As Alt A Mortgages Breakdown, Ultrashort Financial Not So Cool Anymore

This market is so difficult right now trying to balance the reality of what is happening on Main Street with the current and future political interference into free markets. Some of the news out of the real economy is really scary - I had mentioned last August when "subprime" was the big issue that the mortgage issues will climb the food chain, into Alt A loans and then finally into prime. Subprime is just a convenient label and the weakest credit risks, so they would be the first to go. But not the only - as was conventional wisdom back then i.e. "those darn subprime people are the cause of all this - they never should of had a house in the first place". It is so much bigger than that - a truly stressed consumer up and down the food chain.

However... how do I balance this (correct) thesis against the potential for some arm of the government to step in by summer and literally buy up toxic mortgage paper directly? This is the conundrum and why this market is even harder than it appears. If the free markets were allowed to reign I would have one very clear strategy but with all the King's Horses (and Men) working to interfere it clouds things up. Here is some "reality" of just how quickly the vintages of Alt A mortgages from 2005-2007 (the worst era of reckless lending) are degrading. Keep in mind these are sequential increases, meaning one month over another - the pace is incredible - 2006 and 2007 are just horror shows. Frankly, it is degrading more quickly than even I thought. (Is this anywhere in the mainstream financial press or are we too busy high fiving the fact we are going to overload Fannie and Freddie with mortgages?)

• Delinquencies on alt-A mortgages pooled into securities between 2005 and 2007 continue to rise, Standard & Poor's said in a report released Wednesday. Mortgage-backed securities are pools of mortgages combined and sold to investors. Alt-A mortgages are loans given to customers with minor credit problems or who do not have enough documentation to receive a traditional, prime loan.
• For securities rated by S&P in 2005, 11.7 percent of current outstanding balances were delinquent in February, a 6.4 percent increase from the previous month.
• About 15.9 percent of securities rated in 2006 were delinquent in February, a 9.7 percent increase from January.
• Delinquencies for securities rated in 2007 increased 14.3 percent in February to about 10.2 percent.
• S&P said seriously delinquent loans -- loans at least 90 days past due, in foreclosure or homes owned by banks -- continued to rise in February for all three vintages as well, with 2006 deals performing the worst. About 10 percent of 2006 loan volume was seriously delinquent at the end of February

Folks what this means is 2007 paper in the Alt A arena (that includes the whole year including Q4 2007 which is not even half a year old), is already delinquent to the tune of 1 in 10 mortgages! The oldest mortgages in this group are .75 years to 1.25 year old. And already a 10% failure rate. Scary. Scary. Scary.

BUT what do you do when the government will eventually be buying all this paper ? (since it is such a bargain and it is only trading low due to inefficient markets not that its purely junk <---Kool Aid argument) You my taxpayer friends will be paying for the losses, but the markets will scream higher when this day does come as their hands will be washed of this nuclear waste... tough from an investing point to bet either way. But after reading this story, I am going to need to drink a gallon of Kool Aid to keep the faith. Hell, I might need to take a bath in it...

Speaking of Ultrashort Financial (SKF) I took another gander at it's weightings and it's become a bit less attractive as the underlying financial index has changed the weighting as Citigroup has imploded. Last I looked in September [Adding to my Ultrashort Financial Today] I wrote

The top 5 holdings make up 40% of the index, these names are: Citigroup (C), Bank of America (BAC), JPMorgan Chase (JPM), Wells Fargo (WFC), Wachovia (WB)

I don't have the exact weightings in the old post but I do remember I loved the fact Citigroup was the top dog (literally). But now? They've dropped Citigroup to only a 5% weighting. Darn.

Just so I have a historical record in the blog the top 5 now are

Bank of America 7.1%

JPMorgan 5.6%

Citigroup 5.6%

American International Group 5.0%

Wells Fargo 3.7%

It is too bad... of the top 5, Bank of America has the Countrywide (CFC) acquisition to deal with, but based on the Bear Stearns deal they can probably go to the government behind closed doors and say, look we will walk away from this deal unless tax payers guarantee all losses - you did it for Bear, we want the same deal for saving 20% of the mortgage market. Paulson will say, sounds great to me! JPMorgan just stole Bear Stearns and its losses are going to be paid by you, the taxpayer, - so they are golden. And I like Wells Fargo as an operator (except the fact it is so focused on CA). So that leaves only 2 dogs in the top 5. Bummer. And then Goldman Sachs (GS) who is running this country behind the scenes is #6, and US Bankcorp which is actually a great bank is #9. So this makes this index less attractive than it used to be, that's for sure.

Disclosure: Long Ultrashort Financial in fund and personal account

Comments

[jimarb:]

my post on " what happened todat "
what happened today 3/20 - looks like Bear Stern jumped the gun by confessing to the worth of it's bad paper last week - Leyhman on the other hand stalled and therefore over the weekend learned it could take it's bad stuff to the window and exchange it for better stuff - so they kept their mouth shutg - who lost ????? THE TAX PAYERS - who won ????? the guys that made all the bad deals ( and paper ) and are already enjoying their ill gotten gains - there has to be a better way - no9 chance for those not well connected

blueeyedfool answered - why did the taxpayer lose and not Bear Sterns shareholders ?

I answered - the shareholders had plenty of time in the last several months to review Bear Stern holdings ( and get out ) - the taxpayers had someone else make the decision for them - and on the weekend

more - now the taxpayers are saddled with the loss - people need to realize just who the government is and who pays the governments bills - many paying for the good of the few

2008 Mar 20 09:43 PM

[dmankoff:]

good article - in past 48 hours it seemed the entire Wall Street community has embraced the financials. Government intervention too powerful.... xlf should go up now and also the UYG (double up inverse of the XLF)

2008 Mar 20 10:26 PM

[Fighting Yoda:]

Financials will go way down- mortgage resets have not even begun. Lot of writedowns and blow ups still to come. UBS, MER are on the deck Monday.

SKF double short XLF.

2008 Mar 20 11:00 PM

[sliman:]

Does the UYG and SKF have the same stocks?

2008 Mar 21 10:46 AM

[moon:]

counterparty risk is rising anyone concerned UBS envolved in swaps..... just curious have edged out

2008 Mar 21 12:14 PM

[john1:]

Re: "many paying for the good of the few"

Oh, come on now. Don't you mean the peasants willing supporting the most worthy members of our nation? That's how it's supposed to be. Otherwise you’d have redistribution of wealth, which – as we ALL know – isn’t how God wants America to run, and the peasants show their understanding of this by voting for God’s favorite political party. You liberals are all the same!

2008 Mar 21 01:33 PM

[phlash79:]

Yes it would seem that SKF is the place to be...I legged in as the price started falling...I have seen several analyses of the RBMS --residential backed mortgage securities and the CBMS -- commerical backed mortgage securities....specific... monthly default rates and they agree with they synopsis above...in fact the graphs show the upcoming resets for sub-prime are defaulting earlier and at a higher rate...it also showed higher rates for the ALT A and even the Prime...MY GREATEST FEAR with this position is the continued intervention in creative and unexpected ways that the government continues to implement to keep the credit market and the BIG 5 Trading houses from freezing up...this is one play where I believe patience and wide stops to the downside will be necessary...unless the widespread market begins to learn the magnitude of the issue and that we have only been dealing mostly with loans defaults from 2005 resets...

Have a Happy Easter...

2008 Mar 22 11:01 AM

[TraderMark:]

phlash, agree with you 100%

We have a lot more fallout in the Alt A, prime mortgage and then we move on to commercial, credit card, and the like as the consumer recession blooms. But it will take time to play out AND it is very difficult to game anymore with the constant interventions - what the Fed has done the past 9 days is simply historic and makes things very tricky.

www.fundmymutualfund.c...

It is not a free market, so it not easy to trade anymore.

2008 Mar 22 05:27 PM

[loben:]

ON 03/24/08 SKF closed at 103.77. It may trade sideways a while. If you are long don't worry, you'll get another chance. My target says it will be going up to 160-180 around Oct 08. Remember, the Oct/Nov crash thingy?

2008 Mar 25 03:10 AM