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Rating Downgrades Swamp Alt-A Bonds
Asset Backed Alert, Harrison Scott Publications Inc. (February 27, 2009)

The values of securities backed by alternative-A mortgages took another dive this week, after a raft of senior bonds were downgraded to junk status.

Moody's has revised grades since last Friday on billions of dollars of securities collateralized by alt-A credits, lowering many from triple-A to below-investment-grade in one fell swoop. The underlying private-label mortgages, which have performed below expectations, were originally written for prime-quality borrowers but received the alt-A designation because they didn't meet loan-underwriting standards set by Fannie Mae and Freddie Mac.

Overall prices for alt-A bonds are likely to keep declining over the next six months, as Moody's continues downgrading such deals. The agency expects their collateral-default rates to peak around the fourth quarter.

Alt-A bond prices have been declining since last year amid financial-market turmoil and weakening housing prices. This week's downgrades accelerated that trend, as buysiders anticipated a flood of secondary-market offerings from large institutions that can't - or just won't - hold junk-rated bonds.

Market players pointed to State Street Global Advisors as a potential seller, since the Boston money manager is believed to be sitting on a massive cache of alt-A MBS. MetLife and several large banks also hold substantial amounts, including Barclays, Citigroup and RBS Greenwich. Outstanding alt-A bonds that still have their triple-A ratings were making the rounds at prices of 45-49 cents on the dollar in recent days, down 5-10 cents from a week earlier. To be sure, those steep discounts will convince some investors to hang on to their alt-A bonds. But that could be tough for banks, public companies and financial institutions that are required to hold capital against risk tied to their investments.

They're now scrambling to boost reserves, adding "a lot of stress to the capital structure," one market player said. "And that's got everybody on edge because so many of these guys are running on empty." In downgrading the alt-A bonds, Moody's cited mounting losses and rapidly rising delinquency rates among the underlying loans. The agency focused on issues from 2-5 years ago, when the market was engaged in a frenzied run-up in mortgage-lending and securitization activity that culminated with its collapse in mid-2007.

Investors were initially attracted to those issues because alt-A loans were presumed to be of high quality. But the credits have often performed more like subprime home loans, which is a problem for bondholders because alt-A deals usually came with much lower returns and credit-protection levels.

"Clearly these investors thought these bonds were going to be safe and they were just plain wrong," one source added.



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