by Tanta on 7/10/2007 11:23:00 AM

I think we missed our Friday afternoon downgrades last week because of the odd holiday schedule. This one, however, caught my eye today:

Fitch Ratings-New York-09 July 2007: Fitch takes rating actions on the following Structured Asset Security Corp. (SASCO) residential mortgage-backed certificates:
Series 2006-ARS1:
--Class A1 affirmed at 'AAA';
--Class M1 affirmed at 'AA+';
--Class M2 affirmed at 'AA';
--Class M3 affirmed at 'AA-';
--Class M4 rated 'A+' is placed on Rating Watch Negative;
--Class M5 downgraded to 'A-' from 'A' and placed on Rating Watch Negative;
--Class M6 downgraded to 'BBB' from 'A-' and placed on Rating Watch Negative;
--Class M7 downgraded to 'BB' from 'BBB+' and placed on Rating Watch Negative;
--Class M8 downgraded to 'B' from 'BBB' and placed on Rating Watch Negative;
--Class M9 downgraded to 'C' from 'BBB-'; assigned distressed recovery (DR) rating of 'DR6'
--Class B1 downgraded to 'C' from 'BB+'; assigned DR rating of 'DR6';
--Class B2 downgraded to 'C' from 'BB+'; assigned DR rating of 'DR6'.

Series 2006-S1
--Class A1 & A2 affirmed at 'AAA';
--Class M1 affirmed at 'AA';
--Class M2 affirmed at 'AA-';
--Class M3 rated 'A+' and placed on Rating Watch Negative;
--Class M4 downgraded to 'A-' from 'A' and placed on Rating Watch Negative;
--Class M5 downgraded to 'BBB+' from 'A-' and placed on Rating Watch Negative;
--Class M6 downgraded to 'BBB-' from 'BBB+' and placed on Rating Watch Negative;
--Class M7 downgraded to 'BB' from 'BBB' and placed on Rating Watch Negative;
--Class M8 downgraded to 'B' from 'BBB-' and placed on Rating Watch Negative;
--Class B1 downgraded to 'C' from 'BB+'; assigned DR rating of 'DR6';
--Class B2 downgraded to 'C' from 'BB'; assigned DR rating of 'DR6'.

Fitch's Distressed Recovery (DR) ratings, introduced in April 2006 across all sectors of structured finance, are designed to estimate recoveries on a forward-looking basis while taking into account the time value of money. For more information on Distressed Recovery ratings, see the full report ('Structured Finance Distressed Recovery Ratings'), which is available on the Fitch Ratings web site at 'www.fitchratings.com'.

The affirmations reflect adequate relationships of credit enhancement (CE) to future loss expectations and affect approximately $327 million of outstanding certificates. CE is in the form of subordination, overcollateralization (OC) and excess spread. The negative rating actions, affecting approximately $111.1 million of outstanding certificates, reflect deterioration in the relationship between CE and expected losses.

Approximately 11.31% of the pool for series 2006-ARS1 is more than 60 days delinquent (including loans in Bankruptcy, Foreclosure and Real Estate Owned [REO]). The OC amount is currently $5,954,369, or roughly $11 million below its target amount. At 12 months since the first distribution date, the OC is currently equal to 2.54% of the original collateral balance, as compared to a target level of 7.65% of the original collateral balance. In four of the past 6 months, the excess spread has not been sufficient to cover the monthly losses incurred and as a result, OC has further deteriorated. Cumulative losses as a percent of the original collateral balance are 7.98%.

For series 2006-S1, approximately 6.19% of the pool is more than 60 days delinquent (including loans in Bankruptcy, Foreclosure and REO). This series was structured to have growing OC. Because of the faster-than-expected prepayments and earlier-than-expected collateral losses, the OC did not reach the initial target amount of $19.2 million. In five of the past 6 months, the excess spread has not been sufficient to cover the monthly losses incurred. Cumulative losses as a percent of the original collateral balance are 3.70%.

The transactions are twelve and sixteen months seasoned, respectively. The pool factors (current mortgage loan principal outstanding as a percentage of the initial pool) are approximately 71% and 58%, respectively.

The mortgage pools consist of conventional, fixed rate, fully-amortizing and balloon, second lien residential mortgage loans. The mortgage loans were acquired by Lehman Brothers Holdings Inc. from various banks and other mortgage lending institutions and are master serviced by Aurora Loan Services, Inc., which is rated 'RMS1-' by Fitch.

The first security (2006-ARS1) is subprime credit; the second (2006-S1) is definitely Alt-A (I checked the prospectus). The very different serious delinquency numbers reflect that: 11.31% for the subprime pool and 6.19% of the Alt-A pool. Yet these two pools are in almost exactly the same boat, ratings-wise.

How did that happen? The subprime pool started out with more overcollateralization, but losses have exceeded excess interest and so the OC is shrinking. The Alt-A pool started out with low OC--it was meant to grow through application of excess interest--but it too experienced losses exceeding the excess, as well as fast prepayments which have reduced the gross excess spread amount, and so its OC has not grown to its target.

You will notice also that both of these pools are fixed rate closed-end second liens. These borrowers did not get caught in a nasty rate adjustment, nor did they max out a credit line in order to pay bills.

The moral of the story, it seems to me, is twofold: Alt-A isn't performing anywhere near as well as its boosters claimed it would, for one thing. For another, a bad security structure can go a long way to offsetting the higher credit quality of the collateral. A security set up with "growing" OC, that is, initial low overcollateralization that is expected to reach its "target" over time, depends absolutely crucially on the accuracy of the prepayment speed estimates and the loss timing projections that went into its initial structure. The media's obsession with credit risk to the exclusion of other kinds of risk is obscuring this problem for sure.