Falling Mortgage Dominos

Like its subprime sibling, the Alt-A mortgage mart sees rise in late payments and defaults

Investment Dealers Digest
January 28, 2008
BYLINE: Aleksandrs Rozens

The Alt-A mortgage market, which once accounted for 1%-2% of the MBS market but now makes up as much as 20% of the securitized mortgage universe, has seen a rise in late payments and defaults, spurring warnings by credit rating agencies.

While the problems with Alt-A home loans have been ascribed to poor underwriting standards among mortgage lenders, what may be worrisome to investors is that credit scores for many of these borrowers are what would be considered prime or credit-worthy.

"The Alt-A market is displaying the same symptoms as the subprime market," says Thomas Zimmerman, head of asset-backed and mortgage credit research at UBS in New York. "2006 and 2007 loans were as weakly underwritten as subprime loans."

"These are issues we're seeing in all mortgages. We are in a housing correction so all mortgages are seeing an increase in delinquencies off of what were record lows," says Karen Weaver, global head of securitization research at Deutsche Bank. Alt-A "is in some ways a sister product to subprime. Some Alt-A pools are very, very close to subprime quality. There is a pretty big divergence (among loan underwriting practices and standards)."

Alt-A loans have been around since at least the 1990s when they were introduced as a mortgage product designed for small business owners whose income patterns were different from that of a typical borrower.

This meant that borrowers could offer less documentation detailing their earnings. In recent years, these loans were more broadly adopted, particularly among borrowers who used these loans to buy investment properties. In some cases, borrowers who did not qualify for a regular mortgage product because they did not earn enough opted for Alt-A loans where they could "state" their income even though they paid a slightly higher rate.

"[Real estate] investors wanted it done rapidly. They wanted to capture price gains. They didn't want to provide much documentation. The idea was to sell the property or refi the loan," says Douglas Duncan, chief economist at the Mortgage Bankers Association.

In recent weeks, credit rating agencies have downgraded several securities backed by Alt-A loans, including deals with fixed and floating rate mortgages from Indymac, Countrywide, Goldman Sachs, Citigroup and American Home. All of the transactions subject to downgrades in recent weeks have been 2007 deals, but the problems may also crop up in transactions from 2006.

The underlying reason for the downgrades or warnings of bonds being put on review for a downgrade is the higher-than-anticipated rates of delinquency, foreclosure and real estate-owned properties.

"The Alt-A market is a little better than subprime. People were focused on subprime as the most extreme, but some Alt-A is almost as bad as subprime," says Zimmerman. "We're seeing an increase in delinquencies. It is well beyond normal levels."

According to Deutsche Bank's Weaver, Alt-A delinquency rates rose to 6.2% in December 2007 from 1.4% in December 2006. That magnitude of change was greater than that seen in subprime loan delinquencies.

Understanding the loans backing the bonds

The Alt-A mortgages backing the bonds include floating rate and fixed rate mortgages. The loans are first-lien mortgages and their credit scores can run over 700, a level comparable to prime mortgages guaranteed by Freddie Mac and Fannie Mae. (You can get a 95% LTV agency loan with a 660 credit score).

What makes Alt-A paper different is that their loan documentation is not as thorough and Alt-A mortgages have increasingly become the loan of choice for borrowers looking to buy investment properties. Housing finance professionals generally believe that a borrower who lives in a home will be less likely to default than the borrower who sees the property as merely an investment. According to MBA's Duncan, Alt-A mortgages have been very popular in states that saw the biggest run-up in prices and speculation: California, Arizona, Nevada and Florida. "The Alt-A was very popular in the same areas where there was speculative buying," says Duncan.

Nevada and Florida are two states which have seen a marked rise in problem loans.

Realtytrac, a firm that keeps tabs on foreclosure activity, reported last month that Nevada was the leading state in terms of foreclosure activity where one household out of every 152 had a property foreclosure. Florida had a rate of one foreclosure per every 282 households, while Ohio had one foreclosure for every 307 households. Foreclosures in November 2007 were up 68% from a year ago.

Standard & Poor's recently noted that severe delinquencies among Alt-A loans from 2006 - that is 90-days or more, including loans in real estate owned or foreclosure - have seen two times the number of delinquencies of mortgages underwritten in 2005. The number of delinquencies for those 2006 mortgages is more than four times the number seen among loans created in 2003 and 2004.

"The 2006 and 2007 vintages are problematic, but the [borrowers] from 2004 and 2005 still have positive home price growth. The 2006 and 2007 buyers have seen a drop in their home values," says Fitch's Glenn Costello, a managing director at the credit rating agency and co-head of its residential mortgage backed securities group.

Market watchers believe that borrowers who have seen their property retain more of its value are less likely to default, while those who purchased homes in 2006 and 2007 did so at the very peak of the housing boon and may be more apt to fall behind on payments or simply abandon the property.

According to S&P, Nomura Securities was the issuer with the most severe delinquencies, but others with problem loans in their securities included Bear Stearns, Goldman, Impac, Credit Suisse and Morgan Stanley.

ARMs can hurt investors The Alt-A universe includes largely three types of loans: payment option ARMs, hybrid ARMs and fixed-rate loans. Fixed-rate borrowers have been the least problematic because these have not seen the payment shock associated with adjustable rate loans. When it comes to hybrid ARM loans, a rise in borrowing costs often trips up homeowners.

"A hybrid ARM homeowner is presumably more financially stretched than a fixed-rate homeowner and ... is more likely to be falling behind on his or her mortgage payments," according to S&P, which noted that payment option ARMs are the riskiest because the pay shock for these loans is much more dramatic.

"While in the past POA (payment option ARM) borrowers have been afforded ample opportunity to refinance, in the current market environment, troubled POA borrowers no longer have abundant liquidity available to them," S&P warned in its report, adding that "many borrowers in the future may find it difficult to avoid foreclosure."

Declines in home prices have made things even tougher for the Alt-A market because some borrowers purchased their homes with little or no down payment with the help of piggy-back mortgages, says Fitch's Costello. As a result, these borrowers will have little or no equity, hurting their chances of qualifying for a refinance.

While there are parallels to the subprime situation, market observers believe the problems in the Alt-A market likely took longer to surface because these homeowners are of better quality.

Their ability to readily refinance from one Alt-A loan to another was hindered by last summer's credit storm that claimed a well known Alt-A lender - American Home Mortgage. Problems in subprime were first beginning to be felt in late 2006, and were very evident by April 2007 when New Century, a leading subprime mortgage lender, filed for bankruptcy.

American Home filed for bankruptcy on Aug. 6 because it was unable to readily resell mortgage loans into securities. The bankruptcy added to concerns about mortgage credit risk and likely prompted many lenders to hold off from underwriting more Alt-A home loans.

For now, holders of highly-rated securities, AAA paper, backed by Alt-A loans have not experienced massive downgrades. But investors ought to remember that 90-95% of an Alt-A bond transaction - these deals typically total $500 million - is AAA. So, if and when losses pick up and eat through the support classes that higher rated paper could be impacted.

"It could be possible that AAA paper could be downgraded," says Fitch's Costello.

Meanwhile, some participants may have been cheered by the Federal Reserve's dramatic rate cut last week. The easier money likely will aid the economy, but many borrowers with little or no equity in their homes will continue to have a tough time refinancing their mortgage.

Additionally, the problems within the Alt-A mortgage market promise to seep into other areas of the credit markets, notably the collateralized debt obligations (CDO) that bundled low rated classes of various types of mortgage debt. Downgrades of subprime mortgage-backed securities last year led to downgrades of some CDO transactions.

"Yes, we may see some downgrades in CDOs," that included low-rated classes of Alt-A mortgage backed securities, says Deutsche Bank's Weaver.

THE ECONOMIC STIMULUS PLAN

Big loans could get cheaper;
Supporters say the proposal would help borrowers and stabilize the housing market

Los Angeles Times
January 25, 2008 Friday
Home Edition

BYLINE: E. Scott Reckard and Peter Y. Hong, Times Staff Writers

SECTION: BUSINESS; Business Desk; Part C; Pg. 1

The economic stimulus plan worked out Thursday in Washington would provide nearly a year of cheaper loans for Californians buying or refinancing higher-cost homes, and the news elicited jubilation in the beleaguered housing and mortgage industries. Leaders of the House of Representatives and the White House agreed that the size of loans that can be purchased by government-sponsored mortgage buyers Fannie Mae and Freddie Mac should be increased sharply for a year from the current cutoff of $417,000.

The plan also would nearly double the size of loans insurable by the Federal Housing Administration, from $367,000 to $729,750.

The FHA was set up to provide mortgages to first-time buyers, including many with less-than-perfect credit, and insures loans to borrowers with down payments or home equity of as little as 3%.

Currently, any loans above $417,000 are considered "jumbo" mortgages. In recent months, they have become harder to obtain because skittish private investors have become reluctant to buy them.

Interest rates on jumbo loans were running about 6.5% this week -- 1 percentage point higher than rates on the so-called conforming loans that Fannie and Freddie could buy. Someone who wanted to borrow $500,000 would save about $330 a month, or $3,960 a year, if such a loan were considered conforming and thus had a lower rate.

"It's the single most effective step they could take to stabilize the housing and mortgage market," said Rick Simon, a spokesman for Calabasas-based Countrywide Financial Corp., the nation's largest home lender, which had led the lobbying to raise the loan limits.

The precise increase on the "conforming" ceiling was still being debated late Thursday. House Republicans said they had agreed to temporarily raise loan limits for Fannie Mae and Freddie Mac to $625,500 while Democrats said the deal would boost limits to $729,750.Either way, the increased limit on loans eligible to be bought by Fannie Mae and Freddie Mac would be temporary, expiring Dec. 31. It was not clear if the higher FHA limit would be temporary or permanent.

Lobbying for an increase, the National Assn. of Realtors had estimated that increasing the conforming loan limit to $625,000 would strengthen current home prices by 2% to 3% and generate $42 billion in increased economic activity.

Higher loan limits would be especially significant in California, where the median home price is $597,640, housing and lending industry officials said.

Among other things, it would make it easier for battered lenders such as Countrywide, which lost $1.2 billion in the third quarter, to sell new fixed-rate loans to borrowers at risk of defaulting when their adjustable-rate mortgages reset to higher payments.

"This is a very positive development for California's lenders and homeowners," said Susan DeMars, executive director of the California Mortgage Bankers Assn. The California Assn. of Mortgage Brokers said the plan would "increase much-needed liquidity in today's struggling housing market, giving homeowners and home buyers access to safe, sustainable loans."

Not all observers were so optimistic.

Among those sounding skeptical notes was UCLA economist Edward E. Leamer, who said higher loan limits "are not going to matter much now" because the housing markets are still destabilized by bubble-era home prices that must continue to fall.

The proposed new conforming loan limit is far beyond the reach of most people, Leamer said. "Most Americans can't afford a $700,000 house," he added. "They don't have the down payment; they don't have the income."

Mortgages that size seem realistic only because "in the good old days, a year or two ago, you didn't have to have the down payment or income" to get such a loan, he said.

A bill wasn't expected to be signed for six weeks. Banking consultant Bert Ely of Arlington, Va., a frequent critic of Fannie Mae and Freddie Mac, said the final version could be considerably watered down -- restricted by region or available only to borrowers with significant equity in their properties.

Ely said opposition remains strong from critics who believe the plan shifts too much risk from the private housing markets to the government, because FHA insurance is a federal program and investors regard Fannie and Freddie as having the implicit backing of the federal government.

Such observations weren't enough to put a damper on mortgage brokers such as Jeff Lazerson of Laguna Niguel, who said the prospect of higher loan limits was "just fantastic."

Lazerson said he dropped out of the FHA loan program two years ago because home prices had risen so high and his customers with marginal credit found it easy to get sub-prime loans or "alt-A" mortgages from private lenders that didn't require proof of income.

FHA loans, by contrast, are notorious for requiring careful documentation.

Despite that, Lazerson said he was eager to resume providing loans backed by the FHA, which allows borrowers to raise money from family members to make the low 3% down payment.

$417,000 - Current cap of cheaper, non-"jumbo" mortgages.

$625,500 - New cap for non-jumbo loans under Republican plan.

$729,750 - Democrats proposed cap for non-jumbo loans.

$367,000 - Current cap for loans insured by the Federal Housing Administration, which is expected to be raised to as much as $729,750.

A Break on 'Jumbo Loans'

The New York Times
December 9, 2007 Sunday
Late Edition - Final

BYLINE: By BOB TEDESCHI
SECTION: Section 11; Column 0; Real Estate Desk; MORTGAGES; Pg. 11

PROSPECTIVE borrowers in the New York area who are likely to be in the market for a mortgage that is close to the ''jumbo loan'' category have received a break from Washington.

Late last month, the federal government held steady at $417,000 the so-called conforming loan limit -- the line above which mortgages become jumbo loans, and typically carry higher rates.

The limit, which is annually adjusted, usually moves in lock step with average home prices across the country, at least when prices are rising. There was some speculation earlier this year that the government could drop the conforming loan limit because house prices have been dropping.

The national average home price in October, for instance, was $295,573. That was $10,685 lower than a year earlier -- a 3.5 percent drop.

While not falling quite as sharply, parts of the New York area have registered declines. For instance, the median sale price of a home in Nassau and Suffolk Counties was 1.4 percent lower in the third quarter of this year than in the second quarter, according to a report late last month by the Office of Federal Housing Enterprise Oversight.

But some towns have fared far worse. According to First American LoanPerformance, a San Francisco-based mortgage industry consultancy, home prices on Centerport in Suffolk County were 8.6 percent lower in September 2007 than a year earlier.

Thanks to those drops -- and the fact that the conforming loan limit was held steady -- home buyers have somewhat better odds of seeking mortgages that are below the jumbo loan threshold. Jumbo loans typically carry interest rates about one percentage point higher than conventional loans.

Late last month, for instance, borrowers could find a 30-year fixed-rate mortgage for 5.875 percent on a loan of $417,000. For a jumbo loan of $418,000 from the same lender, the rate would rise to 7 percent, said Marc Schwaber, president of Preferred Empire Mortgage, a Manhattan-based brokerage. The monthly principal and interest payment for the jumbo loan would be $2,780.96, compared with $2,466.71 for the conventional loan. Over five years, the jumbo loan would cost $18,855 more.

''Because of the drop in housing prices,'' Mr. Schwaber said, ''many more people are going to qualify for less expensive conventional loans.''

Mr. Schwaber says borrowers who seek conventional mortgages also have an easier time qualifying for a loan because federal law requires Fannie Mae and Freddie Mac to buy conventional loans from lenders. Knowing there is a secondary market for their loans, lenders can offer more generous terms.

Practically peaking, Mr. Schwaber said, borrowers with good credit can often qualify for a conventional loan with a down payment of 5 percent, and borrow extra money to cover two months of principal, interest, taxes and insurance. Borrowers seeking jumbo loans must typically offer significantly higher down payments, and have reserves to cover several months of principal, interest, taxes and insurance.

Borrowers in the tristate area suffer under the yoke of jumbo loans far more than those in many other states, said First American LoanPerformance.

New York, New Jersey and Connecticut were among the six states with the highest percentages of jumbo loans. New York was the highest in the area, at 9.6 percent. California led the nation, with more than 25 percent of its mortgages in the jumbo category

New Jumbo Loan Rule

The Washington Post
February 16, 2008 Saturday
Every Edition
Jumbo Help;
New Rule Could Mean Rate Relief on Big Loans

BYLINE: Dina ElBoghdady; Washington Post Staff Writer

SECTION: FINANCIAL; Pg. F01

Anna Galloway keeps a watchful eye on interest rates and stays in touch with her mortgage broker because she is eager to refinance the "jumbo" loan on her Charles County home.

"But I haven't even bothered to try to refinance yet because I know the jumbo rates are too high right now," said Galloway, 37, a D.C. legal secretary. "I'm just waiting and watching for any sign that the interest rates will drop."

That drop may be coming soon.

The economic stimulus package that President Bush signed this week includes provisions aimed at pulling those rates down and reinvigorating a part of the mortgage market still stunned by problems with subprime borrowers that surfaced last year.

Jumbo mortgages -- those that exceed $417,000 -- got expensive as the credit crisis worsened. Rattled investors stopped buying them. Lenders responded by raising rates. And plenty of people in high-cost areas such as Washington got shut out of the housing market or, like Galloway, lost their chance to refinance into cheaper loans.

As part of the stimulus package, the mortgage giants Fannie Mae and Freddie Mac will be allowed to buy or guarantee mortgages up to $729,750 for single-family homes. That's up from the previous $417,000 cap, which was tied to the average home price nationwide. The amount would vary so that the most expensive areas would qualify for bigger loans. The stimulus package also increases the limits for loans insured by the Federal Housing Administration.

The idea is that investor appetite for these larger loans will grow if they have backing from Fannie Mae and Freddie Mac. The two companies are federally chartered, which means many investors treat their loans as if they have the government's implicit guarantee. Fannie Mae and Freddie Mac ors are buying these days, which is why policymakers wanted jumbos added to the mix.

Mortgage industry experts said the change should encourage lenders to lower jumbo rates. But they disagree on how low and on whether the benefits will be widespread enough to bolster the housing and mortgage markets, especially because the higher caps will be in place for a limited period, through the end of this year.

"The most we can say right now is that there will be some opportunity for some borrowers to achieve perhaps some interest-rate relief on their jumbo mortgages," said Keith Gumbinger, a vice president at HSH Associates, a mortgage research firm.

A lot of the details have not yet been determined. Under the new plan, the Fannie Mae and Freddie Mac loan limits will be set to 125 percent of the median home price in every metropolitan statistical area. Within these parameters, the limit cannot drop below $417,000 or exceed $729,750.

The Department of Housing and Urban Development is in charge of calculating the limits; it's expected to tell lenders next month what the limits are in various areas. It will take several more weeks before Fannie Mae and Freddie Mac can begin to purchase the loans; first they must sort through internal logistical and operational issues.

Many analysts expect limits to increase in about 20 metropolitan areas, mostly pricey markets on the East and West coasts. Federal regulators declined to comment on what they expect the loan limit to be in the Washington area, or on what geographic definition of the region they will use.

But the Stanford Group Company, a policy research firm in the District, estimated that if the cap is based on median prices compiled by the National Association of Realtors, locally it would be about $500,000 and would apply to an area that extends into West Virginia.

"While not every American is going to get to enjoy a higher loan limit, what makes this program exciting is that those who need the assistance the most are going to get it," said Jaret Seiberg, an analyst at Stanford Group. "There are markets where the average home price is well below $417,000, so they do not need any kind of boost."

Lower rates would help Galloway, the Charles County homeowner. She owes about $448,000 on her house. She has an adjustable-rate mortgage and wants to refinance before that loan resets, possibly to a higher level.

But just as she was about to get a new loan, the jumbo rates started climbing and never stopped. In the past, lenders charged about 0.25 percentage point more for 30-year, fixed-rate jumbo loans than they did for smaller loans that conform to Fannie Mae and Freddie Mac standards. But the spread has widened since August to nearly a full percentage point, according to HSH Associates.

Last week, the rates on conforming loans averaged 5.77 percent, while those on jumbo loans averaged 6.7 percent.

Although the aim of the changes is to reduce that gap, investors have become so skittish about jumbos that there's no telling how they will react if the large loans are mixed in with more traditional conforming loans, several industry analysts said.

Why should the average consumer care how investors react?

Because when Fannie Mae and Freddie Mac buy these loans from lenders, they sell them to investors on the secondary market.

If investors feel that the larger loans inject too much risk into the pool of mortgages offered to them, they will demand a higher yield, which translates to higher rates for borrowers, said Ajay Rajadhyaksha, head of U.S. fixed-income strategy at Barclays Capital.

The perceived risk is not a creditworthiness issue, Rajadhyaksha said. Rather, it's the jumbo borrowers' well-documented fondness for refinancing when rates drop, which forces investors to reinvest the money at a lower rate.

"The investor will still be wary of [jumbo loans] even if they come with a Fannie or Freddie guarantee," Rajadhyaksha said. He said he expects the spread between existing jumbos and conforming loans to return to about 0.25 percentage points.

Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard University, said the spread could narrow from about a percentage point to 0.50 to 0.75. "That can be a pretty big number because we're talking about markets with expensive homes."

For instance, a half-percentage-point drop in the rate on a $500,000 mortgage shaves about $200 off monthly payments, said Retsinas, who serves on Freddie's board.

But even if rates drop, not everyone will be able to take advantage of them, Retsinas said. Potential borrowers with less-than-stellar credit will be turned away from any kind of loan these days, as will people who owe more on their mortgages than their homes are worth.

Galloway said that she fits the profile of an on-time borrower lenders want to work with and that she can't wait to see what the new loan limits might mean for her family.

Galloway and her husband have four children, ages 8 to 18, and the oldest is headed to college.

"At this point, I'll take any savings I can get," she said.