The shit is starting to hit the fan. Moody's is downgrading hundreds of subprime securities this afternoon. This will put many in the penalty box of forcing sales now as they cannot hold non-investment grade paper. The blood has just starting to run.
Here is an article out on Bloomberg about it. It looks nasty. Moody's Lowers Ratings on Subprime Mortgage Bonds, S&P May Cut By Mark Pittman July 10 (Bloomberg) -- Moody's Investors Service lowered the credit ratings on $5.2 billion of bonds backed by subprime mortgages and Standard & Poor's said it may cut ratings on $12 billion as the companies seek to deflect criticism they were too slow to act as home-loan defaults rose. Moody's cut ratings on 399 bonds and said it may reduce rankings on another 32 securities. S&P is preparing to lower the ratings on 2.1 percent of the $565.3 billion of subprime bonds issued from late 2005 through 2006 because the housing slump is worse than the company anticipated. U.S. Treasuries rose, the dollar slumped and financial company shares led stocks lower. Ratings changes ``are going to force a lot more people to come to Jesus,'' said Christopher Whalen, an analyst at Institutional Risk Analytics in Hawthorne, California. ``When a ratings agency puts a whole class on watch, it will force all the credit officers to get off their butts and reevaluate everything. This could be one of the triggers we've been waiting for.'' Investors criticized S&P, Moody's and Fitch Ratings because their ratings on bonds backed by mortgages to people with poor or limited credit don't reflect the fastest default rate in a decade. Prices of some bonds backed by subprime mortgages have declined by more than 50 cents on the dollar in the past few months while their credit ratings haven't changed. The actions would be the biggest ever in the subprime market, the companies said. Insurers and pension funds may be among investors required to sell their bonds if they are downgraded, potentially driving down prices of $800 billion in subprime mortgages and $1 trillion of collateralized debt obligations, which package mortgage bonds into new securities. `Global Universe' S&P said it is also reviewing the ``global universe'' of CDOs that contain subprime mortgages. Investors in CDOs alone stand to lose as much as $250 billion, according to Institutional Risk Analytics, which writes computer programs for auditors. The yield on the benchmark 10-year note fell the most since June 29, declining 12 basis points, or 0.12 percentage point, to 5.02 percent at 4:36 p.m. in New York, according to bond broker Cantor Fitzgerald LP. The dollar dropped to $1.3729 per euro from $1.3626 late yesterday. An index of credit-default swaps linked to 20 securities rated BBB- and created in the second half of 2006 fell 7.4 percent to a low of 51.42, according Markit Group Ltd. The ABX- HE-BBB-07-1 index has dropped by nearly half since January, reflecting growing expectations of defaults on underlying bonds. Lehman Brothers Holdings Inc., this year's biggest U.S. underwriter of mortgage bonds, led declines among securities firms with a 5 percent drop. Bear Stearns Cos., No. 2 in mortgage-backed securitizations, fell 4.1 percent. Both firms are based in New York. Bear Stearns Accurate rankings for mortgage bonds and CDOs are important because the securities trade infrequently, making it difficult for investors to immediately value their holdings when market conditions change. Instead, they often rely on sales of similar securities or computer models that use ratings and past performance of the underlying collateral to derive a value for their holdings. CDO investors were jolted last month by losses in two hedge funds run by Bear Stearns. The firm was forced to inject $1.6 billion into one fund after creditors began seizing assets. The threat of forced sales sparked concerns that prices would ratchet down. Almost 65 percent of the bonds in indexes that track subprime mortgage debt don't meet the S&P ratings criteria that were in place when they were sold, according to data compiled by Bloomberg. `Not Abating' S&P said today it plans to change the methods it uses to rate existing and new mortgage bonds to reflect the increased likelihood of mortgage defaults and losses. ``We do not foresee the poor performance abating,'' S&P said. ``Loss rates, which are being fueled by shifting patterns in loss behavior and further evidence of lower underwriting standards and misrepresentations in the mortgage market, remain in excess of historical precedents and our initial assumptions.'' S&P's review covers ratings on 612 pieces of bonds backed by subprime mortgages. S&P will implement a ``stress test,'' of hypothetical scenarios to see how a bond will react. While most of the securities being reviewed by S&P have ratings of BBB+, BBB, or BBB-, the lowest investment grade, some were rated as high as AA. The credit rating of any bond will be cut to CCC+, the sixth-lowest junk rating, if the test shows it would experience a principal loss within the next year, S&P said. Ratings will be reduced to B, the eighth-lowest rating, if the security may have a principal loss in the next 13 to 24 months. S&P will lower the rating to BB if the bond is projected to have a principal loss in the next 24 to 36 months. Criticism Declines in the ABX index indicate that investors believe the bonds are worth less than their ratings suggest. ``If you look at where the market was trading these bonds, they weren't trading like BBB bonds,'' said David Land, a portfolio manager in St. Paul, Minnesota at Advantus Capital Management, which owns $783 million of mortgage bonds. S&P said it will reassess ratings and seek higher protection for investors on bond classes that rank directly above any security it downgrades, a change in practice. Critics of the ratings companies include Bill Gross, chief investment officer at Pacific Investment Management Co. Gross, who runs the world's biggest bond fund, said last month that Moody's and S&P gave mortgage bonds investment-grade ratings because they were fooled by the ``six-inch hooker heels'' of the collateral backing them. `Why Now?' ``I'd like to know: Why now?'' Steven Eisman, a portfolio manager at Frontpoint Partners in New York said on a conference call hosted by S&P to discuss the possible ratings changes. ``The news has been out on subprime now for many, many months. The delinquencies have been a disaster for many, many months. The ratings have been called into question for many, many months. I'd like to know why you're making this move today instead of many months ago.'' Tom Warrack, an S&P managing director, said it takes time for performance to show through. ``We have been surveilling these deals actively on a regular basis beginning in 2005 and 2006,'' Warrack said on the call. ``We believe that the performance that we've been able to observe now warrants action.'' In response to the investor criticism, executives at S&P, Moody's and Fitch have said they were waiting until foreclosure sales of homes proved that the collateral backing the bonds has declined enough to create losses. James Jockle, a spokesman for Fitch, said he had no immediate comment. No Manpower Some investors assume the ratings will lag the bonds' credit quality because there are ``thousands of deals in this space, and the manpower it takes to review each one means they can't stay on top of things,'' said Paul Colonna, a bond manager for Stamford, Connecticut-based GE Asset Management, which has $120 billion in fixed income assets under management. Many of the bonds S&P is reviewing were made up of loans originated by New Century Financial Corp., which filed for bankruptcy protection in April, and Fremont General Corp., which federal regulators forced from the subprime-loan business in March. Delinquencies and foreclosures are increasing for bonds issued in 2006, S&P said. Total losses on all subprime transactions issued since the fourth quarter of 2005 are 0.29 percentage point, compared with .07 percentage point for similar transactions from 2000, which until now had been the worst performing this decade. S&P also said doubt had been cast over some data it used after the Mortgage Asset Research Institute reported mortgage fraud had risen above industry highs. ``Data quality is fundamental to our rating analysis,'' S&P said. ``The loan performance associated with the data to date has been anomalous in a way that calls into question the accuracy of some of the initial data provided to us.'' To contact the reporter on this story: Mark Pittman in New York at mpittman@bloomberg.net . Last Updated: July 10, 2007 16:45 EDT