Posted by Ed Garcia on August 05, 2007 at 23:22:54:
Ben,
Wow, youâ??re going to keep me up all night trying to answer your post.
I didnâ??t mean to get into a shoot out between Alt-A and Sub-prime definitions. Of course they are different products but are so close, brokers usually refereed to them as Sub-prime.
I think we both know the difference, however in the lending community credit worthiness is not always someone who has less then desirable credit or credit issues. Lack of verifiable income is also a defamation of credit worthiness (The Ability To Pay) This is reflected in the cost of the loan as well.
From my stand point the common denominator of these two products are they are both security backed and sold to Wall Street. This is where the problem lies.
Here are two articles you may or may not have seen that I would like to share with you and our viewers.
Alt-A mortgage losses accelerate, study says
Growing Alt-A problems could threaten some mortgage-backed securities
By Alistair Barr, MarketWatch
Last Update: 2:05 PM ET Mar 13, 2007
SAN FRANCISCO (MarketWatch) - Losses on so-called Alt-A home loans are accelerating and could hit the value of lower-rated portions of some mortgage-backed securities, according to a study released on Tuesday.
Alt-A loans are considered less risky than subprime mortgages, but usually have lower credit quality than “prime” loans. Companies such as IndyMac Bancorp (NDE :
NDE
FAF43.00, -1.05, -2.4%) .
This “alarming” deterioration could have dire consequences for some investors in the BBB- rated parts of mortgage-backed securities (MBS) that contain these types of loans, but the market hasn’t priced these risks in yet, Liu warned.
Losses “could potentially wipe out most of the credit support on BBB- rated bonds backed by Alt-A hybrids,” Liu wrote. “And yet we have not seen any spread movements that suggest investors are taking this into consideration.”
Liu’s study, which used LoanPerformance data from the end of January, is based on the housing market remaining relatively flat over the next few years.
“If house prices fall over the next few years, everything in this scenario will be much worst,” he said in an interview.
Alt-A loans were originally designed for borrowers with clean credit records, but with other issues that often meant they provided fewer documents or even no documents showing what they earned. These loans were attractive to investors in mortgage-backed securities because they offered higher yields than traditional “prime” home loans, but were underpinned by the cleaner credit records of the borrowers.
The popularity of Alt-A mortgages exploded in recent years. A record $400 billion of these loans were originated in 2006. They accounted for 13.4% of all mortgages offered last year, up from 2.1% in 2003, according to industry publisher Inside Mortgage Finance.
But as the Alt-A business grew, more of these loans were offered to less creditworthy borrowers and the products became more exotic.
“The Alt-A sector is the poster child for the past decade’s tremendous growth and drastic evolution in the mortgage market,” Liu wrote in the LoanPerformance study.
Alt-A ARM IO loans have “taken the leading role within continuously expanding borrower leverage in the runaway housing market,” he added.
Three quarters of all Alt-A loans originated in 2006 were innovative mortgages such as interest-only loans and option ARMs, he noted.
As ARM IO mortgages took over as one of the dominant ARM products, the performance of these loans deteriorated rapidly, Liu said.
The main reason is that the housing market is much weaker than it was a few years ago and interest rates are much higher, Liu explained. “On top of that, underwriting standards were looser recently,” he added.
MBS ‘endangered’
The deterioration is “alarming” for investors in lower-rated bonds that are backed by these loans, he said.
Mortgage loans are usually packaged together and sold as mortgage-backed securities (MBS) to institutions such as pension funds, insurers, and hedge funds.
They are sliced up into different sections, known as tranches. Higher quality tranches pay lower interest rates, but are less likely to experience losses. Lower-rated slices, rated BBB- and BBB, yield more, but are the first to get hit when losses occur in the underlying mortgages.
An extra chunk of cash is included in MBS - called credit support or enhancement - that protects investors against a certain level of losses.
Liu’s study suggests that losses in Alt-A ARM IO mortgages could wipe out the credit support on BBB- rated tranches of some MBS.
“There is a 34% probability that the entire BBB- tranche might get wiped out,” he wrote. “Similarly, there is a 17% probability that cumulative losses reach 300 basis points, which could make BBB bonds appear on the endangered species list.”
If the housing market remains flat or turns negative for a prolonged period, losses could rise further, “which will wipe out credit support of BBB bonds on these deals,” he added.
If credit support on these tranches is erased, investors would still have access to the income. But Liu warned that they would likely be downgraded by credit rating agencies anyway, cutting their value.
There are a lot of moving parts in these projections, Liu said, noting that the analysis is “relatively crude.”
“Even so, we believe our results are very powerful and are not currently reflected in the market,” he concluded.
Alistair Barr is a reporter for MarketWatch in San Francisco
S. subprime mortgage crisis
Main article: subprime meltdown
Beginning in late 2006, the U.S. subprime mortgage industry entered what many observers have begun to refer to as a meltdown. A steep rise in the rate of subprime mortgage foreclosures has caused more than two dozen subprime mortgage lenders to fail or file for bankruptcy, most prominently New Century Financial Corporation, previously the nation’s second biggest subprime lender.[5] The failure of these companies has caused stock prices in the $6.5 trillion mortgage bundled securities market to collapse, threatening broader impacts on the U.S. housing market and economy as a whole. The crisis is ongoing and has received considerable attention from the U.S. media and from lawmakers during the first half of 2007. [6][7]
Observers of the meltdown have cast blame widely. Some have highlighted the predatory practices of subprime lenders and the lack of effective government oversight.[8] Others have charged mortgage brokers with steering borrowers to unaffordable loans, appraisers with inflating housing values, and Wall Street investors with backing subprime mortgage securities without verifying the strength of the underlying loans. Borrowers have also been criticized for entering into loan agreements they could not meet. [9] Many accounts of the crisis also highlight the role of falling home prices since 2005. As housing prices rose from 2000 to 2005, borrowers having difficulty meeting their payments were still building equity, thus making it easier for them to refinance or sell their homes. But as home prices have weakened in many parts of the country, these strategies have become less available to subprime borrowers.[10]
Several industry experts have suggested that the crisis may soon worsen. Lou Ranieri, formerly of Salomon Brothers, considered the inventor of the mortgage backed securities market in the 1970s, warned of the future impact of mortgage defaults: “This is the leading edge of the storm. â?¦ If you think this is bad, imagine what it’s going to be like in the middle of the crisis.” [11] Echoing these concerns, consumer rights attorney Irv Ackelsberg predicted in testimony to the U.S. Senate Banking Committee that five million foreclosures may occur over the next several years as interest rates on subprime mortgages issued in 2004 and 2005 reset from the initial, lower, fixed rate to the higher, floating adjustable rate or “Adjustable rate mortgage”. [12] Other experts have raised concerns that the crisis may spread to the so-called Alternative-A (Alt-A) mortgage sector, which makes loans to borrowers with better credit than subprime borrowers at not quite prime rates.[13]
Some economists, including former Federal Reserve Board chairman Alan Greenspan, have expressed concerns that the subprime mortgage crisis will impact the housing industry and even the entire U.S. economy. In such a scenario, anticipated defaults on subprime mortgages and tighter lending standards could combine to drive down home values, making homeowners feel less wealthy and thus contributing to a gradual decline in spending that weakens the economy. [14] Other economists, such as Edward Leamer, an economist with the UCLA Anderson Forecast, doubts home prices will fall dramatically because most owners won’t have to sell, but still predicts home values will remain flat or slightly depressed for the next three or four years.[15]
As the crisis has unfolded and predictions about it strengthening have increased, some Democratic lawmakers, such as Senators Charles Schumer, Robert Menendez, and Sherrod Brown have suggested that the U.S. government should offer funding to help troubled borrowers avoid losing their homes.[16] Some economists criticize the proposed bailout, saying it could have the effect of causing more defaults or encouraging riskier lending.
Ben, I have to give you credit, youâ??ve posted 2 well thought out, well worded posts.
The reasons Mortgage Brokers are in such dismay, is because they all basically use the same sources and either sell or broker to lenders that again either sell off in the secondary market to lenders which will sell to Wall Street or sell directly to Wall Street themselves. In either event, the mortgages were ending up in the same place.
One of the things Iâ??ve always done in my workshop is said with all of the hundreds and thousands of lenders in our country, Iâ??d break it down to 8 and categorize them, then explain that they are nothing more then duplications of one another.
Ben, Iâ??m too tired tonight to go into a lot of detail, but your answer is going to be portfolio lenders itâ??s as simple as that. When ever there has been a void in the financial community, someone has always come in and picked up the slack or filled it. I already know who Iâ??m using and how to structure the deals.
Ben, Iâ??m going to bed now, but I want to thank you for the fine job youâ??ve done helping others.
Ed Garcia