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Weekly Thoughts by Jason S. Weissman for February 15th, 2010

“Residential CDO’s Still Are a Problem, a Big One---and Note to Self, Caveat Emptor, Always”

In this week’s Economist, in the special report, on “Financial Risk”, they featured the diagram below.

www.economist.com/specialreports/displayStory.cfm

Simply put, there is no need to explain it. Is this unbelievable? Not to state the obvious, but how can professionals at the bond rating agencies have such variance in their risk underwriting? The A+ Paper issuance category had an estimated default rate of .06% default rate over a three year period. The actual default rate was 20.96%! That’s a variance rate between predicted an actual of performance of 34,833%. How can someone be off by an error of 34,833%? Especially, an expert, who focuses daily on underwriting and analyzing risk!

Rating	Estimated Three Year Default Rate	Actual Default Rate	% Variance between Estimate and Actual
AAA	0.001	0.1	9900%
AA+	0.01	1.68	16700%
AA	0.04	8.16	20300%
AA-	0.05	12.03	23960%
A+	0.06	20.96	34833%
A	0.09	29.21	32356%
A-	0.12	36.55	30358%
BBB+	0.34	48.73	14232%
BBB	0.49	56.1	11349%
BBB-	0.88	66.67	7476%

Source: Variance calculation by Boston Realty Advisors

So when investing in real estate or notes securitized by real estate (or for any investment vehicle for that matter ), you need to rely on “practical” gut feel knowledge. Simply put , when hundreds of thousands of home buyers were putting zero equity into their home purchases without reserve or “skin” in the game, there was an obvious practical problem. This was definitely a case of “group think” on the part of the rating agencies. This topic has circulated the media world and our industry for about four years now. I am writing about in today’s Weekly Report simply based on the extent of how bad this problem was. Even in 2009, no one would of predicted that close to 70% of all BBB- paper would be in default.

So on Caveat emptor: don’t trust the experts, avoid group think. If something doesn’t feel right, it isn’t right. That's how market bubbles are created; market fundamentals that just don't match up with 'everybody's doing it' mentality. So, bottom line: trust your judgment and “Let the Buyer Beware!”

My Prediction: The real estate markets are functioning quite rationally, now. The micro-trend that I am now following that just doesn't make sense, is the following: Why/how the FHA is still lending between 95-97% on residential properties…I wish I had some other macro market "bubble" to predict, but this is the only one I can spot, for now.

I am the Founder and Principal of Boston Realty Advisors. Please check in weekly to review my blog entries. I value client/reader feedback!

Posted at 02/16/2010 09:08 AM by Jason S. Weissman

Categories: Investment, CMBS, Subprime Mortgage, CDO, Lending

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Archive for the 'CDO' category

Weekly Thoughts by Jason S. Weissman for February 15th, 2010