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Defaults on Some `Alt A' Loans Surpass Subprime Ones, Bloomberg News, July 24, 2007

By Jody Shenn
July 24 (Bloomberg) -- Defaults on some so-called Alt A
mortgages packaged into bonds last year are now outpacing those
from subprime loans, according to Citigroup Inc.
The three-month constant default rate for 2006 Alt A hybrid
adjustable-rate mortgages is 2.3 percent, compared with 2.2
percent for subprime ARMs, New York-based Citigroup analysts led
by Rahul Parulekar wrote in a July 20 report. The figures
represent the percentage of balances in a mortgage-bond pool
expected to default in the next year based on 90-day trends.
The speed at which Alt A hybrid ARMs are being paid off due
to home sales or refinancing has also fallen to about the same
level as for subprime ARMs, which typically prepay more slowly,
the analysts said. Slower prepayments can make the same rates of
defaults more damaging by leaving more of the initial balances
outstanding to eat into bond-investor protections.
The combination of challenges mean 2006 bonds backed by Alt
A mortgages, a credit grade above subprime loans, may need
``lower loss severities to still come out with lower cumulative
losses than subprimes,'' the Citigroup analysts wrote.
More than $800 billion of subprime mortgage bonds and $700
billion of Alt A bonds are outstanding, with ARM bonds totaling
more than $600 billion and $450 billion, respectively, according
to a March report by Zurich-based Credit Suisse Group.

Size of Losses

Severities represent the size of losses incurred after
borrowers stop making payments. The losses can include the
difference between what a seized home is sold for and the loan
amount if a homeowner can't sell or catch up on payments; legal
and other foreclosure and sales costs; and reimbursement of
advances made for a time in which a borrower isn't paying.
The Citigroup analysts are working on a report related to
default severities, Parulekar said yesterday.
The three-month constant default rates were measured with
loans in 2006 bonds at an average age of 16 months. The level
for the Alt A ARMs was at a record for that point in time. Late
payments of at least 60 days, foreclosures and already seized
property among all Alt A mortgages in securities issued in 2006
are now at 4 percent, according to data compiled by Bloomberg.
Alt A mortgages, short for Alternative A, are loans that
fall just short of the typical underwriting standards of Fannie
Mae and Freddie Mac, the two largest mortgage companies. They're
usually granted to borrowers with good credit records who seek
atypical underwriting or loans, such as reduced proof of their
pay, lending on an investment property or so-called option ARMs.
Such flexibilities are given on prime loans if borrowers
have enough offsetting positive attributes, like cash for large
down payments. Subprime mortgages are given to borrowers with
poor or limited credit records or high debt burdens.

Ratings Cuts, Warnings

Moody's Investors Service last week said it may downgrade
$316 million of Alt A securities created last year, joining
Standard & Poor's in saying it is considering downgrading such
bonds. Ratings cuts and warnings by the New York-based services
have so far affected more 2006 subprime securities.
Average default rates obscure that ``within things called
Alt A, we see a very wide spectrum of credit quality,'' said
Andrew Davidson, the head of New York-based Andrew Davidson &
Co. Inc., which sells consulting service and risk analytics for
mortgage and asset-backed bonds.

Defining Alt A

``That's the problem with Alt A: It's a name that doesn't
really have a meaning,'' said Davidson. ``The top end of Alt A
is certainly under stress but may not face serious problems.''
The Citigroup analysts used Alt A ARMs with five years of
fixed rates for their study. They didn't include so-called
option ARMs, a type of loan with minimum payments that produce
growing debt in $200 billion of Alt A bonds. Citigroup was the
ninth largest underwriter of non-guaranteed mortgage securities
in the first half, according to newsletter Inside MBS & ABS.
About 83 percent of balances of the 2006 Alt A ARMs were
outstanding by the time the loans reached an average age of 12
months, the report said, compared with 76 percent for loans made
in 2003. For 2006 subprime loans, 84 percent of balances
remained outstanding, compared with 81 percent for 2003 loans.
The previous worst ``vintage'' for non-prime mortgage bonds
was 2000, which has produced 4.5 percent loan losses so far for
subprime bonds and 0.5 percent in Alt A, Citigroup said.
In a typical Alt A ARM transaction this year, buyers of BBB
bonds were protected against losses of 3 percent by having
lower-rated or unrated bonds hurt first, according to a June
report by Bear Stearns Cos. In a subprime deal, the level was 7
percent. At the AAA level, some Alt A bonds were protected
against 10 percent losses, versus 25 percent for subprime.
Between June 1 and July 17, typical yield premiums over
benchmarks on BBB rated Alt A bonds widened by 125 basis points
to 475 basis points, while spreads for BBB subprime bonds rose
200 basis points to 450 basis points, according to Citigroup.

--Editor: A. Goldstein