Yes, Virginia, Servicers Lie to Investors Too: $175 Billion in Loan Losses Not Allocated to Mortgage Backed Securities (and Another $300 Billion on the Way)
The structured credit analytics/research firm R&R Consulting released a bombshell today, and it strongly suggests that prevailing prices on non-GSE (non Freddie and Fannie) residential mortgage backed securities, which are typically referred to as “private label” are considerably overvalued.
R&R Consulting described how the reports presented to RMBS investors show losses at the loan level (which is super eye-numbing detail in the investor reports) that have NOT been allocated to the bonds (boldface ours):
On the securities performing at December 2011, a universe of approximately $1.42 trillion, R&R estimate the amount of additional losses likely to materialize is $300 billion, with one-third concentrated in ten arranger names, including Countrywide, Morgan Stanley and JP Morgan. About 17,000 tranches, or 34% of the universe analyzed by R&R, may lose up to 83% of their remaining principal.
In addition, R&R estimates that approximately $175 billion of losses already incurred on the loans have not yet been allocated to the bonds in the related transactions. Failure to allocate realized loan losses could distort the valuation of related RMBS tranches.
In the course of conducting valuations on RMBS, the R&R analytics team discovered widespread, serious, repeated data discrepancies. Ann Rutledge, a founding principal, asked the team to measure the magnitude of the discrepancy on the RMBS universe. To do this, R&R subtracted cumulative losses allocated to the tranches from unallocated, expected losses, calculated as the sum of defaults, bankruptcies, foreclosures and REOs minus recoveries. “The results were very disturbing: $175 billion of unallocated current losses and $300 billion of imminent losses,” Rutledge said.
Now you might say, how can investors NOT know this is happening? Have you ever looked at an investor report on MBS? They are really really nerdy. Summary stuff up front, tons of pages of detail. Now bond fund managers are presumably paid to care about nerdy stuff like this, but I have spoken to some MBS lifers who have gone to the buy side, and they tell me that the level of expertise among MBS investors is not high.
Another great article that you can check out here…