Monday, October 29, 2007

Fithch Changes its Mind

Fitch Ratings said it might cut ratings on $36.8 billion of collateralized debt obligations (CDO) linked to residential mortgage securities.

Fitch, a unit of Paris-based Fimalac, follows Moody's Investors Service, which last week cut ratings of CDOs linked to $33 billion of subprime mortgage securities. Lower ratings may force owners to either mark down the value of their holdings, or sell the securities. Moody's, Fitch and Standard & Poor's in July began lowering ratings on hundreds of mortgage-linked securities after their value tumbled as much as 80 cents on the dollar.

``The market at this point no longer believes the rating agencies when it comes to mortgage-related products,'' said David Castillo, who trades CDOs in San Francisco at Further Lane Securities. ``It's merely forcing the hand of investors who are ratings-driven from an investment-criteria perspective.'' If they don't believe the CDO ratings then how can an investor trust the ratings on other bonds?

AAA Cuts

All AA, A and BBB rated CDOs are likely to be cut to below investment grade, Fitch said. Speculative grade, or junk, issuers carry ratings of BB+ or lower. About two-thirds of the AAA securities are either mezzanine securities or CDOs of CDOs and are likely to be sliced to between BBB and BB-, Fitch said.

The most severely affected are recent CDOs, which had both the worst-performing subprime mortgage bonds and the highest percentage of those securities as assets, Fitch Ratings Managing Director John Schiavetta said.

``It is clearly subprime that is causing this,'' said Schiavetta, who is based in New York. ``And most of that is from 2005 onward with the bulk of it in '06 and `07.''

Schiavetta predicted that there will be CDOs that will default, including the top-rated AAA parts.

One has to wonder how something that was rated AAA in the spring of 2007 could be worth nothing in October of 2007. Is this a case of throwing the baby out wit the bath water or are we in more serious trouble than anyone thought? I have been concerned that the pendulum was swinging to far in one direction with all of the rating downgrades. I am not so sure now that the pendulum has moved as far as it seems.

If you read the announcement from Fitch more closely, you will see that they are downgrading CDO’s with an AAA rating to junk status. Somebody needs to ask how Fitch and others rated this CDO AAA in the first place. If the rating agencies used basic criteria to rate CDO’s did they use the same criteria to rate other bonds? What else is out there that we don’t know about that has not come to the surface yet?

Dan Perkins

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