AAA RATING FOR SUBPRIME MORTGAGE BONDS!!!
ARE YOU SERIOUS???
I have great news for pension funds, investment banks, and municipalities around the world! Another pool of subprime mortgage backed securities have earned a AAA rating from Moody’s Investors Service. The New Residential Mortgage Loan Trust 2016-1 mortgage bond is a securitization of over $261 million of first-lien prime, subprime, and Alt-A mortgages that were originated from 2001-2005. Over 75% of the 1,789 loans within the portfolio consists of subprime and Alt-A originated mortgages. These are same type of mortgage-backed securities, from the same timeline, originated from the same pool of lenders, and rated by the same rating services that helped cause the American subprime mortgage crisis of 2007-2008 - leading into the Great Recession of 2008-2009. The only difference is that now these mortgages are 11-15 years seasoned.
Moody’s Investor Service gives several reasons why they have rated the bond AAA. They claim that based upon the age of the loans in the pool, the originators of the loans are less relevant. (I highly doubt that some municipalities whom lost millions of dollars within Norway and Ireland would agree with this analogy.) As a mortgage professional of 25 years and having been responsible of helping over 10,000 clients, I believe when names such as Countrywide Home Loans, GMAC Mortgage, and American Home Mortgage (all defunct) show up on a bond, investors should show a certain level of concern. Moody’s also compares the 12-month default rates of prime (1.6%), subprime (3.7%), and Alt-A (3.1%) mortgages. They then discuss the expected default rate of this portfolio at 5.4%. However, if you where to look at the research done by both CoreLogic and the U.S. Federal Reserve, it appears that the rate of default rate continue to increase as time progresses for the years referenced in the portfolio – especially for loans originated during years 2004-2006. Thus, for loans originated during this time, that are within the said portfolio, the default rate continues to climb.
Moody’s also mentions that the weighted average updated loan-to-value (LTV) ratio was 60.7% and FICO score was 697. What was not mentioned was the average combined-loan-to-value (CLTV) in the portfolio. During the 2001-2006 period, a very popular mortgage product was the 80/20. Meaning, one would acquire an 80% first lien position mortgage and simultaneously obtain a 20% second lien position mortgage. This would establish a 100% combined-loan-to-value transaction. This exact transaction, that was prevalent during 2001-2006, is what prevents these borrowers from refinancing or selling today. Another consideration is the extremely low interest rate environment and steady increase of home prices over the last few years. Many loans in this portfolio could be sitting on adjustable rate mortgages on either their first mortgage or second mortgage. When interest rates rise (and it is not “if” they rise, just “when”) this will negatively affect the borrowers whom these loans are issued. Combining increasing interest rates, with a reversal in home prices, and these “new” mortgage backed securities that have loans that have been traded, swapped, and repackaged numerous times could once again create catastrophic results for the bond holders and borrowers.
I have been working as full-time professional in the mortgage industry before, during, and after the subprime mortgage crisis. This has perhaps given me a little more insight then most. Perhaps my opinion is skewed due to what I have seen and lived through. However, when it comes to some of the mortgage-backed securities that have been recently introduced and received such high ratings from the Big Three creit rating agencies (Moody’s, Fitch, and Standard & Poor’s) I have serious concerns. From the opinion of a “street guy”, who meets with clients every day, I have to honestly say that if these borrowers who took out loans between 2001-2006 could refinance, they would. The reason is, mortgage rates from 2001-2006 for a 30 year fixed rate mortgage ranged from the 7.15% to 5.23%, and the current interest rate environment is at 3.75%. However, something is preventing them from doing it. Whether it be too high of a LTV or CLTV, too low of a credit score, not showing enough income, or not having the right characteristic standards established – it takes just ONE of those items to prevent them from obtaining a new mortgage. The same items that prevent these borrowers from obtaining a new mortgage are the same reasons their existing mortgage maintains a greater risk for the bondholders who purchase the portfolios that are holding these loans.
The advantage to these portfolios is they have loans in them that have an interest rate that is well above today’s existing interest rate environment. Investors love the high rates of return these mortgage backed securities from 2001-2006 can produce. However, in some cases, these investors are restricted in what they can invest in; held to only investing in securities that are AAA rated by the credit agencies. The supply of these types of mortgage-backed securities with high returns are low; the demand for these types of bonds with high returns with AAA ratings are very high. However, as it has been for a very long time, without the ratings the bonds are much less valuable. Wall Street has a huge incentive to get these securities into the hands of investors at the highest rating possible. When there are huge incentives for some, the likelihood of misrepresentation or self-interest actions are much higher. My skepticism prevents me from just accepting the 60.7% average LTV, the average FICO score of 697, and the 88.4% of the loans being current or with only one 30 day late in the last 24 months. Anyone who understands both statistics and mortgage lending could cherry pick individual loans that could produce a good looking portfolio, that creates strong averages, but could be a time-bomb just waiting to explode. I say proceed with extreme caution before trusting a credit agencies rating – we saw what happened last time!