Commentary: Anatomy of a Downgrade

(Revised to reflect updated commentary)

Catching up from last week, it’s worth noting a series of RMBS rating actions from last week at Fitch; the following are just from late Thursday and into Friday.

• 57 RMBS Classes from 10 CWALT Transactions — CWALT is short for Countrywide Alt-A, and Fitch downgraded a total of $238.1 million, while putting $253.9 million on negative watch. Some of the downgrades hit investment-grade tranches.
• 9 RMBS Classes from 3 RBSGC Transactions — RBSGC is short for RBS Greenwich Capital, and these are all 2007 deals. Downgrades totalled $30.5 million.
• 9 RMBS Classes from 4 GS Mortgage Securities Transactions — GS is short for Goldman Sachs, downgrades totalled $22.1 million.
• 4 RMBS Classes from 1 Wells Fargo Transaction — downgrades totalled $17.6 million.
• 5 RMBS Ratings from 1 IndyMac Transaction — $20.3 million in downgrades.
• 5 RMBS Classes from 1 J.P. Morgan Transaction — Alt-A collateral, $13.8 million in downgrades.
• 25 RMBS Classes from 13 J.P. Morgan 2006 Prime Transactions — this one stands out to me, because the collateral is prime mortgages. While this is exactly the time frame where the default curve tends to peak — roughly two years out — the fact that these deals are now being downgraded suggests that future expected losses are outstripping original expectations, even for prime loans. $88.7 million downgraded.

Add it all up, and Fitch knocked $431.1 million in RMBS value down right before the end of the week.

I wanted to take a quick look at the prospectus for one of the JPMorgan deals caught up in the downgrades above; I chose Series 2006-A4, although any of them probably would work. What becomes clear from the prospectus is that the aggregate pool consists of loans originated by one of three companies: PHH Mortgage, Countrywide, and/or Chase. What also becomes clear is that these are prime jumbos, with most of the loans well over the conforming limit and most given to borrowers with a FICO over 740.

Sounds great so far. Except for the part where you begin to realize that the vast majority of the mortgages in this transaction are both interest-only and have an adjustable-rate reset. And there’s more: while just less than half of the pool consists of full-doc loans, another 18 percent is “Simply Signature.”

What’s “Simply Signature?” From the prospectus, it’s Chase’s stated income program:

“Stated Income Stated Asset Program” (which is sometimes referred to as “Simply Signature”) is CHF’s “reactive” program. While income and assets are not verified, eligibility and approval are determined by CHF’s automated underwriting system and are based on a stronger borrower credit history and profile.

Another 15.51 percent of the aggregate pool balance is “Preferred,” and it isn’t really clear what this is except to note that it appears as if it might be Countrywide’s equivalent to Chase’s stated-income product.

There’s also 4.74 percent of the pool in “Alternative” — that’s PHH’s version of stated-income loan products — and another 12.18 percent covering all sorts of other creative lending (no income, no assets; no income, full assets; no doc; reduced doc; no income; etc).

It’s been said that risk is commonly underestimated when it comes to mortgage banking. We’re seeing proof of that reality in every downgrade.