Thursday, January 31, 2008

MBIA: Triumph of the technocrats?

(Felix Salmon) In the battle of Bill Ackman vs MBIA, the market seems to be speaking quite clearly: MBIA is winning, if only by sheer force of boredom. Ackman's manifesto might be forcefully written, but MBIA's stock has soared from an opening level of $11.80 to a $15.43 now, something over 110 minutes into one of the longest conference calls I've ever had the misfortune to listen to (slides here). That's an intraday rise of more than 30%.

MBIA's big idea seems to be that the credit-default swaps that they write don't behave like the credit-default swaps that banks write: crucially, they can't be accelerated, except by MBIA, which means that any claims will trickle out rather than having to be paid all at once. But even if that addresses questions over liquidity, it doesn't address concerns about solvency. And the CFO's attempts to show lots of excess capital were pretty unconvincing, given the fact that he was being forced to second-guess the level of capital that the ratings agencies may or may not require going forwards.

It is possible, however, that MBIA has managed to turn a corner today. Its entire market capitalization is less than $2 billion, it announced a quarterly loss of $2.3 billion in the dead of night, and its share price is soaring as a result. Could this be a massive short squeeze? Yes. On the other hand, this could be the triumph of the dull technocrats over the swashbuckling hedge-fund managers.

Borrowers still largely unaware of workout options

(Housing Wire) Freddie Mac said Thursday morning that 57 percent of the nation’s late-paying borrowers still don’t know their lenders may offer alternatives to help them avoid foreclosure. The results, reported in a joint survey from Roper Public Affairs and Media and Freddie Mac, show that despite a historic surge borrower defaults and a resulting crush of press attention, many borrowers aren’t sure how to resolve financial difficulties involving their mortgage.

A previous study in 2005 found that 61 percent of delinquent borrowers didn’t know their lender offered workout options, equating to an improvement in awareness of 4 percent give or take a margin of error in three years.

The news wasn’t all bad, however; the survey also found an increase in the percentages of delinquent borrowers who recall their lenders reaching out to them (86 percent) and who in turn reached out to their lender (75 percent) to discuss workout options. And borrowers are becoming more aware of third-party counseling, with awareness increasing from 36 percent in 2005 to 44 percent today.

“This new survey shows efforts to get borrowers to call counselors are starting to work, but that too many at-risk borrowers are still unaware their servicers routinely provide alternatives that can help them stay in their homes,” said Ingrid Beckles, Freddie Mac’s vice president of servicing and asset management.

“This fact underscores the importance of convincing borrowers to pick up the phone, call their servicer, and find out whether they can avoid foreclosure.”

So why is it that some borrowers still won’t contact their servicers?
Freddie Mac said that one in four deliquent borrowers chose not to accept an invitation to discuss workout options, for one thing. (Fraud, anyone?) Those that didn’t return a servicer’s call because they said they didn’t have enough money to make a payment rose from 7 percent to 16 percent, and the percentage who denied they were having trouble making their payment doubled from six to 12 percent.

HOPE hotline having a positive impact
The survey found that collective awareness of the HOPE hotline at 888-995-HOPE has increased dramatically, signaling that at least some borrower outreach programs are having an impact.

According to the survey, nearly one in four delinquent borrowers (23 percent) report seeing the ads and one in ten (9 percent) who are aware of the HOPE Hotline have made the call. HPF says the toll-free number now receives between 1500 and 3000 calls per day, up from 250 per day one year ago. More than 200,000 homeowners have called the hotline since June 25 of last year, according to HPF.

“The public service campaign is working,” said Ken Wade, CEO of NeighborWorks America.
“Every day, through our partnership with the Homeownership Preservation Foundation, we’re helping thousands of homeowners in financial stress take steps to prevent foreclosure with the 888-995-HOPE hotline. Moreover, those homeowners who call and need additional counseling are being referred to local NeighborWorks organizations for one-on-one, face-to-face foreclosure prevention counseling.”

Click here to read the full survey results.

Subprime Lenders Get Big Accounting Break at SEC: Jonathan Weil

Jan. 30 (Bloomberg) -- Just when it seemed as if the mortgage mess had hit a new low, now comes this: The Securities and Exchange Commission's staff has granted the subprime-lending industry a huge exemption from the normal rules for off-balance- sheet accounting.

In effect, the move will let home lenders keep their balance sheets looking much smaller and less leveraged, even while the off-the-books loans they made get a makeover.

For months, banking regulators and politicians have been pressing lenders to freeze the interest rates on many adjustable-rate subprime mortgages that are scheduled to reset soon at higher interest rates. The idea is to minimize defaults and foreclosures.

While that's a noble objective, all good deeds must be accounted for, and that's been a sticking point for many banks. Through September, just 3.5 percent of subprime mortgages that reset in the first eight months of 2007 had been modified, according to Moody's Investors Service. Even lenders inclined to help don't want to hurt their financial results. And now they might not have to, thanks to a Jan. 8 letter from the SEC's chief accountant, Conrad Hewitt.

Here's the background: Many lenders recorded upfront profits by selling loans in bulk to off-balance-sheet trusts -- known as qualified special purpose entities, or QSPEs -- which then repackaged the loan pools into mortgage-backed securities. The trusts are supposed to be beyond the lenders' control. And if the companies servicing the loans tinker with them in ways that aren't spelled out in the trusts' charters, the sales must be reversed, and the trusts must come onto the lenders' books, under the Financial Accounting Standards Board's rules.

Financial Constraints
That would mean much more assets and debt, possibly limiting banks' ability to make new loans. Not surprisingly, some of the biggest mortgage lenders, including Washington Mutual Inc., Countrywide Financial Corp. and Wells Fargo & Co., had been pushing regulators for a break.

By following new guidelines issued last month by a banking- industry group called the American Securitization Forum, Hewitt said servicers will be allowed to modify subprime mortgages where defaults are ``reasonably foreseeable,'' without jeopardizing the trusts' off-balance-sheet treatment.

Hewitt's letter came in response to requests by the ASF, as well as the Treasury Department and others. On Dec. 6, the ASF published a ``streamlined'' framework for evaluating subprime mortgages issued from January 2005 to July 2007, where the initial rates are scheduled to reset before August 2010.

Loans that meet certain criteria -- based on things such as low credit scores, the number of days delinquent, and high loan- to-value ratios -- are eligible for ``fast-track'' modifications, on the basis that it's foreseeable they'll default, the ASF said.

Losing Status
The wholesale approach includes lots of room for discretion. For instance, if a borrower's credit score is too high, mortgage servicers can use an ``alternate analysis'' and consider a ``tailored modification for a borrower.''

Hewitt said such modifications wouldn't cause the QSPEs to lose their off-the-books status, though he did call for more disclosures by lenders about QSPEs' activities.

Hewitt said he realized there's no way to know how accurate the ASF criteria might be at predicting actual defaults, because there ``is a lack of relevant, observable market data that can be used to perform an objective statistical analysis of the correlation.'' Still, he said the group's criteria looked reasonable, ``based upon a qualitative consideration of the expectation of defaults.''

Hewitt declined to be interviewed, as did FASB officials.
Little Discretion
The accounting standard at issue is FASB Statement No. 140. Its rules had envisioned QSPEs as brain-dead vehicles, akin to wind-up toys. Their actions are supposed to be automatic responses that ``were entirely specified in the legal documents that established'' the trusts. When servicers do exercise discretion, it must be ``significantly limited.''

``I do not believe mortgage modification in such a wholesale and proactive fashion can be reasonably viewed as significantly limited,'' says Stephen Ryan, an accounting professor at New York University, who specializes in financial instruments and institutions.

According to the ASF, many QSPEs' legal documents say loan modifications are permitted where default is ``reasonably foreseeable.'' However, the ASF framework wasn't published until last month. So there's no way the activities it describes could be fully specified in the charters at any of the affected QSPEs.

While it may be a good thing under current circumstances to give servicers incentives to modify lots of subprime mortgages, Ryan says, ``I think the chief accountant should have indicated he was providing an exemption to, rather than interpreting a vague area in, FAS 140.''

Changed Rules
The ASF's executive director, George Miller, says that ``the framework itself cannot be specified in trust documents that existed before the framework was issued.'' However, he says ``it does not need to be'' and that Hewitt's letter is ``not an exemption, just an interpretation'' of whether applying the group's criteria would comply with Statement 140.

This might be a slippery slope. Perhaps the auto industry could be saved, for example, if only we devise new accounting ``interpretations'' of the rules governing their massive pension liabilities.

Hewitt couldn't call his Jan. 8 letter an outright exemption, of course. Unlike the SEC itself, he doesn't have the authority to overturn the FASB's rules. Practically speaking, however, that's what he did.

The SEC and the FASB at least should acknowledge this subterfuge for what it is. Don't count on it, though.

Moody's updates loss projections for 2006 subprime RMBS

(Moody's) announced today that it has revised its expectation of lifetime losses on loans backing 2006 vintage residential mortgage-backed securities (RMBS) to a range of 14% to 18%.

"We are updating our views on the possible loan losses on the 2006 subprime vintage in response to current performance that is proving to be much worse than in prior years and is demonstrating a progressive deterioration," said Moody's Chief Credit Officer Nicolas Weill.

The rating agency, however, cautioned that there remains significant uncertainty around the ultimate losses for these loans, which will depend in part on the rate of loan modifications, the impact of 2008 interest rate resets, and the future state of the US economy.

Such losses are also likely to take some time to materialize. Cumulate loan losses to date on 2006 subprime RMBS are under 1.5%.

"Current losses are still low in part because the loans remain relatively unseasoned and in part because foreclosures are taking longer than in previous years for those mortgages that have already fallen behind," Moody's Weill said.

Moody's also expects significant variation around this average range based on the quality of the originator and the quarter in which the loans were originated. Losses on transactions originated in the fourth quarter, hampered by weaker underwriting standards and already softening real estate prices that inhibited the build-up of home equity, could experience losses over 30% under the agency's worst case scenario.

As a result of these revised estimates, Moody's said that additional negative rating actions are likely on 2006 subprime RMBS. However, these rating adjustments will vary based on current rating, historical performance, quarter of origination, geographic diversification and other qualitative factors. Moody's will continue to examine the ratings on each of the deals over the next several months and will announce the results on an ongoing basis.

Moody's also noted that nearly two-thirds of the bonds originally rated Baa in 2006 have already been downgraded to B or below. Also about 40% of the bonds rated Aa are already on review for possible downgrade.

The report "Moody's Updates Loss Projections for 2006 Subprime Loans," is available at
Moody's indicated that it will perform similar loan loss projection analyses for 2007 originated subprime RMBS and for 2006 and 2007 Alt-A backed transactions and will make its revised estimates for these classes available in the next few weeks.

"We expect the performance of subprime loans backing the 2007 vintage will be more like the performance of the loans backing the third and fourth quarter vintages of 2006 than that of the loans from earlier in 2006," Moody's Weill concludes.

What Went Wrong at Citi and Merrill

Economist Henry Kaufman says senior management was caught up in frenzied pursuit of short-term gain. But "Dr. Doom" still has faith in the American economy's resilience

(Businessweek) Senior managements and the boards of directors of major financial institutions such as Citicorp (C) and Merrill Lynch (MER) failed to perform their proper corporate governance roles, helping to precipitate the financial markets crisis of recent weeks, says Henry Kaufman, president of Henry Kaufman & Co. and a board member at Lehman Brothers (LEH). The Federal Reserve also failed to understand risks created by the proliferation of new financial instruments, says Kaufman, who previously served on the Federal Reserve Bank of New York. Here are edited excerpts from a recent conversation.

From a corporate governance perspective, what went wrong?
At a number of institutions, there was a failure by senior management to know the full extent of the risk-taking. It would seem that their risk modeling did not correctly assess the totality of the risk-taking in the organization.

How is it possible that firms that are in the business of taking risks didn't understand what they were doing?
It has to be recognized that most of the large finance institutions are conglomerates that are in many different types of activities, from underwriting securities to trading securities to proprietary trading. They are in domestic markets and international markets. To comprehend the totality of risk in all these activities is quite an assignment.

But aren't chief executive officers and other top managers tasked with understanding what risks their institutions are undertaking?

You may assume that, but there were other aspects that increased the risk-taking, such as the movement in the financial markets to securitization. That was a major structural change in the financial markets. You now have the opportunity to be in many different markets and assume a larger variety of risks.

[The securitization movement] also created a greater focus on near-term activities rather than the long term. When you securitize, you can package these instruments in different forms. They can be sliced and diced. You can underwrite those obligations. You can trade those obligations. You can create structured investment vehicles, which resulted in some problems. All this creates incentives for the institution to be near-term-oriented.

And there was a change in the power structure inside the institutions. Middle management, such as the traders, took on increasing importance. The more they traded, the greater the opportunity.

Are you suggesting that CEOs and top management were somehow silenced or intimidated?
I think senior management got caught up and couldn't extricate itself. If you don't participate in near-term opportunities, you lose market share. Talent leaves. Bonuses are smaller. Chances are that earnings per share may not be as strong. Therefore, senior management becomes captive.

But isn't the heart of the job of top management to resist short-term risks that threaten the long-term health of the firm?

They did have some risk analysis. Their models of price movements tend to hold up when markets don't go to extremes, but when they do go to extremes those parameters may not hold up. Central banks, including the Federal Reserve and others, did not understand or want to comprehend the implications of the structural changes in financial markets or the changes in economic behavior and what it would have meant for monetary authorities to control the extremes.

Weren't the boards of directors of Citi and Merrill and others supposed to have a handle on risk?
There is the problem of how well the various activities of diversified financial institutions are being disclosed to boards.

Managements may show gross activities to the board, but to what extent are they discussing their subsidiaries that hold some of the assets of the institution? Then there is this question: What is the financial competence of board members?

But there were some very smart, distinguished people on these boards, right?
As a general observation, board members need to be more involved and spend more time and be more familiar with the activities of these institutions.

Are you suggesting they didn't really understand what was taking place?
They depended very much on the acumen and skills of senior management.
So you think senior managers allowed themselves to be swept away by greed?
I'm not sure they allowed themselves to be swept away. But they were part of an environment where they tended to lose control. Top management should understand short-term gain vs. substantial loss. When most people are doing something, you should know very well that you've been caught up in the behavior of the crowd.

What's the key to preventing periodic crises such as this one, the savings and loan mess, and others?
One of the issues for which we have no answer is that when very big financial institutions are too big to fail, it tends to result in too much risk-taking. The other need is for the central bank to increase its supervision of financial institutions and to be much more involved in knowing what is going on in them. If that had happened, these malpractices would not have flourished.

Have any steps been taken yet to address what you seem to suggest is a structural problem?
Not yet. What's been undertaken is a rescue operation in the form of providing a huge volume of liquidity to the markets in terms of low interest rates, which will ease the pressure on institutions. The inverted yield curve gives them an opportunity to make some profits.

But is that a real solution?
Some CEOs have lost their jobs, and some senior managers have lost their jobs. We had similar developments in the 1980s and 1990s. The last problem was 2000 and 2001, and here we are again only a few years later. We had the market crash in 1989. We had problems with the S&Ls and also commercial banks. Then there is always another bubble. It's quite obvious that we have not put in the place a way to limit these excesses.

Isn't that a sweeping indictment of the financial system?
Yes. But at the same time, the American economy has done reasonably well. We have seen nothing the size of the 1930s Depression. We've had recessions. The economy picked itself up, and we continued to expand after a brief hiatus.

What should the Federal Reserve be doing differently?
The examination function must have a higher priority. The central bank cannot depend on the risk analysis provided by the financial institutions. And we should have centralized oversight of major financial institutions. Now we have the Federal Reserve, the Comptroller of the Currency, the Securities & Exchange Commission, and various other state and federal supervisory agencies all involved. In a global environment, that creates a fracture in supervision.

In addition to writing Armchair MBA for, William J. Holstein writes for The New York Times, Fortune, Corporate Board Member, Dealmaker, and Strategy + Business.

S&P Focuses On Appraisals For Residential Properties And Encourages Use Of Automated Valuation Methods

An accurate gauge of property value is an important element of residential mortgage credit analysis. For this reason, Standard & Poor's Ratings Services encourages issuers of residential mortgage-backed securities (RMBS) to make an Automated Value Method (AVM) value on all securitized loans available both to us and to RMBS investors. The AVM value would complement the value generated by a traditional appraisal. We believe the inclusion of AVM values, or other valuations, provides a cross-check for determining an accurate property value and enhancing our analytics. This supplemental data will be considered as part of our operational risk analysis, and would facilitate our ongoing efforts to enhance our analytics and processes and help us to provide additional insightful research to the mortgage and securitization markets.

Standard & Poor's LEVELS® 6.1 Model File Format will provide additional fields to capture the AVM system, the AVM system value, and the date of the AVM.

We would like to receive feedback from the marketplace as to the usefulness of supplemental valuation methods other than AVMs. For example, how worthwhile are the use of "drive-by" appraisals, broker price opinions, or tax assessments as value-add methodologies in determining the most accurate valuation of a property. Comments should be directed to Leslie Albergo at 212-438-2381 (

For mortgage lenders, accurate information about both the borrower and the property being used as collateral for a mortgage loan is a fundamental requirement. The appraisal report, which is the basis for determining just what the real estate asset is worth, contains vital information on the property. So when appraisals are inaccurate or fraudulent, the consequences can be severe—not just for the lending institution, but also for investors in securitized products that include loans originated based on this faulty data.

Reports of abuses of appraisal practices and outright fraud have been mounting, despite many attempts—regulatory and procedural—aimed to prevent such practices. Standard & Poor's believes that the appropriate use of AVMs can help diminish the risk associated with the most commonly reported fraudulent appraisal practices by offering a second opinion on the collateral value, outside of the origination process. Indeed, the use of AVMs may help counteract fraudulent appraisal schemes and increase confidence in both reported property values and the loan-to-value ratios.

Standard & Poor's has been reviewing AVM models for several years, and we are beginning our next round of AVM testing. The results of these vendor-specific tests have long been a part of our loan-level credit enhancement models, using sales price thresholds and incorporating geographic location.

Identifying The Many Sides Of Mortgage Fraud

Mortgage fraud has grown into a problem serious enough to merit attention from the Federal Bureau of Investigation (FBI), which divides mortgage fraud into two general categories: "fraud for housing" and "fraud for profit." (For more information, see the related report, "Federal Bureau of Investigation, Mortgage Fraud: New Partnership to Combat Problem," dated March 9, 2007, and available at 030907.htm.)

Fraud for housing occurs when borrowers misrepresent their income or employment when applying for a loan to buy a home. Given the underperformance of certain types of residential mortgages, there's reason to believe that the incidence of borrower fraud for housing has increased.

More serious appraisal fraud generally falls under fraud for profit, a phenomenon that involves collusion among industry insiders. The FBI categorizes roughly 80% of all fraud schemes as fraud for profit and focuses on this type of fraud in its general investigations.

According to the FBI report, typical schemes include:

  • Flipping: In a fraudulent flip, a buyer purchases a property for a low price or through a foreclosure sale with the intent of inflating the value to a new buyer. Both transactions (the purchase and the resale) close within weeks—or even days—of each other, and the seller uses a fraudulent appraisal to justify the value to the new buyer. However, if the original buyer improves the property and uses a legal appraisal, the resale would not be considered a fraudulent flip.
  • Puffing: In this scenario, the seller and the buyer work together using a fraudulent appraisal. For example: The real or listing value of the home is $100,000. The purchaser buys the home from the seller for $150,000. The seller gets the asking price of $100,000, and the buyer pockets the additional funds from the mortgage lender.
  • Air loans: In an air-loan scheme, the fraudsters create loans on nonexistent properties. For example, they may invent properties and borrowers by establishing certain accounts and phone numbers in the "borrower's" name and then concocting phony employers and documentation. Alternatively, the "borrower" in such a scheme may be a real person whose identity has been stolen. A well-known air-loan scheme in one city used an advertisement for a lucrative job offer. Applicants completed forms and provided copies of driver's licenses and Social Security numbers, which the fraudster used to collect information for the phony air-loan borrower.

Appraiser identity theft is a growing concern. A person skilled at computer technology can easily replicate an appraisal's digital signature and pass off a valuation—complete with the appraiser's license number below the signature—as legitimate. This ability, of course, greatly increases the chance that the fraudster will be successful and remain unidentified.

Third parties to the transaction can also contribute to appraisal fraud, particularly in situations where the mortgage broker needs the value of the home to be a certain amount for the borrower to qualify for financing. Appraisers continue to report pressure from mortgage brokers, originators, real estate professionals, and others—including appraisal management companies who hire them—to inflate the property values.

In fact, a new national survey found that 90% of appraisers reported that mortgage brokers, realty agents, lenders, and even consumers have pressured them to raise property valuations to enable deals to go through. This percentage is up sharply from figures in a parallel survey conducted in 2003, when 55% of appraisers reported attempts to influence their findings and 45% reported that such pressure "never" happened. Now the latter category is down to just 10%.

Both surveys were conducted by October Research Corp., a firm in Richfield, Ohio, that publishes Valuation Review, a popular industry newsletter. The latest survey involved 1,200 appraisers representing a statistical cross-section of the industry in 50 U.S. states, the District of Columbia, and Puerto Rico. The results have a margin of error of plus or minus 2.8 percentage points.

Practices Are Evolving To Prevent Fraud

The mortgage industry has been taking various measures to prevent fraud. For example, the August 2007 Mortgage Bankers Association Appraisal Industry Outreach Task Force Report called for a national appraisal registry or national property database to address the competitive pressures on appraisers to inflate home values. Under this proposal, appraisers would submit reports to a centralized database that would be available to mortgage lenders, rather than funneling their reports back to brokers. The appraiser's valuation would thus be free from any other party's intervention.

In another move to head off fraudulent appraisals, the Mortgage Asset Research Institute (MARI®) recently announced enhancements to its Mortgage Industry Data Exchange (MIDEX®) anti-fraud database. MARI has now added "license verification" of appraisers and real estate agents to the platform. MIDEX-Licensing provides instant online access to licensing information on industry professionals (companies and individuals) from more than 60 federal and state mortgage regulators.

Other suggested practices include appraiser lists and report cards to monitor appraisers' reliability and ethics and more easily identify questionable parties.

Use Of Automated Appraisals

While we support the use of AVMs, regular testing and validation of these models is vital to their acceptability.

Standard & Poor's will soon begin its next round of AVM testing. In order to enhance our testing capabilities, we've added the expertise of AVMetrics LLC to our AVM validation process. We believe this partnership will allow us to leverage the core capabilities of our respective firms. We will use AVMetrics LLC to help coordinate our testing process. We will continue to apply our specific loan-level criteria to the aggregated data we receive from each vendor participating in our validation process.

Standard & Poor's expects to test the accuracy of AVM models semiannually. The testing process begins with a large, geographically diverse data file of property addresses that have sale dates within the prior three to six months. The results are stratified and measured, allowing us to compare the variance of the actual sale price with the estimated value given by the AVM system according to the sales price bucket, state, county, and zip code.

The variance analysis allows us to develop system-specific assumptions at the loan level, which we incorporate into our ratings models. Our ratings assumptions with the use of AVMs include an analysis of the credit quality of the borrower, the location of the property, and the value of the home.

The quality of data supporting an AVM model determines the quality of its performance. The data at the core of any model's results should be as accurate, current, and complete as reasonably possible, a challenge that AVM vendors continually address. Accordingly, Standard & Poor's review process has become helpful to the overall credit risk analysis of residential mortgage portfolios.

AVM vendors interested in participating in this testing should contact Standard & Poor's immediately. For additional information, call Dan Hall at 212-438-1576 or Leslie Albergo.

For more information, please see the related article, "S&P Enhances Its Review of Data Quality Practices for U.S. Residential Mortgage Originations," published Oct. 10, 2007, on RatingsDirect, the real-time Web-based source for Standard & Poor's credit ratings, research, and risk analysis, at

S&P: 2007 Proved To Be A Mixed Bag For The Canadian Structured Finance Market

The Canadian term structured finance market ended 2007 feeling a clear knock-on effect from the turmoil in the global credit markets as well as from the dislocation in the Canadian nonbank asset-backed commercial paper (ABCP) market that started in the summer. Total issuance for 2007 was C$7.11 billion, down 60.94% from C$18.21 billion a year earlier.

Asset-Backed Securities Issuance Down From 2006

The issuance of Canadian term asset-backed securities (ABS) consisted of six issues (see chart 1) compared with 22 issues in 2006. In terms of collateral type securitized (chart 2), there were two credit card-backed transactions that constituted 30.94% of the issuance, two auto-related asset transactions (46.48%), a reverse mortgage transaction (9.48%), and a single residential mortgage transaction completed in the first quarter (13.11%). Poor credit conditions also resulted in the cancellation or postponement of a number of term issues that we now expect to come to the market sometime in 2008.

Chart 1


Chart 2


Generally, the reduction in issuance was across all asset classes but was particularly acute in credit card and auto finance-related transactions. Credit card issuance fell to C$1.1 billion in 2007 from C$5.5 billion in 2006. In addition, auto finance-related issuance dropped to C$1.65 billion in 2007 from C$3.22 billion in 2006.

For 2008, there are a number of factors that Standard & Poor's Ratings Services expects will influence issuances in the ABS term market. Clearly, investor confidence in this market generally will need to be restored before term transactions will return to the market with any degree of regularity. This confidence is predicated on the ability of the Canadian economy to absorb any knock-on effects from the slowdown in the U.S. economy and the resultant impact on asset performance in Canada. Generally, asset performance in Canada hasn't deteriorated as it has in the U.S. However, the passage of time will demonstrate whether this is due to the inherent robustness of the Canadian economy or simply a lag effect from the events in the U.S.

Removal Of Withholding Tax Introduces New Dynamic

A second factor whose impact is still to be determined is the removal of withholding tax by the Canadian government, effective Jan. 1, 2008. See "Elimination Of Canadian Withholding Tax May Prompt Change In Canadian Securitization Landscape", published Jan. 9, 2008, on RatingsDirect for a discussion of this change. It is still too early to determine what, if any, impact such a change will have on the Canadian market. However, the removal of the tax creates an opportunity for U.S. credit card issuers and auto finance companies to fund Canadian assets in their U.S. platforms, thus potentially reducing the amount of issuance of these two dominant asset classes. Moreover, the tax's removal opens up the possibility of Canadian transactions being sold to U.S. investors.

Canadian ABCP Moves To Global Standard

Perhaps the most significant story for 2007 was the dislocation in the Canadian nonbank ABCP market and the resulting movement away from general market disruption (GMD) triggers that were the norm in Canadian ABCP liquidity agreements and the reason why Standard & Poor's did not rate Canadian ABCP conduits. Standard & Poor's global ABCP criteria approach viewed GMD liquidity as an insufficient mitigant to the liquidity risk that exists within GMD supported ABCP programs.

The shift from GMD liquidity has allowed Standard & Poor's to provide its first credit rating to a Canadian ABCP conduit, Okanagan Funding Trust.

We expect that the Canadian market will continue to ask for alternative rating agency opinions where globally consistent criteria and methodologies will be applied. Moreover, we anticipate that Canadian conduits will feature structural components seen globally, such as liquidity and programwide credit enhancement.

Canada Enters Covered Bond Market

Notwithstanding the turmoil in the global markets, two Canadian issuers entered the global covered bond market in 2007 and early 2008. Royal Bank of Canada (AA-/Positive/A-1+) sold a €2 billion five-year series followed quickly by a €1.25 billion 10-year series. In addition, Bank of Montreal (A+/Stable/A-1) issued a €1 billion five-year series. Overall, these issues have been well received in the global market and create an additional source of liquidity for the Canadian banks. For 2008, Standard & Poor's expects continued issuance as well as the entrance of additional financial institutions into the covered bond market.

Strong Issuance In First Half Of 2007 Offset By Weak Issuance In Second Half

The Canadian commercial mortgage-backed securities (CMBS) market began the year much like 2006 ended--with strong issuance throughout the first six months of the year. However, as spreads widened dramatically in the summer the issuance calendar dropped off quickly. In the third quarter there were only two transactions that closed and there were no transactions completed in the fourth quarter. The volatility in the capital markets made it difficult for issuers to price new loans and to issue previously closed loans would result in a loss to the issuer. By year-end there were eight deals completed, which generated an overall issuance of C$3.6 billion (see chart 3). The cumulative issuance through 2007 in the Canadian market was C$23.4 billion in 63 transactions (see chart 4).

Chart 3


Chart 4


Ten Years Of CMBS Issuance In Canada: Back To Basics

The conduit market continues to be the dominant form of issuance; Canadian Imperial Bank of Commerce (A+/Negative/A-1) returned to the market with its ClareGold 2007-1 issue, which combined a seasoned portfolio with new loans. The average transaction size remained consistent with 2006 at about C$400 million. However, the outlook for 2008 is for smaller transactions with concentrations in more "vanilla" property types. These smaller transactions will likely be less diverse.

We'll be monitoring maturity date refinancing risk; in 2008 there is about C$998 million in loans that are scheduled to mature and will need to be refinanced to pay the balloon amounts associated with these loans. The current lack of liquidity in the mortgage market has increased the refinancing risk in these loans. A number of factors, however, mitigate this risk. The largest portion of these loans scheduled to mature were originated in 1998 and 2003. Since origination, these loans have benefited from improved cash flow that has improved the in-place debt service coverage rations. In addition, as cap rates have compressed since 2003, the underlying properties have increased in valuation since origination, reducing the loan to value on maturity. As a result, the maturing loan balances using debt per dollar of cash flow as a measure of leverage; this indicates that the maturing balances are more conservative than current underwriting standards and, therefore, should be able to find refinancing. While this is generally true, individual property dynamics will affect lenders' appetite to refinance the maturing loan balance.

Asset performance in the Canadian CMBS market continues to be strong. Delinquencies have remained consistently low as occupancy levels for most property types in most markets are at or near historical highs, which has maintained coverage levels. Overall, as of Dec. 31, 2007, there were no delinquent loans (0.0% by principal balance) for Standard & Poor's rated transactions. Transaction level performance also was strong, with upgrades again outnumbering downgrades (there were 39 upgrades and two downgrades in 2007). The two downgrades were in credit tenant lease transactions where the ratings depend on the underlying rating on the tenant; there were no downgrades in conduit transactions.


Supporting our CMBS and RMBS initiatives, Standard & Poor's continues to provide servicer rankings on Canadian commercial and residential servicers. The servicer evaluations are intended to assess a servicer's strengths, weaknesses, opportunities, and limitations through an examination of three key areas: management and organization, loan/asset administration, and financial position. To attain a minimum ranking of AVERAGE and become a select servicer, a company must display competency in a number of crucial operational areas and management must have acceptable industry-level experience, with adequate policy and procedure manuals to ensure a well-informed and knowledgeable staff. Companies should display internal controls over the cash management process to minimize the risk of loss from fraud or human error. Select servicers must have a viable internal audit process and appropriate disaster recovery measures. Overall, competent servicers should possess a coherent organizational structure that adequately delegates responsibilities among the dedicated staff.

There was one servicer ranking action in 2007 as First National Financial LP's Master Servicer rankings were raised to ABOVE AVERAGE from AVERAGE. There are 16 commercial rankings on Canadian servicers, as well as two residential rankings and one equipment lease servicer. We expect additional servicer ranking announcements in 2008 as we review and rank the servicing capabilities of financial institutions participating in the covered bond market.

This Year: Lower Issuance Likely, But CMBS Well Positioned

The outlook for 2008 in terms of issuance appears uncertain. While maturing mortgages from transactions that were originated in 1998 and 2003 provide potential to be refinanced into new transactions, many of these loans have been previously defeased. The removal of the withholding tax between Canada and the U.S. may relieve some of the liquidity constraints in Canada. Also, these loans may end up in U.S. transactions, which would also reduce issuance volumes for Canada. Issuance volumes will likely drop considerably from the pace of the past few years, with potential issuance in 2008 likely to be below the issuance levels of 2003 at about C$1.5 billion.

Contrary to the issuance outlook, Canadian commercial real estate fundamentals appear to be well positioned for 2008. Property types such as retail and office properties benefit from long-term leases and new supply coming online in 2008 would appear to be limited. Multifamily properties have benefited from continued rent growth and very low vacancy levels. Industrial properties in eastern markets could see some softening if the manufacturing sector and related industries experience a more prolonged period of weakness. Lastly, the lodging sector could see some weakness in 2008 if business travelers reduce travel budgets and demand softens from leisure travelers as a result of the strong Canadian dollar.

Cuomo using Martin Act to pursue subprime securities fraud

(Naked Capitalism) We had been wondering when subprime-related securities litigation would get going in earnest. New York attorney general, Andrew Cuomo, along with Connecticut attorney general Richard Blumenthal, has been investigating whether underwriters failed to disclose relevant information to investors in subprime deals.

The latest development, according to the Wall Street Journal, is that Cuomo has issued Martin Act subpoenas to Bear Stearns, Deutsche Bank, Morgan Stanley, Lehman, and Merrill. Predecessor Eliot Spitzer demonstrated that New York State's Martin Act is a potent weapon, since the plaintiff does not need to prove intent to defraud, merely that a fraud resulted. Put more simply, incompetence or negligence can be sufficient grounds for a successful case.

If these investigations result in lawsuits, the evidence presented in court would be a boon to individuals and funds who wanted to take action. However, Spitzer's playbook was to threaten criminal prosecution. Since no firm was willing to suffer indictment, they agreed on settlements. If Cuomo goes the civil prosecution route, we may see trials which would be of considerable assistance to other plaintiffs.

From the Wall Street Journal:
The New York attorney general's office, pursuing an investigation into whether Wall Street firms improperly packaged and sold mortgage securities, is latching onto a powerful regulatory tool: the 1921 Martin Act.

The state law, considered one of the most potent legal tools in the nation, spells out a broad definition of securities fraud without requiring that prosecutors prove intent to defraud. As a result, the act has become an influential hammer in recent years for New York state prosecutors in cracking down on securities manipulation, improper allocation of initial public offerings of stock and misleading stock research on Wall Street....

The development comes as the attorney general's office has gained the cooperation of Clayton Holdings Inc., a company that provides due diligence on pools of mortgages for Wall Street firms. At issue is whether the Wall Street firms failed to disclose adequately the warnings they received from Clayton and other due-diligence providers about "exceptions," or mortgages that didn't meet minimum lending standards.

Such disclosures could have prompted credit-ratings firms to judge certain mortgage-backed securities as riskier investments, making them more difficult to sell, these people said. The attorney general is examining, among other things, whether some Wall Street firms concealed information about the exceptions from the credit-rating concerns, these people said, in a bid to bolster ratings of mortgage securities and make them more attractive to buyers, such as pension funds, which often required AAA, or investment grade, ratings on potential investments in securities containing risky mortgages.

The attorney general's office has issued Martin Act subpoenas, which don't spell out whether matters are civil or criminal in nature, according to people familiar with the matter. So far, the recipients include financial firms Bear Stearns Cos., Deutsche Bank AG, Morgan Stanley, Merrill Lynch & Co., and Lehman Brothers Holdings Inc., possibly among others. Representatives of Bear, Deutsche, Morgan, and Lehman declined to comment on the investigation. A Merrill spokesman said, "We cooperate with regulators when they ask us to," but declined to elaborate....

With data provided by Clayton, Mr. Cuomo's office is seeking to gather more information on how Wall Street firms purchased home loans that had been singled out as "exception loans" -- that is, loans that didn't meet the originator's lending standards. Data from Clayton, for instance, indicates that in 2005 and 2006, years in which the mortgage-securitization business was going full throttle, some investment banks acting as underwriters were purchasing large numbers of loans that had been flagged as having exceptions, these people said.

In 2006, according to the data, as much as 30% of the pool of exception loans was purchased by some securities firms, these people said. One likely reason: Flawed loans could be purchased more cheaply than standard loans could be, lowering a firm's costs as it sought to compile enough mortgages for a new security.

Thain says bond insurers bail-out unlikely

(FT) John Thain, Merrill Lynch’s new chief executive, said he expected individual credit insurers would receive capital infusions from investors, but that it would be difficult to craft an “industry-wide” bail-out for the beleaguered guarantors.

Mr Thain said an effort by New York state regulators to help leading bond insurers maintain their credit ratings was raising interest in the sector on the part of investors including private equity groups and specialists in distressed companies.

However, he said in an interview with the Financial Times on Wednesday that getting banks to agree on a single approach was unlikely because they have different exposures to the credit insurers and varying opinions on what should be done.

“I think that’s very hard to get a transaction put together across the whole industry. I think it’s more likely you’ll have a company by company solution,” Mr Thain said.

Uncertainty about whether leading bond insurers will be able to retain their triple-A credit ratings hit the stock market on Wednesday, with shares of Ambac and MBIA, the two largest insurers, falling 16 per cent and 13 per cent, respectively.

Highlighting the pressure on bond insurers, Fitch, a credit rating agency that has already cut Ambac’s triple-A rating, on Wednesday slashed the triple-A rating of FGIC, another bond insurer.

Eric Dinallo, New York state insurance superintendent, last week held a meeting with leading banks to urge them to provide up to $15bn for credit insurers.

Discussions have since focused on two possible sources of support – direct investments and back-up credit lines provided by banks.

Moody’s Investors Service and Standard & Poor’s, the biggest credit rating agencies, have so far maintained their triple-A credit ratings for Ambac and MBIA, although they have warned that these could be cut.

Such a move could force banks to take significant writedowns on securities and hedges that rely on the insurers’ triple-A credit ratings. Merrill already has taken writedowns on its exposure to bond insurers, including those still rated triple-A.

The New York regulators are in daily contact with the rating agencies to reassure them that talks about potential capital infusions are continuing.

Ambac and MBIA: "It's hard to fill a bucket with a hole at the bottom"

William Ackman, the activist shorter of the monolines, has stepped up his one-man campaign to bring the beleaguered insurers down.

He claims he has obtained the most detailed yet data on Ambac and MBIA’s exposure to CDOs, and has bunged it all onto an “open source” website for others to add to.

In an accompanying letter, which you can view here, sent to Eric Dinallo, the SEC and cc-ed (as you do) to Ben Bernanke and the US Senate, Ackman said the data - obtained from an anonymous bank - would mark “a departure from relying on the opaque, faith-based pronouncements that the bond insurance industry has promulgated to the marketplace.”

The hedge fund manager, who took short positions on the monolines back in 2002, says people should feel free to use the data to make their own loss estimates. His own sums leave MBIA and Ambac facing around $11.6 billion of losses apiece on their RMBS and ABS CDO net exposures.

MBIA posts $2.3 billion Q4 loss

(Naked Capitalism) Why MBIA issued its earnings press release at such a weird hour is beyond me. The related news stories are time stamped 0:56 AM at Bloomberg and 1:08 AM at the Wall Street Journal. Saving bad news till the middle of the night is not going to alleviate the reaction.

Or perhaps MBIA has an astrologer? President Reagan was inaugurated at a very odd hour based on a seer's advice, and it seemed to work well for him. With news like this, MBIA needs all the help it can muster.

The bond insurer announced $2.3 billion of losses for the fourth quarter which included $3.4 billion of writedowns ($3.5 billion according to the Wall Street Journal). Premiums also fell, indicating new business is falling off, not surprising given the doubts about the AAA rating. The press release also stated that Warburg Pincus nevertheless closed on its $500 million investment in the firm. I anticipate that this will become a textbook example of a bad deal.

The press release also said that the company's capital raising efforts would offset the losses the firm expected to take. If true, that would be a testament as to how lax the accounting rules in the insurance industry are. In his letter to regulators yesterday, Pershing Square's Bill Ackman said:
The critical importance for the capital markets of ascertaining the amount of these losses is self evident. Perhaps most importantly for policyholders, the accuracy of management’s judgment in estimating losses is critical because it determines how much capital can be extracted from an insurance subsidiary for the benefit of holding company debt and equity holders. It is also essential for determining GAAP book value and earnings for analysts and investors. By using their own estimates for losses, rather than a market-based measure as required by FAS 133 and FAS 157, without appropriate regulatory intervention, the bond insurers effectively can determine the amount of their statutory capital and policyholder surplus for the purpose of calculating amounts available for holding company dividends....

Because a bond insurer’s calculation of statutory capital is effectively a self-graded exam, one would expect management to estimate losses at a level which allows the insurance subsidiary to pay holding company dividends. Rarely is a man willing to sign his own death warrant.

Further details from the Wall Street Journal:
MBIA's fourth quarter derivatives write-down is more than 10 times as large as the $352.4 million write-down it reported in the third quarter, an indication of the rapidly worsening U.S. housing market and its effect on securities backed by loans made to credit-challenged customers.

Of the $3.5 billion charge, MBIA estimated it would realize $200 million of credit impairment or actual claims payments on the portfolio. In addition to the credit impairment on its derivatives portfolio, MBIA also set aside $713.5 million of pretax loss and loss-adjustment expense due to an expected loss of $613.5 million on its guarantees, and a special addition of $100 million to the unallocated loss reserve for MBIA's prime, second-lien mortgage exposure.

Second lien, or home-equity loans, have shown rising losses as home values plunge in some parts of the country.

MBIA, the nation's largest bond insurer, reported a fourth quarter after-tax operating loss of $407.8 million or an operating loss per share of $3.30. Operating earnings or losses don't take into account unrealized mark-to-market losses or investment gains or losses.

The mean per-share loss estimate of analysts polled by Thomson Financial was $2.97 on revenue of $778 million...

MBIA's adjusted direct premiums fell 38% to $262.4 million, on a 98% drop in global public finance and big drops in structured finance worldwide.

MBIA also wrote down the value of its carrying interest in reinsurance unit ChannelRe from $85.7 million to zero....

MBIA's shares were at $13.50, down 3.3%, in after-hours trading.

StanChart consolidates its SIV

(FT Alphaville) Having spent a good portion of the autumn insisting that it would not be consolidating its SIV, Whistlejacket, onto its clean and neatly structured balance sheet, Standard Chartered on Thursday went the whole hog.

A full $7.15bn of unwanted assets is now headed the bank’s way. Whistlejacket can’t roll its commercial paper and medium-term notes, so Standard Chartered - despite previously assuring everyone that it had no obligation to do so - will now have to provide the requisite liquidity.

It could be worse. Whistlejacket’s assets stood at a bloated $18.2bn back in August. The unwinding of assets since then has more than halved the load, although StanChart has already had to take two “vertical slices” of the Whistlejacket portfolio to help that process along.

While other banks with troubled SIVs quickly accepted their responsibility, as sponsors and investment managers, to bail them out, StanChart has seemed strangely loath to do so. This is despite repeated claims that Whistlejacket only contains the best quality paper and clear evidence that StanChart’s balance sheet remains enviously strong.

There was further reticence on Thursday:

There are various pre-conditions to Standard Chartered’s funding. These include a requirement that enforcement proceedings have not commenced and that certain key enforcement triggers, including the capital note Net Asset Value trigger of 50%, have been amended or removed. Standard Chartered will shortly be seeking the necessary consents from all relevant parties, including the senior debt investors, capital note holders and rating agencies. If these consents are forthcoming, Standard Chartered will provide the necessary funding.
For what it’s worth, FT Alphaville reckons Whistlejacket’s immediate problem was in medium term notes, a barrel full of which were due to mature this month. And the problem is sure to extend well beyond StanChart, as the chart at the bottom of this post shows.

A book-keeping error (Economist)

The accounting principle that is meant to capture fair value might end up distorting it
AS THE old joke goes, there are three types of accountant: those who can count and those who cannot. What and how they count is often contentious. A long-fermenting issue is how far “fair-value” accounting, which uses up-to-the-minute market information to price assets, should be pushed in banking. The bodies that set accountancy standards believe the more accurate disclosures are, the better. Regulators meanwhile have fretted that market-based accounting would increase fluctuations in banks' earnings and capital, which might increase risks to financial stability. And commercial banks are reluctant to expose the idiosyncrasies of their loan books to the glare of market scrutiny.

The attractions of fair-value accounts are straightforward. By basing values on recent prices (“marking to market”), they paint a truer picture of a firm's financial health than historical-cost measures. These gauge net worth from the arbitrary dates when assets and liabilities were first booked. In principle, fair-value accounting makes a firm's viability plainer and enables shareholders and regulators to spot financial trouble more quickly. Proponents say that market-based accounting would have limited the fallout from America's savings-and-loan crisis and stopped the rot from Japan's non-performing loans much earlier.

An arbitrary past versus a distorted present
New research suggests that the increasing reach of fair-value accounting might be a mixed blessing. A paper* by Guillaume Plantin of the London Business School, Haresh Sapra of the University of Chicago and Hyun Song Shin of Princeton University concludes that fair-value accounting could sometimes generate fluctuations in asset values that distort the very price information that it puts such store by.

The paper examines the incentives of a bank faced with a choice between selling a loan or keeping it on the balance sheet. Because the bank knows its borrower better than anyone else, it has the best idea of what the loan is really worth. Its managers are rewarded according to the accounting profit of the bank.

If loans are valued at historical cost and market values are rising, the loans are likely to be sold if this is the only way of realising profit, even if the market undervalues them. The banks' managers take a profit and get paid accordingly, although shareholders would be better off if the loans were kept. Fair-value accounting gets around this agency problem. Loans do not have to be sold to cash in on their rising value: marking the assets to their market value has the same beneficial effect on profits and on managers' pay.

However, in the wrong circumstances fair-value accounting could also induce wasteful salesof long-term, illiquid loans. Left on the books and marked to market, a loan will be valued at the price at which others have managed to sell. But when there are only a few potential buyers, that may be especially low. So managers will be tempted to sell in the hope of a better price. Because all banks with similar assets face the same incentives, they will all sell, driving the price down. Their shareholders would have been better off had the loans been kept until they fell due. The temptation to sell is greater for longer-term loans.

In this way, a fair-value regime can itself distort the very prices that are supposed to reflect the true worth of assets. The prospect of lower prices can encourage selling which drives down prices further. The information derived from market prices becomes corrupted, and the result is a growing divergence between reported net worth and true value.

This theoretical model is a challenge to the ideal of fair-value accounting: that more information is always better. Although it is technically feasible to mark to market even idiosyncratic assets such as loans to small businesses, it might not be desirable. The authors point to a well-established principle in economics, that incremental moves towards perfect competition are not always good. Eliminating one market imperfection (such as poor information) need not bring the ideal of a frictionless economy closer, because this may magnify the effect of remaining distortions (such as managerial short-termism or illiquid markets).

The paper also underlines some lessons about market liquidity that have been painfully learned outside of academia in the recent market troubles. There is a fair chance that asset markets will stay liquid (in the sense that willing sellers are matched with willing buyers), as long as the actions of market participants are essentially random. But anything that co-ordinates the actions of sellersin this case, the disclosure required by fair-value accountingcan easily lead to sharp movements in asset prices.

Is the model of self-defeating co-ordinated selling very realistic? Recently, for example, Bear Stearns, a Wall Street investment bank, held off from selling assets into an illiquid market because the transaction prices would have set a nasty benchmark for its other portfolios. So illiquidity prevented asset sales rather than induced them. Mr Shin replies that in instances like this, where there happens to be a dominant holder of assets, there is less chance of sales into a falling market.

Although more accurate disclosure of balance sheets is desirable, the work of Mr Shin and his colleagues is a reminder that there are always trade-offs to any policy change. These authors put their argument in stark terms: “The choice between these measurement regimes boils down to a dilemma between ignoring price signals, or relying on their degraded versions.” In their advocacy of fair-value accounting, accountants are rightly pursuing the interests of investors. But policymakers have to worry about wider issues. Accountancy may be too important to be left solely to accountants. Even the ones that can count.

* “Marking-to-Market: Panacea or Pandora’s Box?” Forthcoming in the Journal of Accounting Research.

Wednesday, January 30, 2008

Moody's: Rapid amortization on HELOCs a concern

(Housing Wire) Moody’s Investors Service said Wednesday that while Countrywide Financial Corp.’s recent fourth quarter earnings report was “within expectations,” a new loss component disclosed by the nation’s largest lender may portend problems for other large securitizers of HELOCs.

The area of concern: so-called rapid amortization.

Buried in Countrywide’s $831 million fourth quarter write-down of residual interests, Moody’s said, was a $704 million charge related to “rapid amortization” on home equity line securitizations.

Moody’s characterized this loss component as new, and one that may impact other mortgage operations with large HELOC securitization exposure. From a press statement (registration req’d), a discussion of the issue that is very much worth reading [breaks added to improve readability]:

For home equity line securitizations, Countrywide, as the servicer, makes advances to borrowers when they request a draw on their line of credit. In normal circumstances Countrywide’s reimbursement for these advances would have a higher priority to securitization cashflows than payments made to securitization trust note holders.

However, in those situations where losses on the loans in the securitization result in claims on the insurance policies supporting the securitization above a certain threshold or duration, the priority of payment shifts. In this situation Countrywide is reimbursed after the trust note holders, insurance providers and other parties to the securitization receive the cashflows to which they are entitled. This is referred to as rapid amortization.

The charge of $704 million represents a liability for losses on estimated advances Countrywide could be required to make on securitizations that have entered or are expected to enter rapid amortization status.

It is important to note that this exposure is not reflected in the traditional balance sheet “residual” amount recorded with a securitization transaction. Prior to rapid amortization occurring, or being highly probable of occurring, this exposure is a contingent liability and not reflected on balance sheet.

Moody’s vice president Craig Emrick said the issue represented an industry first.

“This issue has not been discussed by other large securitizers of home equity lines but it could have broader impact than just Countrywide,” he said.

BoA actually securitizing an Alt-A deal

(Housing Wire) Given the illiquidity in the capital markets right now, the fact that any sort of securitization at all — particularly in subprime or Alt-A — is taking place ought to be news.

Which is why Moodys’ rating of an $834 million BofA Alt-A deal on Wednesday is worth noting. The deal, Banc of America Mortgage 2008-A Trust, is described by Moody’s as being “backed by Bank of America, N.A. originated adjustable-rate, residential first lien Jumbo mortgage loans.”

A look at the prospectus tells much, much more than that. It turns out that this is a deal backed predominately by SISA (stated-income, stated-assets), interest-only jumbo ARMs, the vast majority of which were originated in California during the back half of last year to borrowers with outstanding FICO scores. All loans were originated by Bank of America directly.

Certainly changes the flavor this deal, doesn’t it?

Moody’s, for the record, said in a press statement that it expects collateral losses on this deal to range from 0.40 to 0.50 percent.

Let’s dig a little further: we’re looking at 1,191 mortgage loans totalling $885.6 million in aggregate as of the cut-off date. Of those loans, more than 75 percent are considered “non-standard,” meaning full documentation was either reduced or completely eliminated; nearly 60 percent of loans are stated-income.

More than 70 percent of the loans were originated in California. Nearly 40 percent of the loans have principal balances over $800,000; and roughly 65 percent will see a reset in 2012 (meaning borrowers took out a 5-year interest-only ARM, many ostensibly without documenting their income).

I bring all of this up because Moody’s — like any rating agency — bases its ratings in large part on the credit quality of the loans. And on the surface, these are mortgages given to borrowers with not just good credit; these are borrowers with dynamite credit, since more than half of all borrowers have FICO scores over 750.

That being said, I’m not sold that credit quality is really as high as it might appear here.

S&P Takes Action On 6,389 U.S. Subprime RMBS Ratings And 1,953 CDO Ratings

(Standard & Poor's) Jan. 30, 2008--Standard & Poor's Ratings Services
today announced that it has placed on CreditWatch with negative implications
or downgraded its ratings on 6,389 classes from U.S. residential
mortgage-backed securities (RMBS) transactions backed by U.S. first-lien
subprime mortgage collateral rated between January 2006 and June 2007. At the
same time, it placed on CreditWatch negative 1,953 ratings from 572 global CDO
of asset-backed securities (ABS) and CDO of CDO transactions.

The affected U.S. RMBS classes represent an issuance amount of approximately
$270.1 billion, or approximately 46.6% of the par amount of U.S. RMBS backed
by first-lien subprime mortgage loans rated by Standard & Poor's during 2006
and the first half of 2007. The CDO of ABS and CDO of CDO classes with ratings
placed on CreditWatch negative represent an issuance amount of approximately
$263.9 billion, which is about 35.2% of Standard & Poor's rated CDO of ABS and
CDO of CDO issuance worldwide.

Standard & Poor's has completed its global review of all its rated
asset-backed commercial paper (ABCP) conduits with exposure to these U.S. RMBS
and CDO classes and confirms that none of its ratings on any outstanding ABCP
notes will be adversely affected solely as a result of today's rating actions.

Standard & Poor's has also completed its review of all Standard & Poor's rated
structured investment vehicle (SIV) and SIV-lite structures with regard to
exposure to these U.S. RMBS classes. This review shows that there are nine
SIVs with exposure to 133 of the affected tranches. The vast majority of the
exposure is to tranches with ratings placed on CreditWatch. These exposures
are primarily in SIVs that have restructured, defaulted already, or are
receiving liquidity support, and therefore the SIVs are not adversely affected
by these rating actions. Of the five SIV-lites originally rated, only one is
currently still operating and has been restructured. This review of this
SIV-lite shows that there is exposure to two of the affected U.S. RMBS
classes, and the ratings are not adversely affected by these rating actions.

Complete lists of the classes affected by today's RMBS and CDO rating actions
and CreditWatch placements are available on RatingsDirect, the real-time
Web-based source for Standard & Poor's credit ratings, research, and risk
analysis, at, and also at, Standard &
Poor's special Web site for subprime and related mortgage matters. The list of
RMBS downgrades and CreditWatch placements, along with two related transition
matrices, is included in "U.S. RMBS Ratings Affected By Jan. 30, 2008, Rating
while the list of CDO classes with ratings placed on CreditWatch
negative can be found in "CDO Classes Affected By Jan. 30, 2008, Rating

A teleconference to discuss today's ratings actions will be held on Thursday,
Jan. 31, 2008, at 11:00 a.m. EST. Dial-in information can be found at the end
of this release.


We lowered our ratings on 2,607 classes from the 2006 vintage RMBS backed by
first-lien subprime mortgage collateral. The balance of these downgraded
classes was approximately $34.7 billion as of the December 2007 distribution
date. These rating actions bring the total number of classes issued during
this period and downgraded to date to 2,651. In total, the downgraded classes
represent an original par amount of approximately $35.2 billion, which is 8.2%
of the $422.0 billion original par amount issued during 2006. Approximately
$17.6 billion of the total amount downgraded represents repeat rating actions.

We placed on CreditWatch negative 2,035 classes issued during 2006. These
classes had an original principal balance of $182.0 billion and had paid down
to $136.0 billion as of the December 2007 distribution date. In total, these
actions represent approximately 42.4% of the total amount of subprime
transactions rated by Standard & Poor's during 2006 ($428 billion; total
slightly adjusted to reflect reclassification of mortgage pools). In addition,
44 classes remain on CreditWatch negative, 29 of which were placed there due
to transaction performance and 15 in connection with the placement on
CreditWatch negative of Ambac Assurance Corp.'s 'AAA' financial strength
rating. We affirmed our ratings on the outstanding remaining 1,735 classes
issued during 2006.

The RMBS rating downgrades for the 2007 vintage include 1,180 classes backed
by first-lien subprime mortgage collateral. The balance of the downgraded
classes was approximately $15.4 billion as of the December 2007 distribution
date. These rating actions resolve the CreditWatch negative placements of 19
of the subprime classes placed there on Oct. 17, 2007. Of the remaining 13
subprime classes placed on CreditWatch negative, five are due to transaction
performance and eight are due to the placement on CreditWatch negative of
Ambac. These rating actions bring the total number of classes issued during
this period and downgraded to date to 1,188. In total, the downgraded classes
represent an original par amount of approximately $15.9 billion, which is
10.6% of the $150.4 billion original par amount issued during 2007 (the
original par amount was adjusted to reflect the reclassification of the
mortgage pools). Approximately $14.7 billion of the total amount downgraded
represents repeat rating actions.

We placed on CreditWatch negative 567 classes issued during 2007. These
classes had an original principal balance of $37.8 billion and had paid down
to $34.8 billion as of the December 2007 distribution date. In total, these
actions represent approximately 25% of the total amount of subprime
transactions rated by Standard & Poor's during the period of issuance ($150.4
billion). We affirmed the ratings on the outstanding remaining 691 classes
issued during 2007.

These rating actions follow Standard & Poor's announcement on Jan. 15, 2008,
of further revised assumptions for surveilling RMBS transactions backed by
U.S. residential mortgage collateral and planned revisions to assumptions used
for CDOs of ABS. The Jan. 15, 2008, media release can also be found at

Today's rating actions incorporate our most recent economic assumptions and
reflect our expectation of further defaults and losses on the underlying
mortgage loans and the consequent reduction of credit support from current and
projected losses. Later in this media release we discuss in more detail the
changes to our surveillance assumptions for all of RMBS securities. This
includes the application of lifetime expected losses, our revised expected
losses for 2006, our expected losses for 2007, and our view of the potential
effect of loan modifications.


Today's CDO CreditWatch negative placements result from several factors,
including the effect of today's rating actions on first-lien subprime RMBS
classes. These subprime RMBS classes represent a large proportion of the
collateral assets held by mezzanine and high-grade CDOs. Mezzanine CDOs are
CDOs of ABS typically collateralized at origination primarily by 'A' through
'BB' rated tranches of RMBS and other structured finance assets, while
high-grade CDOs are CDOs of ABS typically collateralized at origination
primarily by 'AAA' through 'A' rated tranches of RMBS and other structured
finance transactions. Generally speaking, the credit performance of the
underlying assets is the most important determinant of CDO rating performance,
and today's RMBS rating actions will significantly affect the ratings assigned
to a large number of 2006 and 2007 vintage mezzanine and high-grade CDOs.
Mezzanine and high-grade CDOs have, on average, approximately 67% and 40%
collateral exposure to subprime RMBS, respectively.

The CDO CreditWatch placements also result from our estimate of the effect of
the changes Standard & Poor's is making to the recovery rate and correlation
assumptions we use to assess U.S. RMBS held within CDO collateral pools. These
assumptions are used for both the rating of new CDO transactions and the
monitoring of existing CDO transactions. We have placed on CreditWatch
negative the ratings of CDO tranches for which we expect to see a negative
rating impact from the lower recovery rate assumptions and higher correlation
assumptions. Standard & Poor's announced on Jan. 15, 2008 that these
assumptions were in the process of being revised (see "U.S. RMBS Surveillance,
CDO Of ABS Assumptions Revised Amid Defaults, Negative Housing Outlook,"

published on RatingsDirect). We expect to publish certain revised correlation
and recovery rate numbers within the next several days.

Included in today's CreditWatch negative placements are ratings from 213
non-excess-spread synthetic CDO transactions. We will resolve these placements
after the updated correlation and recovery assumptions have been released and
incorporated into CDS Accelerator. CDS Accelerator is the analytical tool
through which the non-excess-spread synthetic CDO transactions are run each
month to generate synthetic rated overcollateralization (SROC) numbers, which
serve as the foundation of the surveillance process for these transactions. We
expect to be in a position to incorporate CDS Accelerator with the new CDO
recovery rate and correlation assumptions within the next several weeks.

For the 359 cash flow and hybrid CDO transactions with ratings placed on
CreditWatch negative today, the timing of the resolution will depend in part
on the nature of the underlying collateral pool. Standard & Poor's expects to
resolve the CreditWatch placements on the affected cash flow and hybrid
mezzanine CDO of ABS transactions within the next six weeks. The resolution of
the CreditWatch placements on most high-grade CDOs will occur after the
reviews for the mezzanine CDOs and after the resolution of today's CreditWatch
placements on 'AAA' and 'AA' rated tranches from the 2007 vintage first-lien
subprime RMBS transactions. Because most high-grade CDOs are collateralized in
part by highly rated classes from subprime RMBS transactions, the resolution
of today's RMBS CreditWatch negative placements should provide input into the
analysis for these CDO transactions.

Additionally, the reviews of high-grade CDOs will follow the reviews for
mezzanine CDOs because high-grade CDOs originated during 2006 and 2007 have an
average of 10% to 12% collateral exposure to senior tranches issued by
mezzanine CDOs. To the extent that mezzanine CDO tranches held within a given
high-grade SF CDO's portfolio are impacted by today's RMBS downgrades, this
may affect the outcome of the high-grade CDO review. The CreditWatch
placements on the CDO of CDO transaction ratings should follow the reviews of
the ratings on the underlying CDO transactions.

Including today's CDO CreditWatch placements, globally Standard & Poor's has
lowered the ratings on a total of 1,383 tranches from 420 CDOs, and has placed
on CreditWatch negative the ratings on 2,880 tranches from 719 CDOs, as a
result of RMBS credit deterioration and stress in the U.S. residential
mortgage market, affecting a total of $357.6 billion in CDO issuance.
Information on Standard & Poor's rating actions as a result of RMBS credit
deterioration and stress in the residential mortgage market is updated weekly
and is available on RatingsDirect and at


Mortgage Pool Performance—2006

Monthly performance data reveal that delinquencies and foreclosures continue
to accumulate at an increasing rate for the 2006 vintage. Since July 2007,
cumulative losses on all U.S. subprime RMBS transactions issued during 2006
are 1.13%, an increase of 156%. At the same time, total and severe
delinquencies have increased by 49% and 66%, respectively. As of the December
2007 distribution date the total delinquency rate had increased to 28.79% and
severe delinquencies were 18.83%.

This delinquency trend, together with loan level risk characteristics and
continuing deterioration in the macroeconomic outlook, has caused us to
increase our lifetime loss projection to 19% from the 14% we projected at
mid-year 2007 based on performance up to that date. At that time, the range
for expected losses was 12%–16%, but this range has now increased to 18%–20%.

Mortgage Pool Performance—2007

The transactions issued during the first half of 2007 have what we consider to
be an established trend of poor delinquency performance and have already
realized losses. Many of these transactions closed with approximately 1%–3% of
loans already seasoned by several months. Since July 2007, cumulative losses
on the subprime RMBS transactions issued during the first half of 2007 have
increased to 0.25% from approximately 0.01%. At the same time, total
delinquencies have grown to 20.40% from 7.43% and severe delinquencies have
grown to 11.51% from 2.48%. As of the December 2007 distribution date, the
total delinquency rate had increased to 20.4% and severe delinquencies were
11.51%. We are projecting lifetime losses for these transactions to be around
17%, with a range of approximately 16%–18%.

Our loss projections on the 2007 vintage are based on an analysis of the loan
characteristics and relative vulnerability to property value declines. Credit
scores, loan-to-value (LTV) ratios, and combined loan-to-value (CLTV) ratios
are comparable to mortgages sold in 2006. The pools from the first half of
2007 have a higher percentage of fixed-rate loans, a lower percentage of 2/1
adjustable-rate mortgages (ARMs), a lower percentage of low-doc or no-doc
loans, and a lower percentage of loans used for purchase. Data analysis shows
that these differences yield an overall lower risk profile for the H1 2007

Moreover, an analysis of the S&P/Case-Shiller National House Price Index shows
that price declines from 2006 are larger than the declines experienced since
the first half of 2007, on average, by approximately 2%. By comparing the
index change from 2006 to the October 2007 reported index, we note that prices
have declined about 6% on average. Similarly, comparing the index change from
the first half of 2007 to the October reported index, prices have declined
about 4% on average. Thus, loans from the 2006 vintage are secured by
properties that have suffered greater declines on average than the properties
backing the 2007 vintage. As a result, we believe the projected losses will be
slightly lower than those for 2006.


In reviewing the 2006 and 2007 subprime transactions, we employed the
surveillance assumptions announced on Jan. 15, 2008, and described in "U.S.
RMBS Surveillance, CDO Of ABS Assumptions Revised Amid Defaults, Negative
Housing Outlook." We believe that the application of expected lifetime losses
has become appropriate as the depth and duration of the housing downturn
continues to increase. In most cases our loss expectations exceed the credit
enhancement available for the average 'A' rated class and below. As a result,
those classes that had expected lifetime losses greater than credit
enhancement had their ratings lowered to 'CCC'.

In addition, the ratings on many of the 2006 notes previously rated 'B' and
'CCC' and various ratings from pools with extraordinarily high levels of
severely delinquent loans were lowered to 'CC' as our analysis revealed that
these classes have a greater likelihood of default in the nearer term. Our
view as to the ability of a class to withstand losses in excess of our
projections determined the extent to which a rating was adjusted. In
anticipation of increased loan modifications, we discounted the excess spread
available to cover credit losses. These assumptions are consistent with
scenarios recently published in "Reviewing The Impact Of Rate Freezes On Rated
U.S. First-Lien Subprime RMBS Under Two Scenarios,"
on Dec. 21, 2007.


'AAA' And 'AA' Rating Levels

By number of ratings, we placed on CreditWatch negative approximately 45% of
the outstanding 'AAA' and 57% of the 'AA' rating categories from the 2006
vintage. At the same time, we placed on CreditWatch negative approximately 20%
of the outstanding 'AAA' and 93% of the 'AA' rating categories from the first
half of 2007.

While each of the certificate classes placed on CreditWatch negative currently
lack what we believe to be a sufficient amount of credit enhancement in excess
of projected losses, subsequent rating actions will not occur until additional
analysis is completed on each of the individual classes affected. We expect to
further evaluate the adequacy of credit enhancement given the recent cuts to
the federal fund rates and their effect on excess spread, the date of
projected defaults versus the date of payment in full, and the relationships
between projected credit support and projected losses throughout the remaining
life of the certificates.

Tables 1 and 2 show the classes with ratings lowered and placed on CreditWatch
negative as a percentage of the original balance of the total amount affected
($215 billion for 2006 and $53 billion for 2007).

Table 1
2006 Vintage
Total $ actions (%)
Rating Downgrades CreditWatch negative
AAA 0.00 69.08
AA+ 0.00 5.27
AA 0.00 6.79
AA- 0.00 2.59
A+ 2.41 0.05
A 1.90 0.03
A- 1.36 0.02
BBB+ 2.34 0.03
BBB 0.78 0.03
BBB- 0.66 0.02
BB+ 0.51 0.02
BB 1.94 0.01
BB- 0.03 0.00
B+ 0.10 0.00
B 2.25 0.00
B- 0.01 0.00
CCC 1.79 0.00
Total 16.08 93.92

Table 2
2007 Vintage
Total $ actions (%)
Rating Downgrades CreditWatch negative
AAA 0.00 45.94
AA+ 0.00 12.94
AA 0.00 8.74
AA- 0.00 3.33
A+ 2.10 0.00
A 3.14 0.00
A- 2.77 0.00
BBB+ 3.43 0.00
BBB 3.39 0.00
BBB- 3.54 0.00
BB+ 3.76 0.00
BB 2.94 0.00
BB- 2.15 0.00
B+ 1.09 0.00
B 0.27 0.00
B- 0.48 0.00
CCC 0.00 0.00
Total 29.04 70.96


On a macroeconomic level, we expect that the U.S. housing market, especially
the subprime sector, will continue to decline before it improves, and we
expect housing prices will continue to come under stress. Recent industry
reports reveal that housing prices have declined by approximately 6% since the
start of 2006 and approximately 4% since the start of 2007. Weakness in the
property markets continues to exacerbate losses, with little prospect for
improvement in the near term. As of November 2007, the number of properties in
foreclosure in the U.S. reached 1,329,703.

Furthermore, we expect losses to continue increasing, with borrowers
experiencing rising loan payments as the terms of adjustable-rate loans
originated in early 2006 reset and principal amortization occurs after the
interest-only period ends for both adjustable- and fixed-rate loans. An
estimated $342 billion of mortgages is expected to reset during 2008. However,
we expect many of the affected borrowers will find relief through loan
modifications that will hold initial interest rates constant for several

We expect available credit enhancement to decrease as a result of the loan
modifications. Although property values have decreased approximately 6% to
date, we expect additional declines. David Wyss, Standard & Poor's chief
economist, has adjusted his projection, forecasting that by the end of 2008
property values will have declined by as much as 13% on average since 2006,
and the market will bottom out early in 2009.

While this is an aggregate view, it is important to note that certain markets
have already suffered declines greater than this forecast. According to the
S&P/Case-Shiller Tiered Price Indices, cities such as San Diego and San
Francisco have experienced price declines of 12.0% and 6.5%, respectively, and
lower-priced homes in those areas have experienced declines of 18.5% and
17.5%, respectively. These lower-priced homes, which carry an average loan
balance of around $213,000, generally secure subprime mortgages. Similarly,
for Tampa, the aggregate decline since 2006 averages approximately 12%, and
this is consistent across price tiers. In many cases, the actual losses
experienced to date reflect larger declines in value than those forecasted. It
is possible, therefore, that further price declines may not have as great an
effect on losses as one might expect.

Except for the CreditWatch resolutions, we do not anticipate further major
rating actions for the U.S. RMBS subprime ratings issued during 2006 and the
first half of 2007. We anticipate reviewing other vintages and products in the
RMBS sector over the next few weeks, including prior vintages of subprime
mortgages, RMBS backed by Alt-A mortgages, and securities backed by prime
collateral. We expect that this review will be concluded and the results
announced over the next two months.