My 1st Million At 33 – yes, you can do it too

Using the data taken from Mish’s article:

The tranche breakdown shows total deal size. Total size is 519.159M, “A” Tranches are 476.069M total, “M” Tranches are 30.112M total, “B” tranches 7.788M total and “C” tranche is 5.19M total.

As of today, tranches A1 through A5 are all still rated AAA . Those 5 tranches constitute $476.069M out of an original pool size of 519.159M. In other words, 91.7% of this entire mess is still rated AAA even though REOs are now up to a whopping 10.48% and 60 day delinquencies are 32.69%. Moody’s and the S&P should be embarrassed by this.

The following is just an estimate based on my understanding and guesses on the bond markets: Based on my observation from going to home auctions, REOs are being sold at prices of about 50% to 75% previously valued. Let me use an average of 60% from previously valued after all the fees and expenses, and that’s only assuming 5% or less are fraudulent loans where the property values can be just 10% to 30% of the loan. Assuming that the average loan-to-value LTV ratio was 92.5%, midway between 5% and 10% down payment, the loss on the loans for REO will be (92.5% – 60% recovered)/(92.5%) = 35% loss. Furthermore, it’s probably safe to assume that 90% of those 60 day delinquencies will go into REO. Assuming the rest of the loan do perform, you will be looking at a total loss of 32.69% * 90% * 35% + 10.48% * 35% = 14% of the principal. Let’s say the average interest rate is 6%. The performing loans are 100% – 32.69% * 90% – 10.48% = 60%. With 60% earning 6% divided for all the A tranches (476.069M/519.159M = 91.7%), the A tranches will only be getting an average of 3.9% interest instead of maybe 5.5% that they “deserve”. To get back to 5.5% yield on a 30-year mortgage bond for the same absolute cash flow, the bond prices must fall by about = (1.039^30/1.055^30) or to 63% of its original value. Of course, that does not include any future decrease on the cashflow. Obviously, when all of those REOs are recovered at 60%, the bottom tranches will experience 100% loss. It will wipe out 100% of all the non-A tranches, and more. A tranches will on the average experience a (91.7%-(100%-14%)) / 91.7% = 6.2% loss. Therefore, that will be a 6.2% forced principal loss, and a (100%-63%)=37% marked-to-market loss. Yeah, and that’s for the terrific AAA mortgage bonds that you buy into.

Here is price chart for a AAA bond maturing in 2038 (30 years) from the ABX-HE-AAA 07-2 series at MarkIt.com. It already has a loss of (70-45)/70=36% since this January 2008.

Very unfortunately, real estates will get worse, not better. I expect that these AAA bonds to experience a horrendous loss, something that if you ever put your retirement money into such “fixed income” investment, you would want to forget about it, and will vow to never buy a single US dollar again in your now shorten retirement life and a shorten lifetime possibly due to the financial stress.

I don’t know who else is holding all these losses besides banks. But eventually someone will find out and puke, and will come back and sue all the credit rating agency and bankers for jail time. Even then, it won’t give you back the lost paper money. Don’t let AAA cheat you out of your retirement. Protect your nest egg carefully. For the first time in history, you could be beter off investing your money in stock markets, rather than “fixed income” in a bear market. And where on Earth and when in human history can someone buy a highly rated bond and experience such a big loss? That is USA under Greenspan & Bernanke’s realm.