Refinance Free Credit

One of the most widely used performance-tracking indexes for the U.S. structured finance market, the ABX Index, might not be as good a gauge of credit risk for AAA-rated mortgage bonds as some might think, according to a recent report published by Standard & Poor’s Ratings Services.

“While we believe the ABX provides insight into the U.S. residential subprime mortgage market, we think its indices provide only limited insight into class-level creditworthiness among ‘AAA’ rated U.S. RMBS,” said credit analyst Andrew Giudici, a director in Standard & Poor’s U.S. RMBS surveillance
group.

“The ‘AAA’ tranches that were included in the original ABX indices were the last-pay ‘AAA’ bonds in their respective deals, which are relatively more exposed to losses than ‘AAA’ classes with a priority claim on cash flow.”

Giudici and the report’s other authors argue the ‘AAA’ classes share equally in any losses on a pro rata basis once credit enhancement is exhausted, structural subordination does exist in the form of payment priority — and that subordination often serves to protect senior-most bondholders.

Typically, all principal prepayments are initially directed to pay down the first ‘AAA’ class until it is paid off in full. Once that class is retired, all future principal is directed to repay the next class in sequential order (performance triggers may temporarily alter this payment priority, but we’ll avoid more complex issues here for now).

“As prepayments and losses build over the life of a transaction, the classes with an early claim on principal repay,” Giudici said. “Longer-dated ‘AAA’ classes remain outstanding as losses build and reduce available credit enhancement. As mortgage pools season, prepayment and loss trends provide insight into relative credit quality among all classes, including those rated ‘AAA’.”

S&P’s research comes on the heels of a very recent introduction of the ABX.HE.PENAAA tranche sub-index, or the “penultimate” AAA sub-index, which references AAA-rated bonds that are second to last in principal distribution priority.

It’s worth noting that the 2007 roll of both new penultimate sub-indexes — the ABX-HE-PENAAA 07-1 and ABX-HE-PENAAA 07-2 — settled at all-time lows Friday. The second 2007 series closed at $66.92, according to data provided by MarkIt, which administers the ABX index.

For more information, visit http://www.standardandpoors.com.

With the fourth installment of the much-admired Indiana Jones movie franchise ringing up box-office gold this past holiday weekend, California Attorney General Edmund Brown busted his own group of villians that had been using their knowledge of U.S. history to rip off troubled homeowners facing foreclosure.

A team of scam artists allegedly acquired deeds to hundreds of homes in foreclosure by convincing desperate consumers to place their property in a “land grant,” a phony and worthless real estate document.

Federal Land Grant Company — a San Diego-based business run by Bill Hutchings, his wife Xiaoke Li and former wife Shawna Landis — tricked desperate homeowners into believing that they could protect their homes from foreclosure by deeding their property to “federal land grants.” Land grant transfers, used hundreds of years ago when the United States was still acquiring land from other countries, are no longer recognized by any court or county assessor.

“There hasn’t been a legitimate use of the land grant since the conclusion of the Mexican-American war,” Brown said in a press statement last week. “If some fast talking scam artist offers a quick escape from foreclosure using archaic documents, be extremely suspicious.”

The scammers required homeowners to pay up to $10,000 to put their property in a so-called land grant, which the company claimed would prevent foreclosure. Federal Land Grant also tricked homeowners into signing over the deed to their home and paying the company rent.

To make the meaningless grants appear legitimate, the company attached a land survey from when property was transferred to the United States by a foreign entity hundreds of years ago. In San Diego, for example, the company attached a survey from the Spanish Land Grant of 1872 and said that the deed reinstated the land grant and would protect homes from foreclosure.

State investigators confirmed from realty specialists in the Bureau of Land Management that a “federal land grant” transfer is meaningless, and there is no mechanism in California for establishing a land grant on privately held land. Homeowners who are conned by the land grant scam are typically evicted from their property at the completion of foreclosure proceedings, and retain no legally recognizable title to their property.

At least two Riverside County Superior Court judges, when faced with foreclosure sales involving so-called land grants, did not give any consideration to the deeds and issued eviction orders sought by the lender.

Federal Land Grant often perpetrated their scam by inviting homeowners to attend weekly seminars on the fraudulent land grant program. During these seminars, which had up to 50 participants, the company convinced homeowners to enter a lease back scheme in which the homeowners transfer their property to Federal Land Grant and then make monthly payments, purportedly for rent.

Investigators in the California Attorney General’s Office said they have discovered more than 280 properties in San Diego and Riverside counties that have been transferred to Federal Land Grant or one of its affiliated companies. An additional 65 properties have been transferred in counties including Los Angeles, Orange and San Bernardino.

At least 60 homeowners have had their homes sold through foreclosures already, the state AG’s office said.

“The defendants preyed on mostly non-English speaking, Hispanic homeowners who were in foreclosure, claiming to offer assistance in preventing the victims from losing their home,” San Diego District Attorney Dumanis said. “These transactions were illegal and left the victims even worse off than they were before. Some of the victims have been evicted from their own homes when this scheme failed.”

PIMCO’s Bill Gross, manager of the world’s largest bond fund, is betting big on mortgages.

Yes, really.

The Financial Times reported last last week that Gross had shifted more than 60 percent of the $130 billion PIMCO Total Return fund he manages into agency-backed mortgage debt during the first quarter, a move that has put the PIMCO fund’s returns ahead of 99 percent of its peers. The fund has returned 12.6 percent over the past 12 months, according to Morningstar rankings, and 3.8 percent so far this year.

From the report:

“Government policy is moving to sanctify the status of the government-sponsored agencies. It became a question of which institutions would be sheltered by the government umbrella,” he said …

Mr Gross said Pimco was buying primarily mortgage agency debt and “not the subprime garbage”.

Of course, Gross has been making headlines and grabbing the attention of policymakers with continued bantering around what to do about “the subprime problem,” most recently suggesting that government-subsidized write-downs of mortgages in the private-party market would help stanch price declines. (See earlier HW commentary on the issue here).

But he surely hasn’t been investing in that space, instead favoring an age-old tactic used by most successful fund managers: divert attention into one area, while acting in another. And, if anything, his posturing about the need to do something for troubled subprime homeowners has only buttressed the emerging view of both Fannie and Freddie as saviors of a U.S. housing market undergoing what many economists feel is a needed correction.

As HW has covered extensively in recent weeks, returns in the agency-backed MBS market have been the best in well over a decade; excess returns over Treasuries were at their highest level since 1997 in April, a trend that certainly boosted those funds that had piled into the agency MBS market at the right time.

Which puts us squarely into the current state of the secondary mortgage market: as more than a few market pundits have noted, there are essentially two very distinct secondary markets right now — the agency MBS market, which is ballooning in size, and a sizeable junk-bond private party market teeming with subprime, Alt-A and option ARM mortgage debt gone bad.

Another day, another batch of Gloom-and-Doom stories in the news.  Remember to keep a level head — the media’s job, in part, is to sell newspapers and capture eyeballs.  Using the word “crisis” repeatedly is one way to meet that goal.

A few facts to keep it all in perspective:

1. There are still BILLIONS of dollars being lent to homeowners every single day.
2. In May, 98.3% of full documentation, “prime” conforming and jumbo mortgage payments were not 60 days late
3. In May, 99.5% of full documentation, “prime” conforming and jumbo mortgages were not in default

In other words, there is still a very low default for borrowers willing to submit tax returns, W-2s, bank statements, and other financial data along with their loan application.  This represents the large percentage of American homeowners and is why the mortgage “crisis” is not so bad for most people.

The credit market troubles with home loans are more “inconvenience” than “crisis” and, so far, are limited to those that are self-employed, are highly commissioned, have poor credit history, and/or are unwilling to document their financial world to a mortgage lender.

If you are feeling in any way overwhelmed, reach out and contact me for further insight, advice and opinion.  You’ll get better perspective from an industry insider than an industry reporter.