The Fall And (Pending) Rise Of Alt-A

With a lion's share of attention focused on subprime issues, it is easy to overlook the Alt-A market. In the past two months, however, it appears the Alt-A market has been working overtime to catch up with subprime.

Consider some recent developments regarding Alt-A:

  • On Dec. 20, Standard & Poor's Ratings Services published ‘The Spotlight's On U.S. Alt-A RMBS Issuers As Performance Deteriorates Rapidly.’ As its less-than-rosy title indicates, troubles persist – Alt-A issuance volume fell from June 2007's record-high of $109.5 billion to $39.3 billion in September 2007, a 75% drop. ‘The 2007 deterioration may be the worst ever for the Alt-A market,’ the report found, adding no signs of immediate turnaround are apparent. ‘Standards & Poor's Rating Services expects Alt-A issuance to further decline during fourth-quarter 2007 and into 2008,’ the reports states.
  • On Jan. 8, Moody's Investors Service slashed the ratings on 126 classes of residential mortgage-backed securities supported by Alt-A loans issued by Impac Mortgage, Deutsche Bank and Bear Stearns. Moody's stated its actions were based on the higher-than-anticipated rates of delinquency, foreclosure and real estate owned within the underlying collateral relative to credit support levels.
  • On Jan. 9, Moody's lowered its ratings on 47 bundles of mortgage-backed bonds issued in 2007 by Goldman Sachs Group Inc. The downgraded tranches were mostly backed by first-lien, fixed and adjustable-rate Alt-A mortgages. On Jan. 17, Moody's downgraded the ratings of 19 tranches from deals issued by Merrill Lynch & Co. that are partially backed by Alt-A mortgage loans.
  • On Jan. 15, Canada's Toronto-Dominion Bank announced the pending completion of its $7.6 billion stock-and-cash acquisition of Commerce Bancorp. will be followed by a decision to jettison Commerce's $4 billion portfolio of Alt-A mortgages. Ed Clark, president and CEO of Toronto-Dominion, told Reuters, ‘It's a portfolio we can dispose of – it's not like it's a no-bid world out there.’

So where does that leave Alt-A today? And where is this market heading for the remainder of 2008?

{OPENADS=zone=7} ‘If there are degrees of death, then Alt-A is slightly less dead than subprime,’ says David Oser, chief economist at ShoreBank, Chicago. ‘But it's probably just the difference between being blown to bits and shot two or three times in the head.’

Oser does not blame the product itself for the current problems, but the sloppy underwriting that sped its doom. ‘To get a mortgage these days – and more importantly, to be able to sell one into the secondary market – a borrower has to be able to prove income and assets,’ he says. ‘For some bizarre reason, this was considered hard to do for self-employed people in 2005 and 2006, hence the proliferation of Alt-A. This, of course, is nonsense – just ask the Internal Revenue Service!’

‘You could sum it up with a question: What Alt-A market?’ says Scott Stern, CEO at Lenders One, an independent mortgage bankers cooperative headquartered in St. Louis. ‘Take a look at our lenders' cumulative production from January to December 2007. In January 2007, 50 percent of our loans were conforming, 30 percent were Alt-A and less than 5 percent were government loans. By December 2007, 60 percent were conforming, 30 percent were government loans and 1 percent were Alt-A.’

The road ahead

But what does the near-term future hold?

‘I think there is a fundamental realignment in investor appetite for Alt-A product,’ says Jordan Brown, CEO of MarketWise Advisors LLC, Ponte Vedra Beach, Fla. ‘The downturn will likely continue well into 2009, with virtually no investors willing to take the risks of re-entry into the Alt-A and subprime markets. As the equilibrium returns to the mortgage market in 2009, there will be renewed interest in Alt-A product, but with the much stricter controls and higher risk premium demanded by investors. We are at least 12 to 18 months minimum from the inflection point in the market.'{OPENADS=zone=15}

Edward B. Kramer, the New York-based executive vice president for regulatory programs at Wolters Kluwers Financial Services, doesn't believe Alt-A has given up the ghost.

‘Alt-A is still there,’ he says, adding its presence is not plainly visible given the compression of lending and the emphasis on higher-quality credit. ‘We have an A market and an Alt-A market, but it's blurred a little bit. We're even seeing some jumbo Alt-A loans.’

Dr. Jay Hartzell, associate professor of finance and director of the Real Estate Finance and Investment Center at the University of Texas at Austin, believes the Alt-A market has a more-than-fair chance for recovery.

‘The future is obviously very uncertain, but I think it depends on liquidity returning to the mortgage market, house prices and interest rates – all of which are related,’ he says. ‘Data suggests that about 70 percent of recent Alt-A originations were adjustable-rate mortgages, compared to only 45 percent for prime jumbos over the same 2006 period. So, if rates stay low, then this should help the sector.’

Hartzell adds that Washington may be playing a role in Alt-A's recovery. ‘If the various economic stimulus package items start to go through, such as the proposed hike in the conforming limit, that could also provide a much needed boost to the housing market by improving liquidity,’ he says. ‘And, if some liquidity returns, then perhaps better pricing in the secondary market will give us clearer indications of the real losses involved. I cannot help but hope that the eventual reality will be better than much of what we're hearing forecasted right now.’

{OPENADS=zone=13}However, Tony Rowe, managing partner at Steel Mountain Capital in Lakewood, Colo., believes that time may not adequately heal all of Alt-A's wounds.

‘Mortgage investors now realize that they weren't being adequately compensated for the loose underwriting they accepted, and I can't see them forgetting that fact anytime soon,’ he says. ‘Hopefully, the recent Fed rate cut will ignite a mini-refi boom, but don't look for the product offerings to include limited or no-doc loans in any meaningful way. Even if an Alt-A investor was to reappear, how many borrowers could actually come up with the larger down payment that Alt-A loans require? Alt-A volumes will continue to be limited until we see an appreciating housing market again.’

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