Fund manager Whitney Tilson of the Tilson Funds applauds Gretchen Morgenson’s story on how the rating agencies blew themselves (and much of the financial system) up. Tilson also takes a close look at a typically ghastly security that received a Triple-A Moody’s and S&P rubberstamp. He also concludes that Moody’s (MCO) is STILL rating worthless securities investment grade.
This story by Gretchen Morgenson… pretty much nails what I (and many others) have been saying: the ratings agencies, in chasing ever higher profits and stock prices, threw their standards out the window and prostituted themselves, which was critical in greasing the wheels of The Great Bubble. (We remain short Moody’s.)…
Even worse, they’re STILL mis-rating hundreds of billions of bubble securities! I’d guess they’re about a year behind the curve. They say (correctly) that they’ve downgraded a couple of TRILLION dollars of dreck, but they haven’t downgraded it enough — tranches are STILL rated investment grade that are almost certain to be worthless.
I looked at a recent Moody’s downgrade report and collected some data on just one of the thousands of securities that had been downgraded and it was a joke: it had been downgraded from AAA to A, but was almost certainly a zero…
Morgenson’s story mentions a particular pool of 2nd mortgages Goldman put together (Goldman should hang its head in shame at ever having anything to do with something like this — and they weren’t anywhere near the worst on Wall St.!):
Consider a residential mortgage pool put together in summer 2006 by Goldman Sachs. Called GSAMP 2006-S5, it held $338 million of second mortgages to subprime, or riskier, borrowers.
The safest slice of the security held $165 million in loans. When it was issued on Aug. 17, 2006, Moody’s and S.& P. rated it triple-A. Just eight months later, Moody’s alerted investors that it might downgrade the top-rated tranche. Sure enough, it dropped the rating to Baa, the lowest investment-grade level, on Aug. 16, 2007. Then, on Dec. 4, 2007, Moody’s downgraded the tranche to a “junk” rating. On April 15 of this year, Moody’s downgraded the tranche yet again; today, it no longer trades. The combination of downgrades and defaults hammered the securities. Reversals like this have enraged investors.
I was curious what the pool looked like today and what price the top-rated super-senior (that’ll go down in history as one of the great oxymorons!) tranche would trade for if it did trade, so I asked Sean Dobson, CEO of Amherst Securities (who provided much of the data in our mortgage presentation (posted at www.valueinvestingcongress.com)) to look into it. Below is his reply. I don’t know which is more mind-boggling: that such loans were ever made or that the ratings agencies were ever willing to give ANY PART OF THIS POOL ANY RATING WHATSOEVER!
Attached is Dobson’s analysis of the pool, here are two web pages with the prospectus and other info on this pool when it was issued (http://sec.gov/Archives/edgar/data/1371938/000088237706002830/d551575_424b5.htm and http://sec.gov/Archives/edgar/data/1371938/000102024207000131/gs065s12.htm) and here’s Sean’s answer (my favourite lines: “I guess people are shocked that such a fine pool would experience 60% defaults. We’re more impressed that 25% of the loans actually paid.” and “It’s kind of like watching an hour of Fox news and forming an opinion on the media.”):
GSAMP 06-S5 Born on 8/18/2006
At birth the trust held $330,816,622 face amount of Second Lien Mortgages and issued two AAA rated Bonds with a combined par amount of $231,571,000. The difference between the loan par amounts and the bond par amounts ($99,244,987) is thought of as “Overcollateralization” (OC) and represents 30% of the original loan portfolio.
Class A1 was $164,416,000
Class A2 was $67,155,000
Class A1 was to receive 100% of principal prior to A2 UNLESS the OC ratio became zero. (At which time loan par amounts and bond par amounts would be equal.) After that date the two classes would share all principal repayments “Pro-Rata”.
The loans were accruing @ an 11.25% rate while the A1s were set to earn LIBOR +9bps and the A2’s were set to earn 5.65% Fixed.
As of last month;
The Class A1 has returned 56.5% of its principal amount. The A2 class has returned 1.8% of its principal.
Pool loan losses totaled $161,656,901 or 48.9% of the original pool.
The OC ratio reached zero in May-2008.
The remaining loans had a total remaining balance of $91,853,748 of which 17.9% are behind two payments or more, leaving $75,414,390 performing loans.
The A1 class has a remaining class amount of $71,532,115
The A2 class has a remaining face amount of $66,003,454
For a total remaining balance of $137,535,569
Thus, as of today there are 150% more securities outstanding than there are loans. All principal payments from today forward are to be allocated 52% to the A1 and 48% to the A2 (pro-rata)
Last month there was no principal paid to A1 or A2.
The A1 was paid $28,812.22 in interest which was $164,153 less than the 3.34% coupon accrual. The A2 was paid $46,467.12 which was $264,739.16.
realised losses for the month totaled $7,818,751 and were 102.4% of the liquidated loans remaining balance. (Servicers charge bond holders all of their expenses related to servicing defaulted loans. On second liens this results in greater than 100% losses for defaults)
Gretchen says in her article that these assets “don’t trade” anymore. In reality there is not much left to trade. It would trade around $8-00.
Over the last 6 months, the performing loans have been becoming “non-performing” at the pace of 5% PER MONTH while voluntary prep-payments have been running 0.4% per month. Any reasonable analyst would assume 95% or more of the performing loans will default which will produce some pennies in cashflow for these classes.
Based on the 50% defaults already experienced, and the recent default rates (50+% per annum) it is no stretch to assume the remaining loans (~27% of Original Pool)will all default resulting in a default ratio of 75% of the original pool.
Here is what the pool looked like at origination.(Beginning on page 147 in the prospectus [attached])
The combined LTV was 98.7% ..meaning non of the borrowers put up any money
Only 35% actually verified their income ..
80.8% of the loans were “purchase money” ..meaning the builders “sold” to people who were not qualified and put up no money
CA,FL,AZ and NV represent 53% of the pool
88% were 30year loans ..30yr SECOND LIEN loans
I guess people are shocked that such a fine pool would experience 60% defaults. We’re more impressed that 25% of the loans actually paid.
This is one of the really painful things to watch as the mortgage market gets maligned. For 20 years we turned down these borrowers. Then the gates were opened and a bunch of obviously stupid loans were made. Now they’ve defaulted and people are extrapolating their performance to all “mortgages”.
It’s kind of like watching an hour of Fox news and forming an opinion on the media.