28 May 2008

The Bagholder Battles: Investors vs. Banks

Two stories with one common theme: Things Falling Apart

As reported at Calculated Risk: From Ruth Simon at the WSJ:Investors Press Lenders on Bad Loans.

Unhappy buyers of subprime mortgages, home-equity
loans and other real-estate loans are trying to force banks
and mortgage companies to repurchase a growing pile of
troubled loans. The pressure is the result of provisions in
many loan sales that require lenders to take back loans
that default unusually fast or contained mistakes or fraud.
The potential liability from the growing number of disputed
loans could reach billions of dollars ...

Quote: "Tanta and I were discussing who the eventual bagholders would be way back in 2005 - while the bubble was still inflating - and although the picture is much clearer today, some bagholders still don't want to be, uh, bagholders! And who could blame them?"

Monoline Death Watch: CDO Unwind Disputes

Yves Smith (Naked Capitalism) comments on NY Post article about "simmering disputes between investment banks trying to unwind CDOs and monolines that provided credit enhancement".

To clarify a wee point that is a bombshell if true.

One of the big defenses of the bond insurers against Ackman, the other shorts, and the regulators, was "You don't get it. On many (by implication, most) of these structured finance guarantees, we don't have to pay the piper till so far down the road that on a DCF basis this is chump change."

I dimly recall that the terminus was asserted to be when the CDO was finally dissolved and all claims finally settled (or it might have even been when the underlying mortgages finally matured). Given that most CDOs have a three to five year life, I failed to understand how these vehicles could have gotten AAAs if the insurance really worked in most cases as asserted (as in it would pay out only ages after the CDOs were fini). But never underestimate rating agency stupidity, I suppose.

The article suggests (but isn't clear) that the bone of contention is that the unwinding of the CDOs would accelerate the insurer's liability. On one level, that makes sense, but on another, if it is tied to the final resolution of the underlying mortgages, I don't see who you can dissamble these CDOs (which was a conclusion I had reached a long time ago).


Update 5:00 AM: - The alert folks at FTAlphaville have come to the rescue:

The Post, we assume, is picking up on disputes such as this one, between XLCA and Merrill Lynch. The quid pro quo for cheap insurance on senior CDO tranches then appears to have been “control rights” over the liquidation of those CDOs in the event of default.

The whole thing is a legal mess. Existing CDO documentation would likely have given “control rights” to the most senior noteholders, not distant swap counterparties, so there's plenty of room for disagreement.

Monolines back in the spotlight (Alphaville)

Yves Smith at Naked Capitalism picks up a piece in Tuesday's New York Post - surprisingly, on collateralised debt obligations and monoline bond insurers.
In a nutshell, the Post is reporting that monolines are hampering banks' efforts to liquidate CDOs.

The Post, we assume, is picking up on disputes such as this one , between XLCA and Merrill Lynch. The quid pro quo for cheap insurance on senior CDO tranches then appears to have been “control rights” over the liquidation of those CDOs in the event of default.

The whole thing is a legal mess. Existing CDO documentation would likely have given “control rights” to the most senior noteholders, not distant swap counterparties, so there's plenty of room for disagreement.

But Smith wonders how this plays into the long-standing ‘you dont understand‘ defence the bond insurer's have hitherto used. To wit, under existing CDO insurance contracts liabilities dont have to be met instantaneously, but gradually over a period of 20-30 years or so.

That, however, is rot - or at least, rotten - if it's based solely on the legal sureity of those “control rights”, which is anything but certain.

Whatever the situation regarding paydown is, things broadly are once again, getting tricky for the remaining monolines. MBS fundamentals continue to deteriorate and impairment charges are already biting deep into freshly raised capital cushions at MBIA and Ambac.

The FASB too, has just changed accounting rules, making further impairments all but inevitable.

The triple A is anything but secure.

RE: Second-lien fallout ray_heritage NEW 5/28/2008 3:08:14 AM
Second-lien fallout Alphaville

There's a monoline-related barney going on.

After raising capital in February and March, temporarily easing concerns about their future, the bond insurers are back in the spotlight.

First there's the matter of accountancy - and the prospect of having to set aside money to cover losses on troubled securities earlier, namely when there are signs of deterioration rather than on default.

Shares fell on Friday on the news - and deteriorating sentiment over the past week has pushed MBIA and Ambac's 5-year CDS back towards record wides seen in April, according to Gavan Nolan at Markit. There's been other bad news for the sector, with the downgrade of CIFG to junk status.

There is also a growing spat over second-lien exposure (or exposure to second mortgages) - a brouhaha which now involves Moody's, MBIA, Ambac, and research outfit CreditSights.

The rating agency earlier this month put out a comment, noting the “persistent poor performance and continued downward rating migration among 2005-2007 vintage second lien mortgage securities.”

Moody's notes that financial guarantors have significant exposure to second lien RMBS, primarily through guaranties on direct RMBS transactions, and to a lesser extent, through exposure to ABS CDOs, where second lien RMBS securities typically constitute less than 5% of collateral within such CDOs.

In a nutshell, the agency thinks that losses on these securities will be higher than previously thought, with ensuing impact within the monolines' RMBS and ABS CDO portfolios.

Moody's now expects 2005 vintage subprime second lien pools to lose 17% on average, 2006 vintage pools to lose 42% on average, and 2007 pools to lose 45% on average.

The two largest monolines begged to differ. At least as far as their portfolios are concerned.

From MBIA:… - we believe that there are significant differences between subprime second lien pools referenced in Moody's report and the prime second lien securitizations we have guaranteed. As we discussed on our earnings call on Monday, May 12, we have modeled our portfolio on a deal by deal basis using issuer specific data and we are comfortable with the resulting loss reserves and stress analysis we reported to the market.

Ambac too responded with details of its exposure to home equity lines of credit (HELOC) and closed-end second mortgages (CES), arguing that it had been aggressive in its reserving against its exposure.

Then CreditSights got involved

The research outfit last week published a note arguing continued deterioration in second-lien exposure would be problematic for the two largest bond insurers. Specifically, the analyst wrote:

If losses were to migrate toward the higher end of Moody's stress test, we think that a downgrade of both companies would become inevitable. Based on Moody's most stressed case scenario, Ambac could be facing losses of more than $8bn and MBIA could be facing losses of more than $10bn.

In our opinion, it is likely that both Ambac and MBIA will see continued deterioration in their second lien exposure in the second quarter.

Which is arguably where the matter should have been left. Moody's had raised the issue first off, and both companies had responded robustly and publicly.

But Ambac is apparently in fight-back mode. The monoline has put a 23-slide presentation, running through second-lien RMBS on its website - and issued a statement taking issue with the CreditSights note.

"The Credit Sights article offers little independent analysis, fails to consider the basic structural arrangements of individual transactions (one cannot simply multiply a cumulative loss assumption by net par outstanding to determine ultimate loss) and does not attempt to reconcile to Moody's previously reported RMBS losses for Ambac.

To which CreditSights has this week responded in kind, in support of its analyst.

They argue that the note was merely running a worst-case scenario, and that “in the context of ABK's myriad issues, we looked at the piece as relatively benign given the many slings and arrows that the monolines face on a daily basis.” It concludes:

In the end, we stand by our analyst and his right to an opinion (misrepresented by third parties or otherwise) based not only on the data presented but also a minor dose of common sense based on what has transpired over the past year. Ambac has a right to its view as well.

Regardless, the market appears to have made some decisions long before this point, and the conclusions do not reflect well on Ambac or the credibility of risk models in place and underlying assumptions. The experience has been a bitter one for securities holders and more painful than the minor “sticks and stones” of critical analysis.

None of which serves to inform us whether the Armageddon-esque second-lien scenario will come to pass. But there is now, for those interested, ample more information to ponder in sizing up the possibilities.

ray_heritage NEW 5/28/2008 2:47:24 AM

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