he says.

The previous worst performance ever in the loan market occurred in high risk (sub prime) market loans originated back in 2000. That set the precedent. “The 2000 vintage was the historical poster child for bad sub prime collateral,” Beardsell says. Not all segments underperformed, but in areas where home price growth slowed into the 3-4% range cumulative losses on these high risk loans hit 20% to 25%. What if we see those kinds of defaults again? “That’s what has everyone petrified,” he says.

Loan Performance can make some predictions of the future based on historical information, but the answers depend on one variable it can’t predict: future home price growth.

If home prices in areas that experienced fast growth during the housing bubble remain flat or go negative over the next few years, that could be trouble. “If you asked me a year ago if we could see a national scenario of zero home price growth for even one quarter I’d say you’re crazy,” says Beardsell. But unlike previous housing downturns, which have been regional, this could be the first to be truly national in scope. The problem is that the run up in prices most of the major population centers, and that’s where most of the loans were made. “Now the top 20 metro areas are negative. Home price growth has come to a halt. And the flat to negative numbers could easily overwhelm the pockets of the country where home price growth remains positive. The market is now in uncharted territory.

Rather than the historical 5-7% average growth, many areas could see zero growth for several years. And in some places prices are likely to continue to drop. “That’s trouble for mortgage bond performance,” Beardsell says.

But not for all bonds. For many securities, the current liquidity crisis isn’t linked to the fundamentals – it’s more of a contagion that has spread from the sub prime mess. Who gets hammered depends on how securities were structured and how they take the losses. “The BBB [rated securities] will get hurt badly,” says Beardsell, “but it’s not clear that the upper tiers will.”