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Willy Weasel

Alt-a Defaults Outpace Subprime

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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.

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Don't worry, it's all contained

All contained within the whole system!

It's all going down the pan very soon... :o

I know you're joking, but it is clearly not contained. The cancer is spreading.

When a disease like this spreads it's either time for some seriously nasty medicine, or the patient pegs it, or the patient gets nasty medicine then pegs it.

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