This time it really is different (no, really it is)

MikeStaffertonThis time it really is different (no, really it is) by Mike Stafferton 

Hands up: how many people noticed that last week there was the first launch of a rated sub-prime mortgage securitisation since the crisis? And of those that did how many thought: "here we go again, time to head for the hills" or "let's have look... ok, safe as er, houses but with a juicy coupon, I'm in"?

It's perhaps not surprising that investors who experienced or witnessed the losses from even supposedly AAA-rated mortgage-backed securities during the crisis have since steered clear of the whole area. But that is to ignore one fairly simple and major change that hasn't had much publicity. Securitisations are a bit like banks: banks have to hold a Basel-prescribed minimum amount of capital to protect depositors from possible losses; securitisations also have a hierarchy of different tiers of liabilities and if the issuer wants a good rating for the top tier that tier has to have a big enough cushion of subordinate tiers beneath it. The minimum size is prescribed by the rating agency, based on its assessment of the riskiness of the assets. Which is where it all went horribly wrong in the crisis: very simply, all the agencies under-estimated the riskiness of the sub-prime mortgages and so prescribed too thin cushions. So even the supposedly sacrosanct top tier with its AAA rating experienced loss. For example, using round numbers a typical pre-crisis sub-prime AAA tranche had a cushion of a bit over 20%; but cumulative losses averaged over 25%, resulting in losses for the AAA. So what's changed?

The size of the cushion

Having been way too aggressive the agencies now have gone to the other extreme: the top tranche in last week's issue has a cushion of nearly 45%. So even if we experience the same intensity of crisis again (please, no) the losses will be nowhere near touching the top tranche. And even then the top tranche only got a single A rating. What return do you get for this almost Armageddon-proof security? The equivalent of around LIBOR plus 150 basis points. In the current negative yield environment for many government bonds this screams 'Buy' at me very loudly - provided you can live with limited liquidity and, if you're a large bank or insurer. Happy hunting.