PrefBlog

Sorry about all this sub-prime stuff in a blog that usually sticks pretty close to its knitting, but this is a lot of fun!

Global Diversified Investment Grade Income Trust (TSX: DG.UN) (“Global DIGIT”) has announced:

that, considering the liquidity problems of MMAI-I Trust (“MMAI”) due to its inability to roll its maturing commercial paper in the present state of the Canadian asset-backed commercial paper market, it will not have sufficient financial resources to allow for the payment of the redemption price for the redemption of Units and consequently must announce the suspension, until further notice, of the August 31st, 2007 annual and quarterly redemptions of Units.

This is a fascinating investment scheme. What they have done, according to their financials is (with lots of rounding by me):

– taken $89-million of unitholders equity

– borrowed about $1,400-million, mostly as commercial paper

– put all this money into term deposits in banks, at the Bankers’ Acceptance rate plus a spread.

– written Credit Default Swaps against a portfolio of mainly mortgage backed securities and pledged the term deposits as security (note that writing a CDS gives you exposure and, hopefully, yield basically equivalent to what you wrote the CDS on)

The point? It’s discussed:

The Trust’s objective (save for any loss exceeding the first loss amount) is to provide a return on investment of 5.94% per annum to Unitholders up to September 7, 2009 and thereafter a floating distribution equal to the rate of bankers acceptance plus 2%.

Units cost $10.00 at issue in September 2004, of which sixty-five cents went to start-up costs. The provide a handy computation of their returns since inception, using a starting point of $9.35 net … they’ve made about 5.5% annualized.

It seems to me like a helluva complicated & (term-mismatch-) risky & very highly-leveraged way to go after BAs+200, but I should have said that three years ago if I wanted to be taken seriously.

And now they’re having a little difficulty rolling their CP, have suspended redemptions and I see that DG.UN is now quoted at $2.90-99 on the TSX, compared with a NAVPU of $9.17 reported as of 2007-6-30.

Y’know, the underlying doesn’t look all that terrible to me … having looked at it very, very briefly and with no intent of investing or recommending. The big question is how much of the lolly the CP holders are going to grab and, frankly, I’m not going to rip apart the prospectuses trying to find out. I’m not going to pay for any expensive legal opinions, either! But it does seem to me that this very, very distressed security that has enormous liquidity problems would be worth looking at … although, until we know more about what the CP guys are going to take, it’s a wild speculation and, what’s worse, blind.

Too bad the damn thing’s $1.4-billion … that’s getting into serious money that will be hard to finance in this environment … which, I imagine, is part of the problem. If it were smaller, it would be (I think) attractive to the hedge fund crowd. If any of my readers has $1.4-billion they want to put into a nice floating rate note with a term of nine years, call me and maybe we can help these guys out a little … after looking at this stuff a whole lot more closely, of course!

Hat tip : Financial Webring Forum.

Gee, the last one was so much fun I think I’ll do another! Let’s look at “Bear Stearns Asset Backed Securities Trust 2005-1”.

On August 24, S&P released the following:

Standard & Poor’s Ratings Services today lowered its ratings on seven classes from Bear Stearns Asset Backed Securities Trust’s series 2001-3, 2005-1, 2005-2 and 2005-3 transactions (see list).
     The lowered ratings reflect pool performance that has caused actual and projected credit support for the affected classes to decline considerably. All four transactions have experienced losses that have eroded overcollateralization (O/C) to levels that are significantly below their targets. Furthermore, delinquencies have escalated over the past six months. For series 2001-3, losses have, on average over the past six months, been approximately 2.10x monthly excess interest. For series 2005-1, losses have, on average over the past six months, been approximately 3.73x monthly excess interest. Severe delinquencies (90-plus days, foreclosures, and REOs) for the transactions, as a percentage of the current pool balances, range between
approximately 17.09% (series 2005-1) and 13.40% (series 2001-3). Realized losses for the transactions, as a percentage of the original pool balances, range between approximately 9.20% (series 2001-3) and 1.33% (series 2005-3).
     These performance trends have caused projected credit support for the transactions to fall well below the required levels. Standard & Poor’s will continue to closely monitor the performance of these transactions. If the transactions incur further losses and delinquencies continue to erode projected credit support, we will take further negative rating actions.
     Subordination, excess interest, and O/C provide credit support for the two transactions. The underlying collateral backing the certificates consists of both fixed- and adjustable-rate mortgage loans.

RATINGS LOWERED
  
Bear Stearns Asset Backed Securities Trust
Residential mortgage-backed certificates
                               Rating
Series      Class       To              From
2001-3      M-2         BB              A
2001-3      B           B               BBB
2005-1      M-6         BB              BBB-
2005-1      M-7         CCC             BB
2005-2      M-7         B               BB
2005-3      M-6         B               BBB-
2005-3      M-7         CCC             BB

… which looks pretty horrific. But now let’s look at ALL of BSABST 2005-1:

 US$395 million asset-backed certificates, series 2005-1 
Class  Maturity Date   Rating  Rating Date    
 
A  Mar 25, 2035  AAA  Feb 24, 2005    
 
M-1  Mar 25, 2035  AA  Feb 24, 2005    
 
M-2  Mar 25, 2035  A  Feb 24, 2005    
 
M-3  Mar 25, 2035  A-  Feb 24, 2005    
 
M-4  Mar 25, 2035  BBB+  Feb 24, 2005    
 
M-5  Mar 25, 2035  BBB  Feb 24, 2005    
 
M-6  Mar 25, 2035  BB  Aug 24, 2007    
 
M-7  Mar 25, 2035  CCC  Aug 24, 2007    
 
R-I  Mar 25, 2035  NR  Feb 24, 2005    
 
R-II  Mar 25, 2035  NR  Feb 24, 2005    
 
B-IO  Mar 25, 2035  NR  Feb 24, 2005 
 

The SEC ID for this trust is 333-113636, for those who wish to see all the gory detail. Tranche sizes, from the prospectus on SEC / EDGAR are (this is SEC document 0000911420-05-000084.txt : 20050216) are:

Class A : $313,746,000 (pays LIBOR + 0.35% before optional termination / +0.70% afterwards)

Class M-1: $37,689,000 (+0.70% / +1.05%)

Class M-2: $18,549,000 (+1.40% / +2.10%)

Class M-3: $4,341,000 (+1.60% / +2.40%)

Class M-4: $3,946,000 (+2.20% / +3.30%)

Class M-5: $2,960,000 (+3.00% / +4.50%)

Class M-6: $4,538,000 (+3.50% / +5.25%)

Class M-7 was not offered in the prospectus. R-I and R-II are “residual interests in the real estate mortgage investment conduits established by the trust”, and were also not offered. B-IO gets all the Excess Spread. None of these last three classes had a stated principal value; I’m not going to tear apart the prospectus analyzing them because I don’t really care a lot how they work … I’m just after the principal values here!

The “optional termination” becomes effective “when the stated principal balance of the mortgage loans and any foreclosed real estate owned by the trust fund has declined to or below 10% of the stated principal balance of the mortgage loans as of the cut-off date”. At this point EMC Mortgage corporation could purchase all the assets.

At any rate, it should be clear that – while downgrades are always bad, and to be deplored by all right-thinking people – the downgrades that sounded so awful at the beginning of this post lose a lot of their ability to terrify when put into perspective.

Perspective is what’s needed when thinking about sub-prime … and I can’t provide it. I’m not a specialist, and I think a specialist would need a pretty good database to get it. What I really want is a transition study that has dollar figures attached, not just number of ratings. It would be nice, too, if interest rates could be attached to such a study … because, well, gee, the guys in the downgraded class M-6 were getting LIBOR + 350bp (and still are, since the issue is not in default)!

I’ll keep my eyes out, however, and whenever I see something interesting, I’ll post again.

Update 2007-09-18: I became involved in a discussion at Econbrowser in which this issue came up. In the course of the discussion I retrieved a bit more information from the prospectus, which I shall reproduce here:

The following table summarizes certain characteristics of the mortgage loans as of the cut-off date:

Number of mortgage loans……………………3,527
Aggregate principal balance…………..$394,649,130
Average principal balance………………..$111,894
Range of principal balance………$1,041 to $800,000
Range of mortgage rates……………0.00% to 16.50%
Weighted average mortgage rate……………..8.032%
Weighted average combined loan-to-value ratio……………………84.50%
Range of scheduled remaining terms to maturity……….9 months to 361 months

I’ve just read a good paper by Engel & McCoy, Turning a Blind Eye: Wall Street Finance of Predatory Lending, which, while certainly having an axe to grind (they want more regulation), does give a good overview of the problems. Their central point is:

As this excerpt from one prospectus illustrates,securitization turns a blind eye to the underwriting of subprime loans:

With the exception of approximately 20.82% of the mortgage loans in the statistical mortgage pool that were underwritten in accordance with the underwriting criteria of The Winter Group, underwriting criteria are generally not available with respect to the mortgage loans. In many instances the mortgage loans in the statistical mortgage pool were acquired by Terwin Advisors LLC from sources, including mortgage brokers and other non-originators, that could not provide detailed information regarding the underwriting guidelines of the originators.

As this suggests, Wall Street firms securitize subprime home loans without determining if loan pools contain predatory loans. In the worst situations, secondary market actors have actively facilitated abusive lending.

The big problem (to me) is loan re-negotiation, which has been the subject of some political chatter in recent weeks:

Securitization complicates and often blocks work-outs with borrowers who are harmed by predatory loans. This is because the underlying securitization contracts tie the trustee’s and servicer’s hands if they attempt to negotiate a repayment plan in lieu of foreclosure. The value of the securities and the amount of their returns are based on cash flows that are determined, in part, by the loan terms. To protect these cash flows, securitization contracts typically prohibit changes to the terms of the underlying loans. In addition, securitization contracts often prohibit servicers from waiving prepayment penalties and other loan provisions.

There is a very good table in the Engel & McCoy paper (on page 2056 of the Fordham Law Review), showing S&P Upgrades and Downgrades of Public Subprime RMBS, 2003-2006. It’s not a proper transition matrix, but it’s a start. 

Anyway, what brought on this surge of interest in the mechanics of sub-prime was the recent announce by Fitch:

Fitch has affirmed three classes and downgraded one class of notes issued by Northwall Funding CDO I, Ltd., (Northwall). The following rating actions are effective immediately:

–$165,326,758 class A-1 notes affirmed at ‘AAA’;
–$46,500,000 class A-2 notes affirmed at ‘AAA’;
–$40,500,000 class B notes affirmed at ‘AA’;
–$18,000,000 class C notes downgraded to ‘BB’ from ‘BBB’ and remain on Rating Watch Negative (RWN).

Northwall is a collateralized debt obligation (CDO) that closed May 17, 2005 and is managed by Terwin Money Management, LLC (Terwin). Northwall has a substitution period that grants Terwin limited trading ability until September 2007. The portfolio is composed of approximately 89% subprime residential mortgage-backed securities (RMBS), 8% Prime RMBS, and 3% CDOs.

The downgrade of the class C notes reflects the deterioration in credit quality of the portfolio.
Approximately 11% of the portfolio has been downgraded since last review and as of the most recent trustee report the WARF has increased to 5.07 (‘BBB/BBB-‘) from 4.35 (‘BBB/BBB-‘) at last review. In Fitch’s view approximately 13.5% of the portfolio is below investment grade quality, including approximately 5.9% ‘CCC’ or lower quality. There is one defaulted asset comprising $994,341 of the portfolio. In addition, approximately 7% of bonds in the portfolio are on Rating Watch Negative (RWN).

As far as I can make out from a google-cached report by Credit Suisse, the original issue came in the tranches indicated above, with an additional “equity tranche” representing 5% of the issue.

There was another announcement by Moody’s:

Moody’s Investors Service today announced downgrades on 120 securities originated in the second half of 2005 and backed by subprime, first-lien mortgage loans. The actions follow a review of the securities rated in the second half of 2005 and affect securities with an original face value of over $1.5 billion, representing 0.7% of the dollar volume and 4.1% of the securities rated by Moody’s in the second-half of 2005 that were backed by subprime, first-lien loans.

 

The actions reflect the higher than anticipated delinquency rates of first-lien subprime mortgage loans securitized in the second half of 2005. These loans were originated in an environment of aggressive underwriting, although not to the same degree as the subprime loans originated in 2006. Aggressive underwriting combined with the prolonged slowdown in the housing market has caused significant loan performance deterioration and is the primary factor in these rating actions. Moody’s has noted a persistent negative trend in severe delinquencies for first-lien subprime mortgage loans securitized in late 2005 and 2006.

 

The vast majority of these downgrades impacted securities originally rated Baa or lower. In total 54 securities originally rated Baa and 60 securities previously rated Ba were downgraded. Additionally, 6 tranches originally rated A were downgraded. No action was taken on securities rated Aaa or Aa.

 

In addition to the high rates of early delinquency predicating today’s actions, Moody’s notes that subprime mortgages originated in late 2005 and 2006 that are subject to interest rate reset present an additional cause for credit concern. Subprime borrowers from previous vintages of such collateral avoided “payment shock” and potential default by refinancing. However, with the recent pressure in home price appreciation and tightening of mortgage lending standards, such refinancing opportunities may be more limited. Moody’s has noted that transactions issued in the second half of 2005 have begun to exhibit slower prepayment speeds as they near the two-year interest reset than did prior vintages. Moody’s is actively surveying loan servicers to evaluate the impact of potential increases in loan modification due to these upcoming resets.

Why do I bring this up? Well … no real reason. I just wanted to point out that the highest rated tranche of the issue reviewed by Fitch was the best-protected $165-million of a $300-million issue … asset coverage of 1.8:1, in fact, to put it in terms familiar to those who invest in Split-Share preferreds.

Also, I’m really annoyed at all the weeping and wailing over sub-prime. There have been significant losses, but so far they have been borne by

i) those who bought the lower-rated or equity tranches, and it serves ’em right!

ii) those who have panicked and sold stuff into a panicked market because it has the word “sub-prime” in it somewhere. To say something is a sub-prime derivative is about as meaningful as saying something else is an equity. It comes in many flavours.

There’s more perspective over at Tom Graff’s Accrued Interest.