(Update 1; adds ASF rate freeze quote, discussion) A groundbreaking report from Mark Pittman at Bloomberg argues that despite all of the downgrades that have hit subprime residential mortgage-backed securities in the past year, the major rating agencies have yet to downgrade the class of RMBS that matters most: AAA-rated bonds.
click for interactive graphic
All of which could mean that while the subprime mortgage crisis may have become past-tense in most press reports, we still have a very long way down to go. The interactive graphic linked on the right provides a detailed look at key securities in the ABX, and Bloomberg's assessment of where the securities should be rated using existing agency criteria. From the Bloomberg report:
None of the 80 AAA securities in ABX indexes that track subprime bonds meet the criteria S&P had even before it toughened ratings standards in February, according to data compiled by Bloomberg. A bond sold by Deutsche Bank AG in May 2006 is AAA at both companies even though 43 percent of the underlying mortgages are delinquent. Sticking to the rules would strip at least $120 billion in bonds of their AAA status, extending the pain of a mortgage crisis that's triggered $188 billion in writedowns for the world's largest financial firms. ... "The fact that they've kept those ratings where they are is laughable," said Kyle Bass, chief executive officer of Hayman Capital Partners, a Dallas-based hedge fund that made $500 million last year betting lower-rated subprime-mortgage bonds would decline in value. "Downgrades of AAA and AA bonds are imminent, and they're going to be significant."
Look out below? Deutsche Bank estimates that $650 billion on subprime mortgage bonds are yet outstanding, and that 75 percent -- or nearly $490 million -- were rated AAA at issuance. There is certainly a reason for secondary market participants to want to hold off on downgrading AAA-rated securities, if that's indeed what is taking place. Downgrades to the highest rated investment-grade securities affect the largest dollar amount, in relative and absolute terms, for one thing. For another, downgrades would force banks to write-down the value of their holdings, which would in turn likely force increased capital requirements onto banks at time when capital is at an absolute premium in the financial services sector. Worse, a slew of downgrades could force holders to sell -- and we've already seen what sort of pandemonium that can cause in the capital markets. Potential effect on fast-track loan modifications One source suggested to Housing Wire that the lack of downgrades to AAA-rated subprime-backed securities could be undermining efforts by the Bush administration to see the industry adopt a plan outlined by the American Securitization Forum and backed by the Treasury Department that would see servicers perform bulk loan modifications for certain subprime borrowers facing an adjustable-rate mortgage reset. "If you're holding AAA, and it's still AAA, you're waiting," said the source, who asked not to be identified. "You're at about 60 cents right now on the ABX, and allowing modifications like this would likely only take you lower. It's sort of like 'why take a loss when I'm not forced to?'" The source, a bond trader, said that the result is often senior bondholders in a deal being placed at odds with more junior mezzanine or equity positions that want to see the modifications pushed through. Most securitizations establish senior and junior bond tranches, and losses feed up through the junior levels first. FDIC chairman Sheila Bair recently took investors to task for standing in the way of loan modifications, saying that many needed to "wake up" and help push servicers to fast-track loan modifications under the plan. "When AAA holders see their stuff fall to where it probably should be -- 20 to 30 cents -- then you'll see some real progress, because everyone will suddenly be aligned," said the source. For their part, the rating agencies say they aren't holding off on downgrades. Per Bloomberg, again:
"We continue to monitor these securities, have placed many of them on CreditWatch negative, and will take additional action when, in our judgment, a rating action is warranted," said S&P spokesman Chris Atkins. "We do not forbear or refrain from taking action for anyone else."
Interestingly, Fitch Ratings -- the third-largest rating agency -- has become much more aggressive as of late in downgrading AAA-rated RMBS bonds. Housing Wire has covered numerous of Fitch's recent downgrades.