April 18, 2007 / 12:24 AM / 11 years ago

Weakness creeps into higher quality U.S. mortgages

By Nancy Leinfuss - Analysis

NEW YORK (Reuters) - Delinquency rates are now rising on so-called “Alt-A” home mortgages held by U.S. borrowers who are rated above the “subprime” category of creditworthiness but below the top rated prime borrower.

The trend is worrying because the number of new Alt-A mortgages” rose sharply in 2006 and now comprise 10-15 percent of all U.S. mortgages.

Many Alt-A borrowers used the mortgages to refinance second homes or investment properties, but with U.S. home prices stagnating, and lending criteria being tightened, it will be harder for Alt-A borrowers to sell or refinance their mortgages.

“The Alt-A borrower may have a huge home-equity line of credit out there which he continues to draw down from to stay current on his first mortgage,” said Josh Rosner, managing director at Graham Fisher & Co., an investment research firm in New York.

“They are extending their reach and unless we see home price appreciation turn around, they’re going to blow up.”

For adjustable-rate Alt-A loans originated in 2006, delinquencies of 60 days or more have roughly doubled to 3.5 percent from 2005, while for 2006 subprime mortgages the 60-plus-day delinquency rate is three times higher than for Alt-A loans.

In addition to the displacement of thousands of home owners, a wider shakeout in the U.S. mortgage industry than has already occurred in the subprime sector, could inflict damage on an even bigger group of investors in mortgages.

Companies like American Home Mortgage Investment Corp. AHM.N, which specialize in prime and near-prime loans, are feeling the pain. The company said it was setting aside more reserves due to rising delinquencies in its Alt-A loans. It also cut its dividend and 2007 profit forecasts, citing slow demand for loans.

M&T Bank Corp. (MTB.N) is also among those lenders who have cut profit forecasts.

Losses for lenders who hold second mortgages or liens, such as home equity loans, are likely to be significant, industry experts say.

“If a first-lien holder is going to end up with 30 to 60 percent of the unpaid principal balance outstanding in a foreclosure, there’s not going to be a whole lot left for the second-lien holder,” Rosner said.

About 33 percent of adjustable-rate loans in the Alt-A sector were originated with reduced documentation and a combined loan to value (CLTV) ratio of greater than 95 percent last year. CLTV is the percentage of the property’s estimated market value that is represented by the combined total of the first and second mortgages on the home.

However, the Alt-A market is not likely to suffer a crisis as severe as the one in the subprime market, said Mehmet Camurdan, senior asset-backed securities portfolio manager at Evergreen Investments in Richmond, Virginia.

“While I do see a similar trend, when it comes to the rise in delinquencies, things have been contained. It has not reached the alarming levels of subprime,” he said.

    An average Alt-A borrower has a FICO credit score of 700 to 750. FICO scores are a tool used to measure creditworthiness.

    Lower-range Alt-B borrowers generally have a FICO score that falls in a range of 680 to 690. Alt-B’s usually have a CLTV ratio of between 75 and 90 percent, market experts said.

    “Even though the Alt-A borrower tends to have a higher FICO score, given the lower documentation requirements and in some cases high leverage of the borrower, we are seeing an uptick in losses in Alt-A collateral pools,” said Tom Reese, vice president of ABS at Hartford Investment Management Co. in Connecticut, referring to the groups of loans pooled into a mortgage-backed security (MBS) or collateralized debt obligation (CDO).

    Weakness in the Alt-A sector is being reflected in the market for MBS and CDOs.

    According to UBS Securities data, spreads over U.S. Treasuries on subordinated Alt-A issues, which were very tight through the first half of February, widened dramatically in the second half of the month. Fixed-rate Alt-A paper rated “BBB” which traded at a spread of 250 basis points over Treasuries now trades at 425 basis points.

    The effect is even more dramatic in the adjustable rate mortgage market (ARM) market, where subordination levels are generally higher than fixed rate meaning the investors have less security.

    Spreads on ALT-A issues backed by hybrid ARMS on “BBB” rated subordinated issues have widened 100 basis points and are out at least 225 basis points on “BBB-” issues, UBS said.

    For more on the subprime mortgage market, see <ID:nN16195443>.

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