Downgrades of AAA RMBS Tranches: The Case of CountryWide's CWALT 2005-J11

On Sept 1, S&P downgraded the 1A4 tranche (among others) of a CountryWide deal, CWALT 2005-J11, from AAA to CCC. Investors were certainly shocked to face such a drastic drop in rating, especially since collateral performance has been deteriorating for quite some time on this deal. The chart belows shows the percent of loans on this deal that is delinquent for 90 days.



As early as Q1’08, it was thus obvious things were not going as planned and that defaults would increase. And on this deal, it doesn’t take a lot of defaults to cause loss on AAA tranches. As can be seen on the simulation below, a modest CDR of 4.2 causes a loss of 2.51% of principal on this AAA paper. (The 1A4 tranche is highlighted in blue.) I used a severity of 50%, which is typically true for Alt-A loans such as thos in this deal.



Red bars indicate, quite intuitively, losses. Note however that the x-axis represents time, so the length of the red bar is not proportional to loss severity: a long red bar only means the first loss occurred early and that the last principal repayment happened late.

If you enlarge this graph and peruse the tranche labels, you'll notice that most of the tranches on this screen are senior or super-senior tranches, and suffer their first loss simultaneously. That's because subordinated and support tranches were already wiped out and that, from then on, losses were shared pro-rata between the senior tranches. (Thanks Jack!)