by Tanta on 10/30/2007 10:20:00 AM

Bank of America has kindly given us permission to quote from its Weekly RMBS Trading Desk Strategy Report of October 26 (not online). The subject of this report is Option ARM performance, and the results are rather grim.

While OAs are still performing better than Alt-A ARMs of the same vintage, the trends are, well, ugly. Bear in mind that the overwhelming majority of Alt-A ARMs in these two vintages have not yet experienced a rate reset (less than 10% of Alt-A ARMs in 2005-2006 had an initial fixed period of less than 3 years). So while the Alt-A ARM borrowers are making a higher payment than the OA borrowers, they are not yet experiencing payment shock.

But while OAs may be performing better than Alt-A ARMs in recent vintages, their current performance compared to past vintages of OA is gruesome. This chart and the following one break out OAs by loan size and loan purpose, and they suggest that neither factor is driving the current delinquency spike in the 2005-2006 OA vintages. It's important to remember, of course, that the pre-2005 pools of OAs are tiny compared to the later ones. According to UBS, gross issuance of securitized OA pools was $18.5 billion in 2004, $128 billion in 2005, and $175 billion in 2006.

It's hard to escape the conclusion that the "mass marketization" of the negative amortization loan product hasn't done much for its performance. BoA also reports that prepayment speeds have slowed dramatically for outstanding OAs, including those with and without prepayment penalties (or with expired prepayment penalties). That suggests that a fair number of these loans will be around long enough to test "historical" assumptions about what happens when their payments finally recast.

by Calculated Risk on 10/29/2007 02:54:00 PM

Fitch Completes Review of All Fitch-Rated SF CDOs; Places $36.8B on Rating Watch Negative

Following a comprehensive global review of the 431 Fitch-rated structured finance collateralized debt obligations (SF CDOs) representing $300.1 billion of outstanding debt, Fitch has placed 150 transactions, representing $36.8 billion, on Rating Watch Negative.
...
Of the $23.9 billion of AAA rated securities on Rating Watch Negative, approximately two-thirds ($16 billion) represent 'AAA' rated tranches of mezzanine subprime deals, and CDO-squareds containing these tranches. The ratings from these deals are expected to suffer the most severe downgrades. While a full analysis remains to be completed, preliminary indications are that a three-to-four rating category average downgrade is to be expected for most of this group, with the revised ratings in the range of 'BBB' to 'BB-'.

The remaining $7.8 billion of 'AAA' rated notes on Rating Watch Negative are from high grade subprime RMBS, prime/Alt-A SF CDOs, and synthetic SF CDOs of all types. The magnitude of downgrade for these deals is expected to be less severe, averaging one-to-two categories with revised ratings ranging from 'AA' to 'A-'.

The ratings subject to Rating Watch Negative from classes currently carrying ratings of other investment-grade categories ('AA', 'A', and 'BBB') are expected to suffer downgrades to below investment grade.

by Calculated Risk on 10/29/2007 10:23:00 AM

From Bloomberg: UBS Says Subprime Contagion May Cause More Writedowns

UBS AG, Europe's largest bank by assets, said the slumping U.S. housing market may lead to further writedowns on debt securities following the company's first quarterly loss in almost five years.

UBS is at risk from ``further deterioration in the U.S. housing and mortgage markets as well as rating downgrades'' on mortgage-related securities, the Zurich-based bank said today in a statement.
...
UBS reduced the value of fixed-income securities and leveraged loans by about $4.1 billion in the period, and will release detailed third- quarter results tomorrow.

I wonder what will happen to the value of these assets next year when there will be record foreclosures and significant declines in U.S. house prices.

by Tanta on 10/29/2007 09:56:00 AM

Lenders continue diligently to seek out new customers eager to trade home equity for entrance into the "upscale subprime" class.

From the LA Times:

Sunwest's president and co-owner, Jason Hayes Evans, didn't respond to requests to discuss his company's mailings. But a salesman at Sunwest, describing it as staffed by capable mortgage veterans who survived the industry shakeout, said everyone at the brokerage took pains to carefully explain to borrowers the risks as well as the benefits of option ARMs.

The salesman, who asked not to be identified because he wasn't authorized to speak for Sunwest, said the company provided option-ARM loans from several companies, including Wachovia, that keep the loans as investments rather than sell them.

Sunwest considered disclosing more about pay-option perils in its two-page mailings, the salesman said. "But that would have taken up too much space. You'd need four pages to cover everything." The firm instead relies on explanations by its employees, he said.

The option ARM that allows payments based on a 1% interest rate is intended only for people who have at least 30% home equity, have lived in the home for three years or more and have solidly prime credit scores of 700 and up, the Sunwest salesman said.

Good candidates for such loans, he added, include salespeople living on commissions that vary month to month or people nearing retirement who have more than 50% equity in their homes and know for sure that they will sell their properties when they downsize in a few years.

Of course, the salesman acknowledged, many borrowers at all income levels are attracted to the option ARM because they have let their personal spending get so out of control that the low payment is the only one they can afford.

"Newport Beach, where everyone is driving a Mercedes and the homes start at $1 million, is like an old western movie set," he said, describing the finances of many wealthy homeowners as precarious. "It's all just a front, with stilts holding it up."

This kind of reminds me of my favorite cheesecake recipe, which calls for two and a half pounds of cream cheese, six large eggs, and a half a pint of heavy cream, among other things. It's intended for people in perfect health and at an ideal body weight whose ancestors lived to be 100 and who only eat raw green veggies. Somehow it gets consumed down to the last crumb anyway.

by Tanta on 10/29/2007 09:24:00 AM

Remember all those witty ursine puns in July when the news was all Bear Stearns all the time? Sure you do.

Since it's likely to be all Merrill all day for the foreseeable future, we're going to have to have a talk with the headline writers at Bloomberg.

"O'Neal Ouster Makes Mess of Maternal Merrill Lynch."

"Maternal Merrill"? Is this the New Formality, or did someone's online translator have a bit of difficulty with "Mother Merrill"?

Let it be . . .

by Calculated Risk on 10/28/2007 03:23:00 PM

From the WSJ: Merrill Chief O'Neal Decides To Leave Firm, Source Says

Merrill Lynch & Co. Chief Executive Stan O'Neal has decided to leave the firm, according to a person familiar with the matter.

An announcement on his departure could come today or Monday morning ...

There is an old saying in the corporate world: "New broom sweeps clean". With a new CEO, I'd expect more write-downs and a reduction in headcount.

by Calculated Risk on 10/28/2007 11:00:00 AM

From Gretchen Morgenson at the NY Times: Guesstimates Won’t Cut It Anymore

THE props holding up the values of risky mortgage securities finally started to give way last week. And that means the $30 billion in losses and write-downs taken by big brokerage firms in the third quarter are not likely to be the last.
...
First to face the music was Merrill Lynch, which stunned investors Wednesday with an $8.4 billion write-down, $7.9 billion of which was for mortgage-related assets. The write-down was $3.4 billion more than it had warned investors about just three weeks before.

Until that moment, investors had been willing to trust companies claiming to have limited exposure to the credit mess.
...
The executives on Merrill’s dismal conference call conceded that even after they decided to value their C.D.O. holdings more conservatively — resulting in losses — much of their methodology was based on “quantitative evaluation.” ...

ANALYSTS quickly responded by forecasting an additional $4 billion in write-downs on Merrill’s portfolio. ...

We’ll definitely see a lot more write-downs,” said Josh Rosner, an expert on asset-backed securities at Graham-Fisher, ... “I think that the exposures that we are seeing and the announcement out of Merrill are the leading edge, not the end.”
emphasis added

No worries. It's all contained discounted.

by Calculated Risk on 10/27/2007 03:44:00 PM

From Fleck at MSN: Tech stocks' pain proves they're vulnerable, too. Here is an excerpt on housing and credit:

... the Lord of the Dark Matter, whose postings on the mortgage-paper unwind will be familiar to my regular readers [says] [t]he problems continue to worsen ... But people keep giving him the same silly line, that it's all been discounted, which is a variation of "it's contained." He says that there are more dark-matter downgrades to come and that some of the insurers of credit may find themselves in serious trouble as credits go bad. He points out that if the insurers get into trouble, then all of the credits they insure obviously will worsen.

For those who don't know, there is an absolute mountain of paper that trades where it does only because it has insurance. Sort of like the paper that traded where it did because it was supposedly AAA, and that rating turned out to be worthless. Any AAA, AA, A or whatever rating that's based on insurance may not be worth the paper it's written on.

Barf went the Merrill bull

It's a lesson that hit Merrill Lynch hard. Witness the subprime fallout behind the company's sobering third-quarter earnings report. Merrill wrote down about $5.8 billion of $14.2 billion in what's known as super-senior subprime assets -- the stuff that's supposedly above AAA and bulletproof.

When asked on the conference call if everything was marked where it could be sold, there was no answer, leaving folks with the idea that there was plenty of stuff still marked to model. And you can be sure that if Merrill Lynch has this problem of potentially mismarked paper, so do all of the brokers and probably some of the big banks. This is a huge deal. (Memo to nonbelievers: The problem is spreading, it has not been discounted and it has not been contained.)

Discounted, the new Contained.

by Tanta on 10/26/2007 06:00:00 PM

The Joint Economic Committee report discussed in the Times yesterday, "The Subprime Lending Crisis: The Economic Impact on Wealth, Property Values and Tax Revenues," is now available online.

There's lots in here to discuss, but I just noticed one little snippet while I was skimming that answers a question I had a while back. In 2006, 29% of all mortgage loans were originated through mortgage brokers, but 63% of all subprime mortgages were originated through brokers (page 17).

Otherwise, enjoy the graphs, charts, and maps.

by Calculated Risk on 10/26/2007 05:23:00 PM

From PMI: David W. Berson Joins PMI as Chief Economist and Strategist (hat tip Lurker).

I wish Dr. Berson well at PMI, but I'm going to miss his publicly available economic analysis at Fannie Mae. Here is his final Fannie Mae piece: Twenty years of economic, housing, and mortgage market analysis.

Friday, October 26, 2007 marks my retirement from Fannie Mae after almost exactly 20 years (I started on Monday, November 2). Much has changed in the economy, housing, and mortgage finance markets over that time -- but there are many similarities as well. In that 1987 period, the stock market had crashed just two weeks before and analysts weren’t sure if the economy would head into a downturn (or worse) as a result (it didn’t). Today, we have the severe housing downturn and a broadening credit crisis. Will this be the precursor of a downturn? Most economists don’t think so, although we are skirting dangerously close to recession (not that the real GDP numbers show it) and economists are notorious for egregiously missing business cycle turning points (both up and down). The high odds of a downturn (even if not over 50 percent) suggest that households, businesses, and governments should start to make contingency plans for such an event. Another interesting similarity between that late-1980s period and today has been the rise of new, aggressive mortgage products. In the earlier period, we saw a rise of low-documentation lending -- starting out with loan-to-value ratios (LTVs) of less than 70 percent, but over time moving to LTVs of over 90 percent. Additionally, the investor share of purchase originations rose sharply. More recently we have had a plethora of low-doc, no-doc, investor, 2/28 subprime, even more investors, and option ARMs -- arguably more aggressive lending than in the late-1980s. Of course, in late 1987 the housing/mortgage market was still ramping-up with these new mortgage products. Today, we are suffering the downside of overexposure to them (making 2007 perhaps more similar to 1990, in that regard). Ultimately, the lending practices of the late 1980s resulted in an extended period of weakness in home sales, house prices, and mortgage market volumes. We may be in year two of a similar five-year downturn today. (Note that not all of these areas fell for five years in the earlier period, nor are they all likely to decline for five years this time -- but some of them may.)
...
And now, in the immortal words of Porky Pig, “that’s all folks!”
emphasis added

Best wishes to David Berson! Thanks for all the great analysis.