(Corrects first paragraph to show risk reaches record, not near record. Corrects 13th paragraph to show sellers, not buyers, receive upfront payments)

June 12 (Bloomberg) -- The perceived risk of owning low- rated subprime-mortgage bonds created in the second half of 2006 rose to a record as loan delinquencies and mortgage rates climb, according to an index of credit derivatives.

An index of credit-default swaps linked to 20 bonds rated BBB- fell 2.9 percent to 62.12, according to Markit Group Ltd. The ABX-HE-BBB- 07-1 index's previous low of 62.25 came on Feb. 27. An ABX index linked to 20 similar securities from the first half of 2006 remains about 10 percent off a low hit in February.

Improved investor sentiment in May and early June about subprime-mortgage bonds and related collateralized debt obligations may have represented an ``eye of the storm,'' Louis Lucido, group managing director at Los Angeles-based money manager TCW Group Inc., said at a conference in New York last week sponsored by industry group American Securitization Forum.

Yields on 10-year Treasury notes, which mortgage rates generally track, have increased about 0.37 percentage points this month to 5.26 percent, amid bond buyer speculation that concerns about inflation will keep the Federal Reserve from lowering its target rate to boost a slumping housing market.

Higher mortgage rates lessen the chances that subprime borrowers will be able to refinance into new loans when their initial ``teaser'' rates end after two or three years. They can also cut into the so-called excess spread available within subprime-bond deals to cover losses before they hit bondholders.

New bonds rated BBB-, the lowest investment-grade, and backed by subprime mortgages were typically sold at yields of 3.60 percentage points over benchmarks last week, down from a record 10 percentage points in April, Credit Suisse Group says. Lucido said views of improving loan standards are premature.

Late Payments

About $515 billion of securities backed by subprime mortgages were sold last year, according to Arlington, Virginia- based Friedman Billings Ramsey Group. U.S. foreclosure filings surged 90 percent in May from a year earlier, to 176,137, Irvine, California-based RealtyTrac Inc. said today.

Subprime mortgages are made to borrowers with poor or limited credit histories or high debt. Interest rates on the loans are usually fixed for two years, usually at least two percentage points higher than the safest mortgages, and then typically rise 3 percentage points or more unless benchmarks that the rates are tied to decline.

Late payments of at least 60 days, foreclosures and seized property among loans tied to the latest ABX index rose 1.63 percentage points to 8.75 percent in April, after climbing more slowly in the previous two months, Barclays Plc analysts say, based on ``remittance reports'' bond trustees released May 25. The index had rebounded 18 percent between Feb. 27 and May 14.

Moody's Report

The later in the year that subprime-mortgage bonds were issued in 2006, the more likely the underlying borrowers were to quickly experience difficulty in paying back their loans, Moody's Investors Service said in a report last week.

After six months, delinquencies and defaults on loans in bonds created in January totaled 2.8 percent, compared with about 8 percent for October bonds. Subprime bonds from last year have experienced the most early borrower trouble on record.

New ABX indexes are created every six months by securities firms, including Deutsche Bank Ag and Goldman Sachs Group Inc., and managed by London-based Markit. They indicate prices for credit-default swaps linked to 20 bonds, not for contracts on each. Credit-default swaps on mortgage bonds offer payments to buyers of protection if the securities aren't repaid as expected, in return for regular insurance-like payments.

Buyer Protection

Subtracting an ABX contract ``price'' from 100 and multiplying that figure by the amount of underlying debt still outstanding represents how much a seller of protection receives upfront. Lumping upfront and regular costs together, the level of the latest ABX index translates to annual premiums of more than $1.6 million to protect against defaults on $10 million of bonds, according to one dealer's estimates of the bonds' lives.

An ABX index linked to BBB- bonds from the first half of 2006 fell 2.1 percent today to 69.62. That ABX index and the most-recent BBB- one each plunged by about a third in February as the failures of lenders raised concerns about subprime bonds.

``The ABX currently trades from remittance date to remittance date, so we expect pricing to be range-bound for the next two weeks,'' Barclays analysts Joseph Astorina and Elena Warshawsky in New York wrote in a report today. Premiums on typical default swaps linked to individual BBB rated bonds have tightened to 2.4 percentage points last week, from 3.9 percentage points in early April, they said.

The 20 mortgage pools in the 07-01 index have an average of 4.54 percent of loan debt in foreclosure and 0.5 percent that has already been turned into seized property, bond filings show.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net.

Last Updated: June 12, 2007 19:04 EDT