Massive Wave of 2nd Lien Downgrades

The ratings agency Thursday announced it lowered ratings on 793 classes worth $23 billion in 116 U.S. residential mortgage-backed securities backed by closed-end second-lien mortgage collateral issued from the beginning of 2004 through yearend 2006. At the same time, all 746 classes that were on CreditWatch negative were removed from such status.

The negative actions were due to expectations that losses on second lien RMBS issued in those three years will “significantly” exceed historical precedent and because recent performance data indicates that performance is likely to be even worse than previously anticipated, the ratings agency stated. Factors driving the performance include looser underwriting standards, pressure on home prices, speculative borrowing behavior, risk layering, very high combined loan-to-values, payment increases on first-lien mortgages, questionable data quality and more difficulty in borrowers being able to refinance.

The downgraded classes account for about 32 percent of the total volume of U.S. second lien RMBS rated by S&P in the three-year period. Of the AAA bonds affected, 58 classes were downgraded below investment-grade. Over 59 percent of the volume of classes was lowered from AAA ratings, about 15 percent from AA, 11 percent from A, 7 percent from BBB, close to 3 percent from BB, more than 3 percent from B and less than 1 percent from CCC.

S&P said its revised methodology for loss curves in second lien RMBS includes a more stressful cumulative loss curve from high CLTV transactions issued in 1996, and the current charge-off rate and delinquency levels it has observed in recent performance data. From the July 2007 distribution date to the November 2007 distribution, total delinquency has increased by 14% to total 11.61% for the affected 2004 deals, by 43% to a total 15.25% in the 2005 issuance, and by 36% to 16.92% for the 2006 vintage. Cumulative charge-offs increased to 3.34% in November from 2.49% in July for the transactions issued in 2004, to 7.57% from 4.48% for the 2005 vintage and to 9.55% from 3.84% for the 2006 deals.

Second lien-backed deals that saw downgrades by Moody’s Investors Service because the bonds’ current credit enhancement levels, including excess spread, compared to the current projected losses may not be consistent with the existing ratings on the bonds included ACE Securities Corp. Home Equity Loan Trust, Series 2005-SL1; First Franklin Mortgage Loan Trust 2005-FFA; and two deals issued by GSAMP Trust in 2005. And this same reason led to downgrade and, or, potential downgrades on classes of home equity line-of-credit-backed deals CWHEQ Revolving Home Equity Loan Trust Series 2006-A and Bear Stearns Second Lien Trust 2007-1, according to several news releases.

Moody’s said analysis of the credit enhancement provided by subordination, overcollateralization and excess spread relative to the expected loss resulted in downgrades for downgrades on second lien-backed Terwin Mortgage Trust 2007-1SL and downgrades on two certificates from HELOC-backed GreenPoint Mortgage Funding Trust 2007-HE1, Mortgage-Backed Notes, Series 2007-HE1.