OK so you thought you had seen it all, not so fast. This starts out horrible, then they claim it is temporary, then, buried in the bottom of the release you see how they were able to avoid disaster for now, how you ask?
cf, these bonds are set up so that payments of principal (scheduled ones made in a borrower's monthly payment or prepayments due to refinance or sale of home, etc.) are directed first to the top-most, senior tranches in the first few years (usually three) of the deal. That means that the highest-rated tranches retire first, and that the subordinate tranches have to wait a while to get principal payments.
At the end of this period, on the "step-down date," the cashflow of the deal can change so that principal is also directed to the subordinate classes. It will do so only if it "passes" a set of "triggers." These are conditions, such as cumulative losses no more than x% or current delinquencies no more than y%. If the deal fails the triggers, then the additional principal cashflow isn't released to the subordinate notes.
Think of it like the parole hearing. What Fitch is saying about this bond is that the collateral performed badly enough that the subordinate notes will have to serve out their full sentence--nobody gets time off for good behavior.
It's good news for the senior notes--it looks like even the seniors will take some losses, but the failed triggers means they won't have to share principal cashflow with the subs.
Jun 28th 2007
From The Economist print edition
Debt markets turn grouchy as creditors ask for more
"BEFORE the brain was established as the body's ruling organ, the stomach was thought to be king. Descartes may have thought and therefore known that he was, but he reckoned that most of his moods were regulated by his guts. Credit markets seem never to have adjusted to this reordering, and still think with their stomachs. This week they were grumbling, and several big bond sales were postponed until they settle. It's not a buyers' strike, says Paul Read, a bond fund-manager at Invesco, but a bit of indigestion.
Until two Bear Stearns hedge funds got into trouble last week, things had been bubbling along merrily in the credit markets. Last year default rates on high-yield bonds fell to their lowest since 1981, according to Edward Altman of New York University. They have stayed low this year and, with healthy corporate profits and plenty of liquidity, there is no reason to suggest that is about to change.
Even so, there are signs that investors still holding American subprime mortgage debt might not be the only ones feeling a little queasy. "
...
"Although modest repricing is going on, investors are still willing to take risks if they are paid a little more to do so, and plenty of deals are still going ahead. Yet all is not well. There's so much leverage in the system that it wouldn't surprise me to see more problems, says Jim Reid, credit strategist at Deutsche Bank. The place to look for a decisive shift in sentiment is in the buy-out market, which has been fuelled by a trio of habits that in more sober times would have had lenders reaching for the Alka-Seltzer.
The first of these lies in the burgeoning market for covenant-lite loans."
...
"A second place to watch for changing appetites to risk is in bridge finance."
...
"That leaves a third bellwether for the buy-out market. Some firms bought by private equity have been issuing payment-in-kind (PIK) notes. These allow them to pay interest in the form of further loan notes, rather than hard cash. This further weakens the hands of creditors, adds to the sum of risky paper blowing around and makes investors wonder who owes money to whom. Harsher terms on PIKs would be further evidence of a shift in sentiment. Potential buyers of US Foodservice's debt reportedly balked at both the PIKS and also the lack of covenants.
There are other indications that the appetite for risk is heading down, albeit from somewhere a few thousand feet above the peak of Everest. On June 27th the VIX, a measure of stockmarket volatility (otherwise known as nervousness), rose to 19%. It has been higher only once this year. The yen has appreciated, which is a sign that the buccaneering spirit reflected in the carry trade is
"The yen has appreciated, which is a sign that the buccaneering spirit reflected in the carry trade is waning a little (since unwinding this trade involves buying the currency). After lurching upward in early-June, the yield on American Treasury bonds has been falling, reflecting a stronger demand for safe investments. And spreads on high-yield bonds have widened. None of which means disaster is on the way. But it may leave a sickly feeling, something like a knee to the stomach."
"ISSUANCE OF CONVERTIBLE TRUST PREFERRED SECURITIES
The Company also announced today that it has issued in a private placement $125 million of convertible trust preferred securities to funds managed by Marathon Asset Management, LLC. The trust preferred securities pay a dividend of 9.75% per annum, and are convertible into the Company's common stock at an initial conversion price of $25.57 per share. The conversion price is subject to limited downward adjustments based on the performance of the Company's shares and its common dividend yield."
"After 12 months of seasoning, losses to date as a percentage of the original pool balance are 9.86%. Approximately 14% of the outstanding pool balance is delinquent."
And that is likely for people paying the teaser or option ARM rate. For those that can't refi, I would expect to see 50% or higher losses.
I don't want to double post something that is old news CR. But I don't know if you had seen this yet, so just in case you hadn't, the Economist had done an article on the U.S. housing market and economy on 6/7 that seems to agree fairly well with your estimates.
Second-lien backed securities are likely to be in a bloodbath mode in the following months. They are much more delinquent that the first liens because it seems that some homeowners stoped paying the second mortgage much sooner than the first one (can you be foreclosured based on the second mortgage only?). And the recoveries for second liens are close to zero. With so many delinquent loans it is impossible to secure excess cashflow and after a short time, the whole overcollaterization is gone. I wonder how many AAA issues would get principal losses when the dust settles.
Tanta, thanks for translating from English to English, but what do you mean by "have to serve out their full sentence"? If a trigger failed, and the subordinate (i.e. junkier) notes have to pay the price, what does that mean for the bond holders ?
My take = Loaning money to CFC seems to be about as safe as going to the dog track. Do you feel lucky, punk?
I've been investing in defaulted notes on properties in foreclsure in Colorado for over 15 years. My buisness maintains a data base of all foreclosures in the Denver metro area- population 2.5mil or so.
I can tell you that Countrywide never steps up to the plate anymore on their 2nd's when the 1st is foreclosing.
I witness the daily zeroing out of their loans. I'd be amazed if the losses are not much much more then are currently being acknowledged.
If someone can tell me how to place a bet on the risky tranches getting completely wiped out please let me know. It is a sure thing.
IMHO any subprime securitized 2nd pool will ultimately experience total losses in excess of 50% given the vast deflation of values in AZ, CA, NV and FL in the next few years.
BTW I just discovered this blog a month ago and can not tell you how much I'm learning/enjoying Tanta and CR's keen insight and great writing. Keep it up!
Please help me out. If I read this Fitch comment correctly, in approximately 12 months almost 10% of the original pool has defaulted and of the 90% remaining, almost 15% of that is "delinquent" (with delinquent undefined).
So in about 12 months, roughly 42 of the original 189mm is gone or going, correct? Without knowing the amount of overcollateralization (can anyone help out with a typical percentage), does it seem appropriate that only the lowest tranches are DR rated? Or is Fitch just delaying the inevitable.
BTW -- awsome blog. Steveb earlier comment about the length of an entry exemplifies exactly why we're in the mess we're in today (e.g. "don't bother to read the documents, they're just standard forms).
According to the prospectus, the original overcollaterization was 7.65% but there was some excess cashflow during the life of this securitization so this 10% loss is still covered by the overcollaterization. Since the lower tranches are not rated as in default, the overcollaterization is not breached yet but is close. According to data on ABSnet.net, current overcollaterization is only 0.6%.
good work bacon dreamz, we appreciate ur skillz and brilliamt comments. you brighten all our days. even if they won't give you the muthaf'in hat tip we know it was your scoop.
What is a failed trigger? Forgive me, I'm a govie guy.
OK so you thought you had seen it all, not so fast. This starts out horrible, then they claim it is temporary, then, buried in the bottom of the release you see how they were able to avoid disaster for now, how you ask?
A toxic convert of course-
Expired
They are limbering up for tomorrow.
Fitch was busy tonight-
MarketWatch.com
cf, these bonds are set up so that payments of principal (scheduled ones made in a borrower's monthly payment or prepayments due to refinance or sale of home, etc.) are directed first to the top-most, senior tranches in the first few years (usually three) of the deal. That means that the highest-rated tranches retire first, and that the subordinate tranches have to wait a while to get principal payments.
At the end of this period, on the "step-down date," the cashflow of the deal can change so that principal is also directed to the subordinate classes. It will do so only if it "passes" a set of "triggers." These are conditions, such as cumulative losses no more than x% or current delinquencies no more than y%. If the deal fails the triggers, then the additional principal cashflow isn't released to the subordinate notes.
Think of it like the parole hearing. What Fitch is saying about this bond is that the collateral performed badly enough that the subordinate notes will have to serve out their full sentence--nobody gets time off for good behavior.
It's good news for the senior notes--it looks like even the seniors will take some losses, but the failed triggers means they won't have to share principal cashflow with the subs.
Economist article on the changing appetite for debt.
Premium content | Economist.com
You only give me your funny paper
Jun 28th 2007
From The Economist print edition
Debt markets turn grouchy as creditors ask for more
"BEFORE the brain was established as the body's ruling organ, the stomach was thought to be king. Descartes may have thought and therefore known that he was, but he reckoned that most of his moods were regulated by his guts. Credit markets seem never to have adjusted to this reordering, and still think with their stomachs. This week they were grumbling, and several big bond sales were postponed until they settle. It's not a buyers' strike, says Paul Read, a bond fund-manager at Invesco, but a bit of indigestion.
Until two Bear Stearns hedge funds got into trouble last week, things had been bubbling along merrily in the credit markets. Last year default rates on high-yield bonds fell to their lowest since 1981, according to Edward Altman of New York University. They have stayed low this year and, with healthy corporate profits and plenty of liquidity, there is no reason to suggest that is about to change.
Even so, there are signs that investors still holding American subprime mortgage debt might not be the only ones feeling a little queasy. "
...
"Although modest repricing is going on, investors are still willing to take risks if they are paid a little more to do so, and plenty of deals are still going ahead. Yet all is not well. There's so much leverage in the system that it wouldn't surprise me to see more problems, says Jim Reid, credit strategist at Deutsche Bank. The place to look for a decisive shift in sentiment is in the buy-out market, which has been fuelled by a trio of habits that in more sober times would have had lenders reaching for the Alka-Seltzer.
The first of these lies in the burgeoning market for covenant-lite loans."
...
"A second place to watch for changing appetites to risk is in bridge finance."
...
"That leaves a third bellwether for the buy-out market. Some firms bought by private equity have been issuing payment-in-kind (PIK) notes. These allow them to pay interest in the form of further loan notes, rather than hard cash. This further weakens the hands of creditors, adds to the sum of risky paper blowing around and makes investors wonder who owes money to whom. Harsher terms on PIKs would be further evidence of a shift in sentiment. Potential buyers of US Foodservice's debt reportedly balked at both the PIKS and also the lack of covenants.
There are other indications that the appetite for risk is heading down, albeit from somewhere a few thousand feet above the peak of Everest. On June 27th the VIX, a measure of stockmarket volatility (otherwise known as nervousness), rose to 19%. It has been higher only once this year. The yen has appreciated, which is a sign that the buccaneering spirit reflected in the carry trade is
"The yen has appreciated, which is a sign that the buccaneering spirit reflected in the carry trade is waning a little (since unwinding this trade involves buying the currency). After lurching upward in early-June, the yield on American Treasury bonds has been falling, reflecting a stronger demand for safe investments. And spreads on high-yield bonds have widened. None of which means disaster is on the way. But it may leave a sickly feeling, something like a knee to the stomach."
Hey, it's not Friday yet! I think we might see some Prime related downgrades tomorrow.
Best to all.
cr- you missed this-
"ISSUANCE OF CONVERTIBLE TRUST PREFERRED SECURITIES
The Company also announced today that it has issued in a private placement $125 million of convertible trust preferred securities to funds managed by Marathon Asset Management, LLC. The trust preferred securities pay a dividend of 9.75% per annum, and are convertible into the Company's common stock at an initial conversion price of $25.57 per share. The conversion price is subject to limited downward adjustments based on the performance of the Company's shares and its common dividend yield."
"After 12 months of seasoning, losses to date as a percentage of the original pool balance are 9.86%. Approximately 14% of the outstanding pool balance is delinquent."
And that is likely for people paying the teaser or option ARM rate. For those that can't refi, I would expect to see 50% or higher losses.
I don't want to double post something that is old news CR. But I don't know if you had seen this yet, so just in case you hadn't, the Economist had done an article on the U.S. housing market and economy on 6/7 that seems to agree fairly well with your estimates.
Premium content | Economist.com
"America's economy - Checking the engine"
Thank you, Tanta. As usual, a simple, well thought out answer.
Second-lien backed securities are likely to be in a bloodbath mode in the following months. They are much more delinquent that the first liens because it seems that some homeowners stoped paying the second mortgage much sooner than the first one (can you be foreclosured based on the second mortgage only?). And the recoveries for second liens are close to zero. With so many delinquent loans it is impossible to secure excess cashflow and after a short time, the whole overcollaterization is gone. I wonder how many AAA issues would get principal losses when the dust settles.
Tanta
Thank you for your insight into this story.
Sometimes it seems like I am watching a train wreck in slow motion. Is there anyone out there who feels the same way?
hey! where's my hat tip (see kb home comment)?? iwant to see my name in lights! and nobody even weighed in on my bet!!!
Sometimes it seems like I am watching a train wreck in slow motion. Is there anyone out there who feels the same way?
I think a lot of us onlookers can hardly keep our mouths from repeatedly falling open.
Tanta, thanks for translating from English to English, but what do you mean by "have to serve out their full sentence"? If a trigger failed, and the subordinate (i.e. junkier) notes have to pay the price, what does that mean for the bond holders ?
My take = Loaning money to CFC seems to be about as safe as going to the dog track. Do you feel lucky, punk?
I've been investing in defaulted notes on properties in foreclsure in Colorado for over 15 years. My buisness maintains a data base of all foreclosures in the Denver metro area- population 2.5mil or so.
I can tell you that Countrywide never steps up to the plate anymore on their 2nd's when the 1st is foreclosing.
I witness the daily zeroing out of their loans. I'd be amazed if the losses are not much much more then are currently being acknowledged.
If someone can tell me how to place a bet on the risky tranches getting completely wiped out please let me know. It is a sure thing.
IMHO any subprime securitized 2nd pool will ultimately experience total losses in excess of 50% given the vast deflation of values in AZ, CA, NV and FL in the next few years.
BTW I just discovered this blog a month ago and can not tell you how much I'm learning/enjoying Tanta and CR's keen insight and great writing. Keep it up!
Please help me out. If I read this Fitch comment correctly, in approximately 12 months almost 10% of the original pool has defaulted and of the 90% remaining, almost 15% of that is "delinquent" (with delinquent undefined).
So in about 12 months, roughly 42 of the original 189mm is gone or going, correct? Without knowing the amount of overcollateralization (can anyone help out with a typical percentage), does it seem appropriate that only the lowest tranches are DR rated? Or is Fitch just delaying the inevitable.
BTW -- awsome blog. Steveb earlier comment about the length of an entry exemplifies exactly why we're in the mess we're in today (e.g. "don't bother to read the documents, they're just standard forms).
Ed S.,
According to the prospectus, the original overcollaterization was 7.65% but there was some excess cashflow during the life of this securitization so this 10% loss is still covered by the overcollaterization. Since the lower tranches are not rated as in default, the overcollaterization is not breached yet but is close. According to data on ABSnet.net, current overcollaterization is only 0.6%.
Life is good, debt means wealth.
Where is my beer ??
Sounds like its time to open up the confessional.
good work bacon dreamz, we appreciate ur skillz and brilliamt comments. you brighten all our days. even if they won't give you the muthaf'in hat tip we know it was your scoop.
signed,
Commenters for Justice!!!
PIK notes = Corporate Option ARM's?
AFAIK Fitch is the most aggressive downgrader from the big three. That's probably why.
Give Fitch some credit; they are being relatively aggressive, and unlike Moody's and S&P, they put out press releases on their ratings actions.