Feb. 22 (Bloomberg) -- The perceived risk of owning low- rated subprime mortgage bonds rose to a record for a fifth day after Moody's Investors Service said it may cut the loan servicing ratings of five lenders.

An index of credit-default swaps linked to 20 securities rated BBB-, the lowest investment grade, and sold in the second half of 2006 today fell 5.6 percent to 74.2, according to Markit Group Ltd. It's down 24 percent since being introduced Jan. 18, meaning an investor would pay more than $1.12 million a year to protect $10 million of bonds against default, up from $389,000.

Moody's said late yesterday that it may cut the so-called servicer ratings for affiliates or units of lenders including Irvine, California-based New Century Financial Corp., the second- largest lender to subprime borrowers. Declines in the ABX-HE-BBB- 07-1 and similar indexes accelerated this month as New Century and HSBC Holdings PLC, the biggest lender, said more of their loans were going bad than they expected. London-based HSBC today said the head of its North American unit stepped down.

``I do not think it is surprising we have trouble in this sector of the market; I think the surprise is the speed at which it has unfolded in the last couple of months,'' said Mary Miller, director of fixed-income at Baltimore-based T. Rowe Price Group Inc., which manages about $335 billion in assets.

Credit-default swaps on mortgage bonds offer payments to protection buyers if the securities aren't repaid as expected. Sellers of the contracts are provided monthly payments.

Moody's Review

``Protection-sellers largely have stepped away until the market settles down,'' Peter DiMartino, asset-backed securities strategist at RBS Greenwich Capital, wrote in a note to clients today. ``Recent mini-rallies were just a few brave souls hoping they could actually catch the falling knife.''

Moody's said it also may reduce servicer ratings of affiliates or units of Ameriquest Mortgage Co., Accredited Home Lenders Holdings Co., Winter Group and NovaStar Financial Inc., which this week reported a surprise fourth-quarter loss of $14.4 million. The ratings affect how much protection for mortgage bond investors ratings firms require. Potentially weaker servicing at the companies may hurt existing bonds, Moody's said.

Subprime mortgages are given to people with poor or limited credit records or high debt burdens and typically have rates at least two or three percentage points above safer prime loans. They made up about a fifth of all new mortgages last year and about 13.5 percent of outstanding home loans, according to the Washington-based Mortgage Bankers Association.

The level of delinquencies and defaults on subprime mortgages made last year is the highest ever for such loans at a similar age, according to New York-based Bear Stearns Cos.

`Taken a Hit'

Concern about low-rated subprime mortgage bonds have caused yield premiums to rise on low-rated bonds of so-called collateralized debt obligations backed by the debt. Yields on typical BBB bonds from such CDOs widened 1 percentage point relative to benchmarks in the week ended Feb. 15 to 5.50 percentage points, according to JPMorgan Securities Inc.

``Liquidity has taken a hit as market participants wait for the dust to settle,'' Christopher Flanagan, an analyst at New York-based JPMorgan, wrote in a Feb. 20 report. CDOs buy loans, bonds and derivatives, and resell the cash flows in new bonds, some of which have higher credit ratings.

Yield premiums on high-rated subprime mortgage bonds are little changed. An ABX index linked to credit swaps on AAA bonds has fallen 0.3 percent since its started trading on Jan. 19.

``There's so much credit protection in those securities it just takes a very, very stressed environment to impact their credit profile,'' said Scott Kirby, a portfolio manager at Minneapolis-based Riversource Investments LLC, which manages about $100 billion in fixed-income assets. ``We're not there yet, and certainly we aren't forecasting that.''

Low-rated subprime bond prices are getting to the point where Kirby said he may need to ``reassess'' whether the yields are high enough to cover the risks.

`Going to Zero'

New series of ABX indexes are created every six months by securities firms including Bear Stearns, and Goldman Sachs Group Inc., and London-based Markit. They indicate prices for default swaps linked to 20 bonds, not prices for swaps on each.

Besides bondholders, stock investors have used ABX contracts as a way to bet on the declining fortunes of subprime mortgage companies or the housing market.

The BBB- rated portions of ABX contracts are ``going to zero,'' said Peter Schiff, president of Euro Pacific Capital, a securities brokerage in Darien, Connecticut. ``It's a self- perpetuating spiral, where as subprime companies tighten lending standards they create even more defaults'' by removing demand from the housing market and hurting home prices, he said.

Schiff said he has steered his clients to invest in the U.S. Residential Real Estate Hedge V fund, which has $17 million in bearish bets through ABX contracts. The fund has made about 50 percent this year, said Andrew Lahde, head of Ladhe Capital Management in Santa Monica, California and manager of the fund.

To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Jody Shenn in New York at jshenn@bloomberg.net.

Last Updated: February 22, 2007 16:48 EST