Investors in asset-backed securities, their confidence damaged by the problems at Mercury Finance Co., may be scaling back their purchases of new issues backed by subprime loans.
Issues made up of mortgages for people with bruised credit and home equity loans could be dragged down along with used-car loans, in which Mercury specialized, industry experts said. No dumping of existing securities was evident, but investors were clearly looking upon the subprime sector with new skepticism.
Such reluctance on the part of investors could force lenders to offer more-generous yields to ensure a continuing flow of fresh funds.
"The very public display of weakness will cause caution throughout the subprime industry," said Paul Ullman, vice president of fixed-income management at Alliance Capital Management, New York.
Industry experts were beginning to question the firmness of subprime issues even before problems surfaced at Mercury and at Jayhawk Acceptance Corp., another used-car lender. Experts said these lenders don't have much of a track record, especially for weathering a significant economic downturn.
Mercury, based in Lake Forest, Ill., wasn't an issuer of securities, but it was peddling debt to institutional investors. One such investor-the manager of an $80 billion-asset pension fund-said he feels as though he has dodged a bullet.
"We did look at Mercury (commercial) paper and declined to invest," said Edward J. Grzybowski, director of portfolio management for Teachers Insurance and Annuity Association-College Retirement Equities Fund. "We saw the risks we would be taking, but weren't comfortable with the rewards."
Investors "want reassurance" that their holdings won't sputter, said a fixed-income trader at a large Wall Street investment bank. But the historical record provides no comfort.
"Just think if we have a dip," said Roth Schleck, senior vice president of fixed income investing at Stein Roe & Farnham, San Francisco. "We're operating on the margin in an area that's never been explored before."
The investors' reservations come on the heels of the first significant blow the asset-backed market has experienced since catching fire a couple of years ago. Subprime securities-backed by loans to people with bruised credit or heavy debt-make up as much as 50% of the asset-backed market, experts say.
Last week, Mercury Finance-considered a model among subprime lenders- disclosed that some of its earnings reports had been inflated.
At the same time, Jayhawk, which does securitize its loans, added to the industry's uncertainty with a surprising fourth-quarter loss.
The one-two blow has dizzied the subprime industry, with portfolio managers at mutual funds and pension funds taking a look at their approach to the asset-backed market.
"These products have been everybody's darling," said Mr. Schleck of Stein Roe & Farnham. "I don't know if that will be the case in the future."
Mr. Schleck, who helps oversee portfolios worth $300 million, said he will confine his purchases of asset-backed securities to those carrying shorter maturities so he can better monitor their performance.
Mr. Ullman, who co-manages $4.5 billion of fixed-income assets at Alliance, said the episode at Mercury Finance reinforced his long-held reluctance to deal with anything but higher-grade securities.
There are too many questions about the way subprime securities are policed, he said. "We've had a lot of suspicions about the companies that service these products."
The asset-backed market, which includes home equity and subprime mortgage loans, has erupted over the past two years. Issuance reached $148 billion in 1996 and $119 billion in 1995, up from a scant $10 billion 10 years ago. All the while, portfolio managers earned respectable returns on investments they believed carried only moderate risk.
If portfolio managers pull back now, subprime lenders could be left holding the bag, unable to sell the loans they make and thus without funds to keep on lending, industry experts said. At the very least, skittishness by investors could drive up subprime loan rates by a couple of basis points, experts said.
"To the extent that securitization is not an option, or is a limited option, it could increase the cost of loans," said Gary J. Kopff, president of Heritage Management, a Washington securitization consultant. "It will be interesting to see over the next couple of weeks how deals are priced."