Interest Rate Roundup

Monday, February 04, 2008

Ratings agency loss estimates keep ratcheting higher

In what has become an almost-daily occurance, another ratings agency has increased its loss estimates for securities tied to the housing market. The latest move by Moody's covers Collateralized Debt Obligations with mortgage exposure. I've excerpted a few of these recent statements so you can get a sense for what these guys are saying:

From Moody's on CDO loss estimates, 2/4/08:

"Moody's Investors Service today announced that effective immediately it is revising its expected loss assumptions used for surveillance of ratings of Structured Finance CDO transactions (SF CDOs) holding 2006 vintage subprime residential mortgage-backed securities (RMBS). The announcement was made in light of expectations for continued performance deterioration among 2006 vintage subprime RMBS, as detailed in a Moody's special report published earlier this week, "Moody's Updates Loss Projections for 2006 Subprime Loans".

"Moody's stated that for purposes of monitoring its ratings of SF CDOs with exposure to 2006 subprime RMBS it will rely on certain projections of the lifetime average cumulative losses for 2006's quarterly vintages of RMBS set forth in the recent Moody's Special Report. That report illustrated average loss results for the 2006 quarterly vintages under five distinct loss projection scenarios. Moody's explained that it will utilize the range of loss projections set forth in Scenarios 2 and 3 based on deal performance and quarterly vintage to modify its prior assumptions of the expected loss inputs when monitoring SF CDO ratings. The scenarios each consist of several components and are progressively more stressful, as explained in the Special Report."

From Fitch Ratings on mortgage performance, 2/1/08:

"With U.S. subprime mortgage performance deteriorating markedly over the last several months, Fitch Ratings has adjusted its subprime RMBS loss projections accordingly. Fitch attributes this deterioration to accelerating home price declines which are in part due to the dramatic contraction in the mortgage origination and securitization markets. Fitch has also increased its loss expectations for U.S. subprime RMBS backed predominately by first-lien mortgages originated in 2006 and the first half of 2007. The average cumulative loss expectations, as a percentage of the initial securitized balance, are now 21% and 26%, respectively. Accordingly, Fitch has placed approximately $139 billion, of 2006 and 2007 subprime RMBS (comprised of 2,972 rated classes) on Rating Watch Negative. Fitch will be releasing updated ratings through the course of February and anticipates that its rating review of these securities will be substantively completed by Feb. 29, 2008.

"Fitch's new loss expectations are based on projection of three major variables:

--The percentage of delinquent loans that are expected to default;
--The percentage of currently performing loans that are expected to default; and
--The severity of loss upon liquidation of defaulted loans.

"Mortgage performance in each of these areas has deteriorated. In Fitch's opinion the contraction in the mortgage markets has contributed to an acceleration and deepening of home price declines, and has eliminated the option to sell or refinance a home to avoid foreclosure for many borrowers. Additionally, the apparent willingness of borrowers to 'walk away' from mortgage debt has contributed to extraordinarily high levels of early default, which is particularly noticeable in the 2007 vintage mortgages. As Fitch has described in recent research reports, this behavior appears to be largely attributable to the use of high risk mortgage products such as 'piggy-back' second liens and stated-income documentation programs, which in many instances were poorly underwritten and susceptible to borrower/broker fraud."

From Moody's on 2006 RMBS lifetime losses, 1/31/2008:

"Moody's Investors Service announced today that it has revised its expectation of lifetime losses on loans backing 2006 vintage residential mortgage-backed securities (RMBS) to a range of 14% to 18%.

"We are updating our views on the possible loan losses on the 2006 subprime vintage in response to current performance that is proving to be much worse than in prior years and is demonstrating a progressive deterioration," said Moody's Chief Credit Officer Nicolas Weill.

"The rating agency, however, cautioned that there remains significant uncertainty around the ultimate losses for these loans, which will depend in part on the rate of loan modifications, the impact of 2008 interest rate resets, and the future state of the US economy.

"Such losses are also likely to take some time to materialize. Cumulate loan losses to date on 2006 subprime RMBS are under 1.5%."

And of course, there was the M.O.A.D. (Mother of All Downgrades) from S&P on 1/30/08:

"Standard & Poor's Ratings Services today announced that it has placed on CreditWatch with negative implications or downgraded its ratings on 6,389 classes from U.S. residential mortgage-backed securities (RMBS) transactions backed by U.S. first-lien subprime mortgage collateral rated between January 2006 and June 2007. At the same time, it placed on CreditWatch negative 1,953 ratings from 572 global CDO of asset-backed securities (ABS) and CDO of CDO transactions.

"The affected U.S. RMBS classes represent an issuance amount of approximately $270.1 billion, or approximately 46.6% of the par amount of U.S. RMBS backed by first-lien subprime mortgage loans rated by Standard & Poor's during 2006 and the first half of 2007. The CDO of ABS and CDO of CDO classes with ratings placed on CreditWatch negative represent an issuance amount of approximately $263.9 billion, which is about 35.2% of Standard & Poor's rated CDO of ABS and CDO of CDO issuance worldwide."

What drove said downgrades? This data on the performance of 2006-vintage loans ...

"Monthly performance data reveal that delinquencies and foreclosures continue to accumulate at an increasing rate for the 2006 vintage. Since July 2007, cumulative losses on all U.S. subprime RMBS transactions issued during 2006 are 1.13%, an increase of 156%. At the same time, total and severe delinquencies have increased by 49% and 66%, respectively. As of the December 2007 distribution date the total delinquency rate had increased to 28.79% and severe delinquencies were 18.83%.

"This delinquency trend, together with loan level risk characteristics and continuing deterioration in the macroeconomic outlook, has caused us to increase our lifetime loss projection to 19% from the 14% we projected at mid-year 2007 based on performance up to that date. At that time, the range for expected losses was 12%–16%, but this range has now increased to 18%–20%."

... Plus the ugly stats for 2007-vintage loans:

"The transactions issued during the first half of 2007 have what we consider to be an established trend of poor delinquency performance and have already realized losses. Many of these transactions closed with approximately 1%–3% of loans already seasoned by several months. Since July 2007, cumulative losses on the subprime RMBS transactions issued during the first half of 2007 have increased to 0.25% from approximately 0.01%. At the same time, total delinquencies have grown to 20.40% from 7.43% and severe delinquencies have grown to 11.51% from 2.48%. As of the December 2007 distribution date, the total delinquency rate had increased to 20.4% and severe delinquencies were 11.51%. We are projecting lifetime losses for these transactions to be around 17%, with a range of approximately 16%–18%.

"Our loss projections on the 2007 vintage are based on an analysis of the loan characteristics and relative vulnerability to property value declines. Credit scores, loan-to-value (LTV) ratios, and combined loan-to-value (CLTV) ratios are comparable to mortgages sold in 2006. The pools from the first half of 2007 have a higher percentage of fixed-rate loans, a lower percentage of 2/1 adjustable-rate mortgages (ARMs), a lower percentage of low-doc or no-doc loans, and a lower percentage of loans used for purchase. Data analysis shows that these differences yield an overall lower risk profile for the H1 2007 vintage.

"Moreover, an analysis of the S&P/Case-Shiller National House Price Index shows that price declines from 2006 are larger than the declines experienced since the first half of 2007, on average, by approximately 2%. By comparing the index change from 2006 to the October 2007 reported index, we note that prices have declined about 6% on average. Similarly, comparing the index change from the first half of 2007 to the October reported index, prices have declined about 4% on average. Thus, loans from the 2006 vintage are secured by properties that have suffered greater declines on average than the properties backing the 2007 vintage. As a result, we believe the projected losses will be slightly lower than those for 2006."


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