Friday, July 27, 2012

Agency Shortcuts and Shortfalls

Investors in certain "AAA" resecuritizations won't be happy. Late last night, Moody's downgraded a bunch of securities, even though they are supported by Agency-guaranteed RMBS.

Many of these were downgraded from Aaa to junk (some at Ba1, others all the way to B1) in one fell swoop, while others went only to A1.  (It looks like S&P still carries most of these securities at AA+, which is lower than Moody's Aaa as S&P has downgraded the United States to AA+.)

What's most interesting here is the reason.  It's not the case that either Fannie or Freddie hasn't paid up on their guarantees, but it looks like the deals may not have been modeled (possibly ever!) - or at least may not have been modeled correctly.  According to their press release, the resecuritization vehicles seem not to have the necessary protections in place to support the bonds issued, or the ratings provided.  Some of these deals were structured in 2007 and even late 2008.  Many of these deals are already suffering shortfalls.

From Moody's press release:
"The downgrade rating actions on the bonds are a result of continual interest shortfalls or lack of adequate structural mechanisms to prevent future interest shortfalls should the deals incur any extraordinary expenses."

... and ...

"Interest due on the resecuritization bonds is not subject to any net weighted average coupon (WAC) cap whereas interest due on some of the underlying bonds backing these deals is subject to a net WAC cap."

... and ...

"Since the coupon on the resecuritization bonds is currently higher than that of the underlying bonds, the resecuritization bonds are experiencing interest shortfalls which on a deal basis are accruing steadily."

Total issuance of $483mm affected, according to Moody's. Deals are of Structured Asset Securities Corp. and Structured Asset Mortgage Investments shelves.

Relevant CUSIPs Downgraded Last Night

Monday, July 23, 2012

Marc Joffe Discusses Pros of Open Source Rating Models for Sovereigns / Munis

On Friday night, PF2 consultant Marc Joffe was profiled on The Lang and O’Leary Exchange, a popular Canadian business program.

Tuesday, July 3, 2012

LIBOR and Transparency

Americans obsessing over last week’s healthcare decision or zoning out ahead of July 4th may have missed the latest episode in the financial industry corruption soap opera. Last week. Barclay’s agreed to pay a $453 million fine for misreporting the rates at which it borrowed funds to the British Bankers Association, thereby distorting the value of the London InterBank Offer Rate (LIBOR). The bank’s Chairman and COO have both stepped down.

This instance of financial industry malfeasance appears to lack the compelling narrative needed to upset the general public. For those advocating on behalf of the “little guy”, this scandal may lack appeal, since most of the LIBOR manipulation appears to have been downward -thereby lowering mortgage rates paid by ordinary borrowers. Financial industry critics seem less concerned by the fact that many “little guys” who directly or indirectly invest in LIBOR-based vehicles were cheated out of some income. Journalists and bloggers have thus focused their ire on the rich and powerful individuals who have been caught cooking the books. This is unfortunate, because chopping off a few heads is not the real solution. As we will see in the coming days and weeks, misreporting of bank borrowing rates was pervasive. It is simply too tempting for most of us mortals in the financial industry to resist.

Rather than focus on the people involved or expect bank executives to morph into Mother Theresa, we should instead direct our attention to fixing the institutional framework. The problem is with how LIBOR and many other financial market prices and rates are estimated and reported. The systems we have are too easy to game and the benefits of gaming them are simply too great to resist.

In the case of LIBOR - as with bank loan prices and CDS spreads - the mechanism involves dealers reporting their bids and offers to a data aggregator, like Thomson Reuters or MarkIt. The aggregator then averages the reported quotes, often dropping the highest and lowest marks from the composite. As we’ve now seen, these dealer quotes are subject to manipulation. In less liquid markets, they may not be updated regularly since the dealer does not see new bids or offers. In either case, the composite marks reported by the aggregator do not reflect actual value.

This should concern everyone (who pays taxes to bail out banks), because it means that we don’t really know what most bank assets are worth. A better alternative would be to require all bank transactions to be reported and made publicly available. Reporting should be real time, easily accessible on the internet and as detailed as possible. Specifically, consumers of the data should be able to identify inter-dealer trades that may be executed for the purpose of manipulating mark-to-market prices.

Comprehensive transaction reporting will not be welcome by many in the financial industry. Although the major complaint may revolve compliance costs, these should be minimal, since banks already have to collect all of the transaction data for their internal systems. The real concern will be the loss of income suffered by traders, who realize significant gains from the opaqueness of many markets. Of course, that issue is much less of a concern for the rest of us.

With a few spectacular exceptions, prices of equities and other exchange traded products have proven trustworthy because of their relative transparency. By making markets for bank funding, asset backed securities, derivatives and exotic fixed income instruments more transparent, we can restore trust in quoted prices, enhance liquidity and increase the stability of our financial system.

Rather than simply scapegoating those who were caught, let’s use the LIBOR scandal as an opportunity to provide more transparent and reliable pricing not only to the market for short term bank financing, but to all markets touched by our “too big to fail” financial institutions.