S&P Lowers Hammer on Thousands of Toxic Securities

A: It was November that I last discussed the downgrades of supposedly 'AAA' sugar pies to 'CCC' rated junk. We all know the banks are holding these assets as AAA on their books, waiting for the downgrades to come, and in the meantime assigning flawed model valuations to the securities that can't find buyers on the secondary market. Well that's not entirely true, there are some buyers out there but the sellers are not interested in unloading at the bids being offered because of the massive hit the deal would have to their books, and the rest of the toxic junk held. In meantime, institutions wait patiently for the next move from the government to see if a bad bank will really take off; ultimately allowing a place to warehouse all these junk securities that are crippling our banking system.

From Housingwire.com's, "S&P Slashes Thousands of RMBS Ratings":

On Monday, Standard & Poor’s Ratings Services lowered the boom — again — on thousands of Alt-A and subprime RMBS, moving them all to a ‘D’ rating, as well as cutting hundreds of formerly AAA-rated securities multiple notches from their previous perch atop the ratings heap. The agency also began cutting ratings on prime deals, as well.

The rating agency said it had lowered its ratings to ‘D’ on 1,078 classes of mortgage pass-through certificates from 650 U.S. Alt-A RMBS transactions from various issuers, while also placing 2,111 ratings from 143 of the affected transactions on CreditWatch with negative implications. Approximately 81.82 percent of the ratings on the 1,078 defaulted classes were lowered from the ‘CCC’ or ‘CC’ rating categories, and approximately 98.98 percent of the ratings were lowered from a speculative-grade rating, S&P said in a statement.

Despite all of the cuts to securities that were already considered speculative grade, it’s perhaps more telling that S&P also took the hatchet to AAA-rated classes — an example of a few Wells Fargo deals involving 32 classes is here, but there are others. These downgrades weren’t to a ‘D’ level, of course, but a fall from the AAA perch is likely to be comparatively far more painful for an investor. And for those really, really geeked out by this sort of stuff: some of the 2007 deals being downgraded here now have cumulative loss projections exceeding 20 percent. For the ENTIRE issue. That’s nearly unheard of outside of the subprime space.

The bottom line here is this: for all of the pain felt in this area already, plenty of banks large and small are still generally carrying securities on their books at a level justifiable against current ratings levels, which is partly why trades in this space have been frozen. Buyers know the securities aren’t worth the AAA rating they’ve got, and frankly so too do any would-be sellers, but nobody can sell a security still at AAA at C-level prices and then justify the hit that so doing would have on the rest of their books.

There is a reason there is so much discussion — heated discussion — around a bad bank right now. Financial institutions are quite aware these downgrades are coming in waves, and are trying to figure out how to get out from underneath the second wave of soon-to-be bad debt as fast as they possibly can.

Ahhhh, what a wonderful world. I love how these firms honestly think that by hiding untradable securities off their balance sheets, it makes the problem go away. They can't all honestly believe this? Ehh, it's all temporary anyway, because in the end, it will all come out. It's looking more and more likely that an RTC-like vehicle will be set up to warehouse all these troubled assets. Problems will arise, what price will be paid, will taxpayers get screwd, how will it affect assets still held, how long until performing non-toxic assets start underperforming now that Alt-A & Prime are shitting the bed?

What we know is that they won't let the banks fail. And for some reason, they seem to be wary of a full fledged nationalization of the most troubled of institutions, which also happens to be one of the biggest names in the banking system --> Citibank!

This balance sheet problem will take time to iron out, and in the meantime, the problem continues to spread to higher quality debt classes, as proof from today's S&P announcement. I guess we know part of the reason why banks are hoarding cash in excess reserves that get paid interest! As Jeff stated in that great discussion:

My guess is that these excess reserves will be melted away as banks absorb losses on delinquent loans and as marked down securities see their income streams actually collapse.

BINGO! In addition, according to the fed's loan officer survey, bank lending is contracting, HELOC underwriting criteria is tightening, and demand in general for prime loans is waning as criteria there gets tightened as well; all this with government actions to bring down interest rates to spur lending! Oh what a tangled web we weave! When will they understand that when credit quality is deteriorating, home values falling, unemployment rising, consumer spending falling, and a severe economic slowdown that crunches individual balance sheets, lending SHOULD decline!