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Tuesday, July 10, 2007

S&P Subprime Massacre

Standard & Poors released information putting 612 classes on ratings watch negative with the expectation of downgrading them. Overall these ratings affect 2.13% of the total RMBS outstanding.

The overall effect of this release is to warn a whole lot of suckers that they had better clear their investment-graded paper while it is still investment graded.

Among the juicy details in their releases was that they are now going to be more cautious in leaving the ratings of higher-rated tranches unchanged when they downgrade lower tranches, they expect the overall housing situation to continue to worsen, they are going to review the CDO's containing any of this junk once they get done with the junk itself, and they have increased their expected loss (severity) from 33% to 40%.
In addition, we have modified our approach to reviewing the ratings on senior classes in a transaction in which subordinate classes have been downgraded. Historically, our practice has been to maintain a rating on any class that has passed our stress assumptions and has had at least the same level of outstanding credit enhancement as it had at issuance. Going forward, there will be a higher degree of correlation between the rating actions on classes located sequentially in the capital structure. A class will have to demonstrate a higher level of relative protection to maintain its rating when the class immediately subordinate to it is being downgraded.
They can't tell what's good and what's not from the data:
Data quality is fundamental to our rating analysis. The loan performance associated with the data to date has been anomalous in a way that calls into question the accuracy of some of the initial data provided to us regarding the loan and borrower characteristics. A discriminate analysis was performed to identify the characteristics associated with the group of transactions performing within initial expectations and those performing below initial expectations. The following characteristics associated with each group were analyzed: LTV, CLTV, FICO, debt-to-income (DTI), weighted-average coupon (WAC), margin, payment cap, rate adjustment frequency, periodic rate cap on first adjustment, periodic rate cap subsequent to first adjustment, lifetime max rate, term, and issuer. Our results show no statistically significant differentiation between the two groups of transactions on any of the above characteristics.
So they gave up and just made up a methodology. They are changing their models. But my goodness gracious, these recent vintages are setting new records for losses:
Total aggregate losses on all subprime transactions issued since the fourth quarter of 2005 is 29 basis points, as compared with 7 basis points for similar transactions issued in 2000. Transactions from the 2000 vintage are used as a comparison because they were, up until now, the worst performing vintage of this decade. When recent transactions with the same seasoning are compared on a quarterly basis with similar transactions issued in 2000, we find that both mean losses and standard deviations are running in excess of the 2000 book for the fourth quarter of 2005 through the fourth quarter of 2006.
The figure they are using for overall home devaluation is 8% from 2006 to 2008. They use 22% for B grade tranches but they note that the environment is worsening. Both are too optimistic. Also, both mean little when your LTVs mean little (bogus appraisals).

They also comment that they believe the same risk factors are present in 2007 vintages and they will apply their new methodology to those vintages. They will now concentrate much more on the quality of the originators in rating new issues.

I think the 2.13% is a little misleading, and perhaps you can think this thru with me. It sounds like that number refers only to the lower rated traunches, so in fact the bonds under observation might total something closer to 200 Billion vs. the stated 12 billion.
ed in texas
Sounds like, in the ongoing game of 'screw the proles' that is known as Wall Street, S&P (and now Moody's too) looked around and couldn't figure out who is supposed to be the fall guy in this debacle.
And you know what that means.
(If you don't know who the pigeon is, you're the pigeon.)
CF - I didn't have time to look them all up, but the effect of this one and Moody's update are such that they affect at least one quarter of the market. It's a very large number.

The look at the CDO's might end up inflicting even more damage, and now the controversy over listing this stuff on Trace has emerged again.

It's kind of a slow-moving fireball.
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