AAA Bonds That Fail the Investment Grade Test

Check out this interactive chart from Bloomberg which looks at the 80 AAA bonds in the ABX. It compares the ratio of credit support to collateral at risk for these 80 bonds. It makes it pretty clear that 74 of 80 of these funds fail the test used by the ratings agencies for investment grade i.e. above two times credit support. Yet, miraculously many of these bonds still remain AAA according to the rating agencies. Twelve of the bonds in the ABX, mostly those issued in 2006 and 2007, have collateral at risk which exceeds credit support. Check out The Prince’s post encouraging the rating agencies to come clean and proceed with across the board downgrades of mortgage related securities. This is getting ridiculous, don’t you think?

For the uninitiated:

Credit Support: Percentage of a bond’s total collateral that can be lost before it stops making payments.

Collateral at Risk: Percentage of a bond’s total collateral that is 90 days delinquent, foreclosed, or repossessed.

click to enlarge

Comments

[andrewpmk]

ABX = Junk bond fund

[The Princeof WallStreet]

Couldn't agree more.

[Vikram]

The market is already pricing the risk.
Here is what the different AAA ABX indices are trading at:
Index Series Version Coupon RED ID Price High Low

ABX-HE-AAA 06-1 6 1 18 0A08AHAA1 86.19 100.38 84.17
ABX-HE-AAA 06-2 6 2 11 0A08AHAB8 70.06 100.12 66.1
ABX-HE-AAA 07-1 7 1 9 0A08AHAC6 55.94 100.09 53.46
ABX-HE-AAA 07-2 7 2 76 0A08AHAD4 52.92 99.33 52.47

Another thing to keep in mind: The salvage value for loans on homes in foreclosure varies between 50-80% of the home's equityng depending on the size of the loan and the market condition. Assuming an average recovery of 65%, the number of loans defaulting has to be 3 times the credit support before the bonds get hit. And not all these loans were no-down payment loans; in many cases they homeowners had some equity in the deal.