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Mortgage-Backed Mess

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By RodgerRafter
March 25, 2008

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I haven't posted in a few days because I've been trying to immerse myself in the world of residential mortgage backed securities to figure out exactly how bad the mess is and what it will mean for the issuers.

I found a nice, chart-filled report from Fitch describing what's going on in Sub-Prime and Alt-A RMBS.

I think the most impressive chart is on page 10 and it shows how Foreclosures and REO are ballooning out of control within the RMBS universe.

Lots of other charts show how:
About 5% of current sub-prime loans are going delinquent each month.
Defaults are up to about 30% already for 2005 and 2006 vintages, with 2007s catching up quickly.
Loss severity has been trending up, to the 60% range.

Fitch is projecting losses of 21.1% on 2006 vintage pools (assuming about 48% frequency of foreclosure and about 58% loss severity) and 25.8% for 1st half 2007 vintage (42% and 63%).

Based on this, they downgraded almost half of AAA RMBS securities and most of the lower rated ones as well.

To me that seems overly generous of them, as I think they are underestimating the impact huge levels of REO will have on loss severity and the effect a slowing economy will have on frequency of foreclosure.

I've been trying to "follow the money" through the remittance statements ( ) for one of Novastar's MBS trusts (2006-5). They don't make it easy. I've also read the prospectus and prospectus supplement ( ). There's a whole lot of interesting info about how they work, but no clear explanation of how the numbers connect in the statements.

So far they haven't missed any interest payments to Mezzanine or AAA investors and a third of the principal has been returned to the AAA levels as a result of prepayments (early on) and liquidations (more recently). However, it also looks like they did this recently by advancing money and that will eventually be taken back via a senior claim on payments. If I'm reading it right, pretty much all of the Mezzanine and AAA tranches could go bad at almost the same time. Of course i may not be reading it right. From the Prospectus:

"The servicer will be required to advance amounts representing delinquent payments of scheduled principal and interest, other than balloon payments, as well as expenses to preserve and to protect the value of collateral, in each case to the extent considered recoverable. Reimbursement of these advances is senior to payments to the certificate holders."

Calculated Risk has a good 3-part summary of how MBS work in his UberNerd section:

Enough of the world of private label RMBS... Freddie Mac issued their Monthly Volume Summary today:

The delinquency trend now is:
Jan 0.43%
Feb 0.43%
Mar 0.40%
Apr 0.40%
May 0.40%
Jun 0.40%
Jul 0.44%
Aug 0.46%
Sep 0.51%
Oct 0.54%
Nov 0.60%
Dec 0.65%
Jan 0.71%

Of course this excludes "modified loans," often where delinquent borrowers are loaned additional, unsecured money to make them temporarily current. The GSEs have been doing a lot more of this recently.

It also doesn't count their structured portfolio where delinquencies are much higher. The trend there:

Jul $22.4 B, 8.7%
Aug $20.8 B, 8.8%
Sep $20.2 B 9.0%
Oct $20.2 B, 9.32%
Nov $19.7 B. 9.45%
Dec $19.2 B, 9.86%
Jan $19.0 B, 10.43%

REO is piling up at the GSEs, just as it is in the private label MBS world and at big lenders. I started tracking Fannie's REO last week for a sampling of big cities:

Atlanta has 183 Fannie Mae REO properties at last count.

To their credit, Novastar's 2006-5 trust has liquidated about 10% of REO per month lately and Countrywide appears to have brought their own totals down:

I see the three big, ugly overhanging factors for the housing market right now:

1. Pressure to unload REO quickly as MBS pools and banks face liquidity concerns.
2. The ability of consumers to purchase homes as their budgets get squeezed by rising costs of living.
3. Rising defaults and declining purchases as the economy slows.

It will be interesting to see how these factors present themselves in the data in coming months.