Structured financial products linked to homebuilding and real estate continued to suffer more downgrades than upgrades in the third quarter and the outlook remains dim, according to a Standard & Poor’s quarterly report on rated global structured securities.
Both areas could experience additional stress if housing demand is further constrained by a deeper, more protracted recession and/or continued turmoil within the home lending industry. We will continue to closely monitor homebuilder cash positions and revolver availability, as liquidity remains critical to surviving this downturn.
Downgrades on residential mortgage-backed securities (RMBS) rose in the quarter ended Sept. 30 as monthly delinquencies and foreclosures on the underlying collateral increased, especially for transactions issued between 2005 and 2007, S & P said.
Commercial mortgage-backed securities (CMBS) also took a turn for the worse in the quarter, with four times as many rated CMBS sinking to speculative-grade status.
Among the other trends for the third quarter:
–Asset-backed securities (ABS) saw fewer downgrades in the third quarter, with S & P lowering its ratings on 119 ABS classes, down from a record-high 555 downgrades in the second quarter of 2008.
–Collateralized debt obligations (CDOs) were most negatively impacted by the September bankruptcy filing of Lehman Bros. Holdings Inc.
–Downgrades outnumbered upgrades by more than 4.7 to 1 in Europe, with CDOs accounting for the majority of the lowered ratings.
For details, see “Ratings Roundup: Third Quarter 2008 Global Structured Finance Trends.”
Technorati Tags: ABS, asset-backed-securities, CDO, CMBS, commercial mortgage-backed securities, commercial-real-estate, home sales, homebuilders, homebuilding, housing crisis, residential mortgage-backed securities, residential real estate, RMBS, structured-finance
Fitch Ratings says the high degree of support extended by the US government to AIG (NYSE: AIG) has removed the risk of adverse rating action on global structured finance transactions where AIG or one of its subsidiaries is a counterparty.
Fitch affirmed AIG’s Issuer Default rating (IDR) at ‘A’ on 10 November 2008, among other rating affirmations, and removed its ratings from Rating Watch Evolving (RWE). This followed the announcement by the US Treasury and the Federal Reserve of a series of actions to provide a high level of explicit and implicit government support to AIG. Furthermore, Fitch believes the US government has significant incentives to ensure AIG is successful in implementing its restructuring plan.
Fitch expects the assumed ‘government support floor’ for AIG to remain in place until AIG fully executes its restructuring plan, thereby limiting immediate AIG counterparty risk in existing structured finance transactions.
Many of the transactions involved were exposed to AIG counterparty risk in the form of interest rate and FX swaps or other derivative contracts and, to a much lesser extent, in the form of rental guarantees of rental payments in certain CMBS transactions. Each contract has specific remedies to mitigate counterparty risk. In most instances collateral was posted by the relevant AIG entity for the benefit of the transaction following AIG’s downgrade in September 2008.
Had the RWE, prior to its removal, resulted in adverse rating action for the insurer, AIG would have breached Fitch’s current criteria for counterparties that support structured finance transactions with the highest investment-grade ratings, which incorporates a minimum rating expectation of ‘A’/'F1′. In that event, Fitch would have expected AIG to take remedial action in the form of either replacement or guarantee of AIG’s commitment or collateralisation of the position, in order for the structured finance ratings to be maintained at current levels.
Fitch is currently reviewing its counterparty criteria in light of recent market turmoil. For more information see “Counterparty Criteria for Global Structured Finance Under Review”, published on October 15 2008.
Technorati Tags: (AIG), credit-crisis, credit-markets, structured-finance
Rising unemployment is pushing up delinquencies in US subprime mortgages at an “alarming” rate, according to CreditSights.
“The latest numbers from our Subprime RMBS sample show a huge jump in delinquencies 
in the past two months, ” CreditSights says in a new report: Subprime Pool Performance Update: Delinquencies Rocket as Unemployment Rises. “All three of the vintages that we track posted their largest one month increases in October and the largest three month increases since March. As the chart shows, delinquencies as a percentage of the remaining balance in 2005 subprime RMBS had even started to fall despite the remaining balances continuing to shrink.”
“It is possible that delinquent borrowers are making payments to keep their mortgages at the same degree of delinquency while they wait for mortgage investors to jump on board HOPE for Homeowners.”
“However, we believe the rise is driven firstly by delinquency growth returning to trend after a tax-rebate slowdown and secondly by rising unemployment and rate resets creating disposable income shocks for borrowers.”
CreditSights has suggested that the slowdown in delinquencies in the second and third quarters might have been the result of the second quarter tax rebates.
Unfortunately the benefits from the rebates have proved short-lived and the scale of the recent deterioration is alarming.
Technorati Tags: credit-crisis, mortgage-backed-securities, RMBS, structured-finance, subprime
Commercial mortgage-backed securities (CMBS), or bonds backed by a pool of commercial retail properties, are under close scrutiny for possible downgrades as U.S. retailers see their sales nosedive, according to Standard & Poor’s Credit Research.
So far, store closings and bankruptcies such as Circuit City Stores (NYSE:CC) have not resulted in widespread retail CMBS downgrades, S&P said.
The ratings agency has also concluded that CMBS with exposure to mall operator General Growth Properties (NYSE: GGP) are not at immediate risk of a downgrade. General Growth Properties warned Tuesday it would be forced to file for bankruptcy unless it could raise capital or refinance its debt.
To date, retail bankruptcies and store closings have not contributed to widespread downgrades, reflecting in our opinion, diversity and limited exposure to troubled tenants. We believe, however, that continued weakness in this sector will likely cause more retail loans to underperform, which would trigger increased delinquencies and could ultimately translate into more retail-related downgrades.
S&P identified only 14 CMBS transactions with a greater than 2 percent exposure to troubled retail tenants. CMBS with exposure to bankrupt retailers are more of a concern than those with exposure to retailers that are simply closing stores.
For details, see “The Potential Impact of the Troubled Retail Sector on Rated U.S. CMBS.”
Technorati Tags: (CC), (GGP), bankruptcy, Circuit-City, CMBS, commercial mortgage-backed securities, credit-crisis, General Growth Properties, mortgage-backed-securities, retail, retail delinquencies, retailers, shopping malls, store closings, structured-finance
US borrowers appear to be hoarding cash and using home equity lines of credit (HELOCs) to pay bills rather than dip into their savings, according to CreditSights.
HELOCs have been drawn down at an unprecedented rate in late September with total lending by banks rising by almost $40 billion in one week. Although it is difficult to know exactly what the money is being used for, the draw downs coincide with a rise in non-transaction bank deposits - mostly non-corporate savings accounts - and a slowdown in credit card borrowing, CreditSights says.
We believe that some of that increase in savings could be borrowers effectively hoarding cash by using the HELOCs to cover planned expenditures rather than dip into their savings or use up all of their monthly incomes.
For details see: A HELOC’s Chance in HEL: Examining Home Equity Borrower Behavior.
Technorati Tags: credit-crisis, HELOC, structured-finance
Standard & Poor’s today warned against a further relaxation of international fair-value accounting standards as a way to ease the pressures on financial institutions in Europe and elsewhere.
The International Accounting Standards Board has already relaxed International Financial Reporting Standards (IFRS) for assets required to be accounted for at fair value, a boon to banks holding hard to value structured finance products. In an “emergency” response to the current market conditions, changes to IFRS were published by the IASB and approved by the European Commission for use in Europe within one week.
“Despite these momentous steps, taken with unprecedented speed, we understand that there are still further discussions that could lead to additional changes or even a European override of the IASB’s standards, ” S&P says in European Banks: IFRS Revisions Allow Banks Certain Options To Avoid Fair Value Accounting.
We believe that such a move to override IFRS would have significant implications for the quality of financial reporting in Europe and how it is viewed globally.
“We are also concerned that such a move, if taken at this crucial point when even the U.S. is considering implementing IFRS, could harm longer-term prospects for a global set of accounting standards, particularly if changes result in further differences from U.S. GAAP. As a global standard setter, the IASB, in our view, will need to demonstrate that it is independent of regional or political influence, and deliver standards that provide information capable of meeting the needs of a broad range of users of financial statements, including investors and analysts.”
The IASB has introduced changes that give banks the option to reclassify certain assets as early as the reporting of results for the already completed third quarter of this year.
“From a financial analysis standpoint, we believe that the permitted reclassifications will render the balance sheet carrying amounts of transferred assets less meaningful and will generally not facilitate meaningful comparisons,” said Standard & Poor’s credit analyst Sue Harding.
“The result will be neither fair value nor a typical amortized cost. Instead it will be fair value as of a somewhat arbitrary reclassification date, that has then been amortized. Earnings analysis will, in our view, continue to be at least as complex.”
Harding continued: “We expect there to be a trade-off of potentially higher capital requirements in exchange for more predictable reported earnings and capital that should be less of a moving target for banks. Assets transferred to the banking book may on average require capital that is several times the level required if they had been left in the trading book. However, we do not expect increases in capital requirements to be significant overall, as a multiple of a modest capital requirement would still be modest.”
Technorati Tags: accounting, banks, credit-crisis, european-banks, fair-value, FASB, financial-regulation, gaap, iasb, IFRS, structured-finance
The market for collateralized debt obligations is unlikely ever to fully recover from the credit crunch, no matter how much better the credit rating agencies get at assessing the risks of the complex structured finance derivatives, a new working paper* published by Harvard Business School argues.
Some practitioners believe that the credit crunch of 2007 and 2008 will work itself out, as such episodes tend to do, and the market for structured credit will return as before, the paper’s authors write.
We hold the more skeptical view that the market for structured credit appears to have serious structural problems that may be difficult to overcome.
“As we have explained, these claims are highly sensitive to the assumptions of (1) default probability and recovery value, (2) correlation of defaults, and (3) the relation between payoffs and the economic states that investors care about most. Beginning in late 2007 and continuing well into 2008, it became increasingly clear to investors in highly-rated structured products that each of these three key assumptions were systematically biased against them. These investors are now reluctant to invest in securities that they do not fully understand.”
The ability to create large quantities of AAA-rated securities from a given pool of underlying assets is likely to be forever diminished, as the rating process evolves to better account for parameter and model uncertainty, the authors write. “The key is recognizing that small errors that would not be costly in the single-name market, are significantly magnified by the collateralized debt obligation structure, and can be further magnified when CDOs are created from the tranches of other collateralized debt obligations, as was common in mortgage-backed securitizations. The good news is that this mistake can be fixed. For example, a Bayesian approach that explicitly acknowledges that parameters are uncertain would go a long way towards solving this problem. Of course, adopting a Bayesian perspective on parameter uncertainty will necessarily mean far less AAA-rated securities can be issued and therefore fewer opportunities to offer investors attractive yields.”
“Additionally, investors need to recognize the fundamental difference between single name and structured securities, when it comes to exposure to systematic risk. Unlike traditional corporate bonds, whose fortunes are primarily driven by firm-specific considerations, the performance of securities created by tranching large asset pools is strongly affected by the performance of the economy as a whole. In particular, senior structured finance claims have the features of economic catastrophe bonds, in that they are designed to default only in the event of extreme economic duress.”
Because credit ratings are silent regarding the state of the world in which default is likely to happen, they do not capture this exposure to systematic risks. The lack of consideration for these types of exposures reduces the usefulness of ratings, no matter how precise they are made to be.
*The Economics of Structured Finance by Joshua D. Coval (Harvard), Jakub Jurek (Princeton), Erik Stafford (Harvard).
Technorati Tags: CDO, collateralized debt obligations, credit-rating-agencies, mbs, mortgage-backed-securities, structured-finance
As in the previous quarter, the global credit crisis dominated Research Recap’s Top Ten Posts of the third quarter, with only one post not related in some way to the market meltdown. Many of the posts turned out to be prescient, led by Fitch Ratings’ July warning that US Mortgage Insurers’ Troubles May Worsen. This prediction was borne out this month when Moody’s put several of the insurers on watch for possible downgrade.
In the runner-up spot was NERA Economic Consulting’s July report Subprime-Related Litigation on the Rise, which was buttressed by a Stanford Law School analysis showing that subprime lawsuits were running at double last year’s pace.
The bronze medal goes to the lone non-financial post, Ernst & Young’s July report US Oil Production Flat Over Past 4 Years, published near the peak of the recent oil price spike.
The fourth place post based on the International Monetary Fund’s December 2007 report examining the Role of Hedge Funds in Subprime Crisis Examined is approaching Hall-of-Fame status, consistently featuring among our top posts nine months after it was first published. The IMF also featured in the fifth place post in which Oxford Analytica drew on IMF and OECD data in September to conclude that Speculation Does Not Explain Apparent Housing Overvaluation.
The sixth place post based on a June Moody’s report, Global Junk Bond Default Rate Doubled in First Five Months, now seems modest. Standard & Poors now expects the speculative default rate to triple in the next 12 months. Standard & Poor’s served up the seventh most popular post, in which the ratings agency accurately assessed that Lehman Failure’s Impact on European Banks would be significant.
In what now seems like understatement, the eighth place post based on a June report from Audit Integrity was also right on the money: Credit Default Swaps Adding Rather Than Mitigating Risk? Moody’s July Guide To Interpreting Mark-to-Market Losses of Monolines took the ninth spot.
In what may now seem like wishful thinking, rounding out the top ten on a more optimistic note was KPMG’s July report Greentech Expected to Lead Resurgence of IPOs in 2010.
Technorati Tags: (LEH), CDS, credit-default-swaps, european-banks, green-tech, Hedge-Funds, housing, IPO, junk-bonds, Lehman, litigation, monoline-insurers, oil-exploration, oil-refining, private-mortgage-insurers, structured-finance, subprime, Zeitgeist
Despite the global macro-economic slowdown, downgrades of residential mortgage backed securities (RMBS) are likely to be limited to the junior notes in most affected sectors, according to Fitch Ratings.
The rating outlook for RMBS in several European countries, including Belgium, France, Greece, Ireland and the Netherlands, remains Stable.
In the UK non-conforming sector in particular, delinquency and repossession rates continue to rise. With negative events unfolding in the wider economy, further declines in these key metrics are expected to continue well into 2009. As a result, ratings are likely to be negatively affected for the remainder of 2008 and into 2009 - particularly since UK house prices are expected to remain under significant pressure during this timeframe.
Fitch notes, however, that its UK non-conforming index shows a wide array of performance and continued upgrades in the higher rating categories can still happen for transactions that have experienced significant de-leveraging and where arrears and loss performance is materially better than original expectations.
UK prime RMBS is expected to experience further deterioration in arrears performance. An increase in loss severities is expected within transactions, especially given that the UK has already seen an approximate 12% house price decline. Despite this deterioration in performance, it should be noted that these are from historically low levels. The outlook for the remainder of 2008 and into 2009 for UK prime RMBS is stable for older vintages but negative for more recent vintages.
Spanish RMBS is experiencing deterioration in collateral performance with rising arrears levels, albeit starting from a relatively low base. However, Fitch does not expect significant rating volatility in Spanish RMBS as many transactions have benefited from prepayments and transaction de-leveraging. The more recent vintages are, however, more vulnerable.
German RMBS transactions are expected to remain under pressure with higher-than-expected levels of arrears and, more concerning, significantly lower recoveries than originally assumed. Adjustments to Fitch’s Germany market value decline (MVDs) assumptions could have an impact on classes above the most junior tranches.
For details see Fitch’s European Structured Finance, RMBS Outlook - October 2008.
Technorati Tags: Europe, Germany, mortgage-backed-securities, RMBS, Spain, structured-finance, UK
Despite falling commercial property values across Europe, the number of loans in payment default remains extremely low across European commercial mortgage-backed securities (CMBS), according to Fitch Ratings. “This will inevitably rise in the coming year as economies slow and corporate insolvencies increase, but is still not expected to be the principal cause for concern for CMBS ratings across the continent,” Fitch says in a new report. “It is the risk that borrowers will be unable to make their balloon payments at loan maturity that represents the greater risk.”
The combination of declining property values with a restricted new lending market, means that borrowers facing loan maturity in the near future may well struggle to make expected balloon payments, at least in a timely manner.
“Declines in European commercial property values have been greatest in the UK, while other property markets that contribute significant collateral to European CMBS, including Germany and France, suffered relatively slight value declines. This reflects the strength of the preceding boom in capital values in the UK and is likely to bring greater downward rating pressure on UK CMBS than in other European countries. However, rating actions are likely to be restricted to the junior tranches, with most senior tranches still adequately covered.”
“The weakening performance of the UK property market will only fully translate into the performance of CMBS when properties have to be sold or refinanced to repay the loans,” says Euan Gatfield, Senior Director, in Fitch’s EMEA CMBS team. “This is unlikely to be the case for many loans in the near future as they are not scheduled to reach maturity and, unless tenant defaults result in reduced cash flow, interest service payments are likely to be made until then.”
The German property market appears to have shown relative resilience to the credit crunch. This, coupled with the fact that German banks continue to have access to wholesale funding via Pfandbrief issuance, allowing them to continue lending in significant volumes, is supporting property values. Fitch, however, cautions that although the multi-family housing market remains stable and is set to produce steady rental income in support of many loans, the costs required to effectively operate a portfolio of multi-family housing have increased in many cases, leaving several borrowers at increased risk of loan payment defaults.
French occupational markets remain close to equilibrium and so again overall valuation declines in France are expected to be relatively muted. Markets focused on the financial services sector are likely to be the first to suffer, including the La Defense district of Paris. However, new development has been muted across Paris, limiting the likely effects of declining demand.
For details see Fitch’s European Structured Finance CMBS Outlook - October 2008.
Technorati Tags: CMBS, commercial-real-estate, Europe, structured-finance