Ratings Party Crashing

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On Wednesday Moody’s and S&P downgraded or placed on review 431 and 612 bonds backed by subprime mortgages respectively. These bonds are pooled into more than 91 CDOs being reviewed by each agency for downgrade, representing $5 billion of securities. The CDOs under review constitute only 0.5% of the overall market (that is rated, at least), but the broad credit review initiative marks a change in the usual “baby step” approach used to review a class of securities, according to analysts at UBS.
Even though a broad downgrade may be underway, many believe that not only are the rating agencies late to address the inflated ratings of subprime backed securities, but also that the action taken is not adequate. All the agencies are saying at this point is that they may cut ratings on 91 CDOs and a slew of bonds, which seems like a strange delayed reaction given the cents on the dollar many CDOs are fetching on the open market, despite non-junk ratings.
Not to be left out, Fitch Ratings got in on the review party yesterday by issuing a report reinforcing the notion that there is more trouble to come in the commercial real estate market due to rising default rates. The overall delinquency rate of mortgages rose in the second quarter from 2.87% to 3.15%. To give a sense of how risky certain traunches of CDOs are, many of the CDOs targeted by review from the credit agencies had 20% delinquency rates among each security’s pooled mortgages, hence poor structuring of many CDOs is as much of a problem as rising subprime delinquencies. Volume of CDO issuance is at an all time high this year at $265 billion, but growth in that volume has slowed from 2005.
Although the laxity of the credit agencies helped enable subprime problems, Felix Salmon of Portfolio says the blame should be shared by the underwriters. Many of the bonds subject to downgrade were underwritten by New Century Financial and Freemont General. The loose standards of these underwriters is evident in the fact that New Century filed for bankruptcy in April and Freemont was cast from the subprime business by federal regulators in March.
CDOs Are Hit With Fallout From Laxity With Subprimes [Wall Street Journal]
Subprime: The Unraveling Continues [Wall Street Journal]
Why the S&P-Triggered Subprime Selloff Makes No Sense [Portfolio]

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