Bloomberg has a delightful story today about a new JPMorgan RMBS transaction, its first non-agency deal since the crisis. Specifically about this:
The bonds are made riskier by the New York-based bank and other originators of the mortgages offering weaker promises to repurchase misrepresented loans than those on similar deals, Fitch Ratings said today in an e-mailed report. Lenders and bond sponsors have been seeking to trim potential liabilities in such deals as the market revives after suffering billions of dollars of losses from debt sold before the collapse in home prices.
The value of the so-called representations and warranties in the JPMorgan transaction is “significantly diluted by qualifying and conditional language that substantially reduces lender loan breach liability and the inclusion of sunsets for a number of provisions including fraud,” New York-based Fitch analysts including Roelof Slump wrote in the presale report.
So naturally the deal is limited to an Aa rating, as it would be at Moody’s based on those sort of rep and warranty weaknesses, right? Errr not so much:
The classes of the deal expected to receive top credit ratings carried loss buffers of 7.4 percent as Fitch said it adjusted its analysis to reflect the greater investor dangers created by the weaker contracts, according to the report.
So 92.6% of the deal will be AAA rated at Fitch and Kroll, the other rating agency on the deal. Here’s the cap structure from Kroll’s report: Read more »
A primary goal of financial engineering is to confuse the bejeezus out of Them while remaining crystal clear to Us. There’s no point to it if it doesn’t in some way confound the expectations of some Other, whether that Other is the tax authorities, bank capital regulators, rating agencies, customers, or markets generally.1 But the worst possible outcome is for a product to be unpredictable to whoever built it, mostly because, if it was any good, they built a lot of it, and if it blows up on them it’ll hurt.
There is an obvious tension here: complicated products serve well to confuse Them but are more likely to end up acting up on Us as well.2 One fruitful approach is for Us to be just a bit smarter than Them. Another approach, lovely when it works, is to build a product that is so beautifully simple that anyone can understand it, but that has one simple conceptual twist that falls right in the particular blind spot of one particular targeted Them.3
You can bracket the question of whom residential mortgage backed securitizations were designed to confound,4 and just take a moment to realize: they kind of screwed the banks that did them, no? I mean, “compared to what” I guess – imagine if Countrywide had done all the lending it actually did, but kept everything on its balance sheet – but the fact that BofA has eighty zillion dollars in putback liability must be discouraging for whoever’s left there on the securitization desk. Like: the whole idea was to put some loans in a box and sell the box to investors; the investors, not you, now own the credit risk on the loans. You own nothing. The loans have nothing to do with you. Sure you signed a piece of paper saying some stuff about the loans, just before you waved goodbye to them, but why would you have read that? Those are just reps and warranties; those are for the junior law firm associates to haggle over. You sold the loans, it’s done, right? Read more »
Until recently, being chief executive officer of Jefferies was an exercise in getting shit on. As the man in charge for the last 13 years, Richard Handler has had to put up with a lot of hurtful remarks that, while nothing to the person tossing them off, undoubtedly stung quite badly. “Third-tier bank.” Place “I wouldn’t let my maid’s kid work.” “Poor man’s Morgan Keegan.” So you can imagine that after a string of victories over the last several months that included getting involved in the slaughterhouse business and paying all-cash bonuses unlike some people, Handler and Co. would be feeling pretty good about themselves and that after announcing to the world they were getting paid more this year than their counterparts at big kid banks, they’d be feeling REALLY good about themselves. That payday, however, did not go over well when input into Moody’s proprietary just-make-it-up credit-rating model, and now Handler’s plan to gather everyone up to watch as the board shoots his compensation out of a tee-shirt gun in hundred dollar bills is completely ruined.* Read more »
Here are two tiny little puzzles about Moody’s’s’s downgrade of the European Financial Stability Facility from Aaa to Aa1 just now. But first, here is some math on EFSF guarantees; basically every €100 of EFSF bonds has €165 of member guarantees, of which €103ish were Aaa-rated and €62ish were not. Until Moody’s downgraded France last week. Now it appears that each €100 EFSF bond has only €67 of Aaa guarantees, €36 of Aa1, and €62 of … various lesser things.
So the puzzles: first, this thing – the EFSF – is basically a structured credit product that is roughly two-thirds guaranteed by a Aaa thing, one-third guaranteed by an Aa1 thing, and roughly another two-thirds guaranteed by an assorted lower-rated miscellany that you can safely ignore. Should that make it (1) Aaa, (2) Aa1, or (4) other? S&P, as it happens, has a mechanism to sort of solve this, which is to say that a bond is rated by its probability of defaulting. Discarding the cats and dogs (and ignoring correlation questions), something that is 1/3 AA+ and 2/3 AAA has about an AA+ chance of defaulting: even if those AAAs are rock-solid, a default by that AA+ counts 100% as a default. Moody’s doesn’t have that – they, in theory, rate structured products1 based on expected loss, not just chances that there will be a default. So something that is two-thirds Aaa and one-third Aa1 is … at least arithmetically closer to Aaa than Aa1, is it not? (Especially if you assume the cats and dogs add a little bit of recovery.) But here you are stuck in a granular world: a thing that is two-thirds Germany and one-third France may be better than France, but I guess it’s also worse than Germany, so you gotta pick one or the other and I suppose pessimism is always a good look.
But a second and possibly related puzzle: if you were the EFSF, would you be bummed about being downgraded? Here is a weird fact2 (via Alea): Read more »
There are many great businesses in the world but surely none is as great as being paid money not to do stuff. I was in that line of work for two glorious months in the summer of 2011 and I’m pretty sure it was the peak of my career. Counterintuitively this business is not always massively scaleable,1 but there are some examples. My favorite is that in the 1980s companies would pay Skadden Arps a retainer fee to prevent Skadden from representing a hostile acquirer; I have idly suggested that David Einhorn look into charging similar fees to direct-marketing companies who want peaceful earnings calls.
If I were Moody’s I’d have a sliding scale of CMBS fees that goes like: