Standard and Poor's today made a move that will likely force a dramatic change in the secondary mortgage markets, placing more than $12 billion in rated subprime mortgage securities under a negative ratings watch and announcing significant changes to its ratings methodology. Here's the full press release (also freely available on S&P's Web site) -- and I don't think you should miss any of it. Highlights:
Standard & Poor's Ratings Services said today it placed its credit ratings on 612 classes of residential mortgage-backed securities (RMBS) backed by U.S. subprime collateral on CreditWatch with negative implications ... The affected classes total approximately $12.078 billion in rated securities, which represents 2.13% of the $565.3 billion in U.S. RMBS rated by Standard & Poor's between the fourth quarter of 2005 and the fourth quarter of 2006. The CreditWatch actions are being taken at this time because of poor collateral performance, our expectation of increasing losses on the underlying collateral pools, the consequent reduction of credit support, and changes that will be implemented with respect to the ethodology for rating new transactions. Many of the classes issued in late 2005 and much of 2006 now have sufficient seasoning to evidence delinquency, default, and loss trend lines that are indicative of weak future credit performance. The levels of loss continue to exceed historical precedents and our initial expectations.
S&P also said it expects the vast majority of the classes involved "will be downgraded" in the days ahead. Lost in most of the business press on the pending downgrades, however, is S&P's announcement of a new rating methodology, which according to the rating agency is the result of higher-than-expected loss rates. (Translation: our models haven't been working very well.) What stood out to me among the new survellience methods that S&P says it will use going forward is a new assumption for loss severity -- moving to 40% from the previous 33%. This move alone will hurt nearly every subordinate class of every subprime deal in existence, and is likely a huge driver of the scope of deals now under negative Ratings Watch. Keep in mind, too, that today's action comes on the heels of an earlier negative ratings move at S&P on June 22 that affected 133 subprime RMBS ratings. It isn't clear to me what degree of overlap we're looking at with today's announcement, but I'm sure there is some. Getting a Grip on Associated CDO Risk The RMBS ratings cuts are big news, but the bigger news here would seem to be that S&P is no longer content to stop with just RMBS: the company issued a dual press release in conjuction with the first one that discussed global CDO exposure to U.S. RMBS deals, saying it would review each and every deal in its ratings database for any adverse effects of the pending RMBS downgrades. The full report is available here (and on S&P's Web site), and -- again -- I'd highly recommend reading it. Highlights:
Of the U.S. cash flow and hybrid CDO of ABS transactions currently outstanding, 218 (approximately 13.5%) have exposure to one or more of the subprime RMBS tranches on CreditWatch ... Of the transactions with exposure, 168 are mezzanine SF CDOs, which are collateralized primarily by 'BBB' and other rated tranches of RMBS and other SF transactions.
Some of the CDO deals listed in the press release have roughly 30 to 40 percent of their assets invested in deals now facing an imminent ratings downgrade (!). Not surprisingly, National Mortgage News is reporting today that the ABX is in its latest freefall, citing a RBS Greenwich Capital report:
Standard & Poor's placement of 612 subprime bonds on CreditWatch negative (see item below) "has triggered massive widening" in the U.S. ABX index, which is sometimes viewed as a subprime/home equity indicator, according to a Tuesday morning RBS Greenwich Capital report.
If you'll recall my post yesterday about the money Paulson & Co. made in June, just wait until you see how much his fund makes in July. Update: Market commentary from Rex Nutting over at MarketWatch says that "Standard & Poor's just drove a huge harpoon into the heart of the mortgage credit bubble."