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Friday, August 10, 2007

Alt-A Update: We Prefer Subprime, Thanks

by Tanta on 8/10/2007 07:04:00 AM

Via Clyde, from Financial Times:

Borrowers of alt-A mortgages may be of higher caliber than their subprime counterparts, but that hierarchy doesn’t necessarily hold for the bonds backed by the two types of loans. In fact, some alt-A securities are trading in line with comparable subprime-backed bonds, according to several market participants.

“We’ve historically been very wary of alt-A because of the decreased levels of subordination in the transactions,” said a buyside source. “We are much bigger believers in subprime.” . . .

Despite what may be higher credit fundamentals of alt-A mortgages, securitizations of the loans are more vulnerable to losses in underlying collateral. That’s because rating agencies have not required as much credit enhancement on the transactions as they have for subprime deals, according to a research report by JPMorgan Chase.

For now, alt-A borrowers are defaulting more slowly than subprime mortgage borrowers, as evidenced by their lower delinquency rates. JPMorgan found that 60+ day delinquencies averaged 7% for a sample of alt-A loans originated in 2H06 versus just under 13% for the ABX deals of the same vintage.

But some investors are opting for subprime securities because of their higher yields and credit protection relative to alt-A. Increasingly valued as interest only investments, subprime-backed bonds purchased at low enough dollar prices may generate superior returns, the investors say.

While subrime delinquencies outnumber those on alt-A mortgages, a fair number of alt-A bonds rated A2 and lower and originated in the second half of 2006 have loss coverage ratios of less than 1 assuming a 30% severity, according to JPMorgan. That compares with an average 1.31 loss coverage ratio for BBB rated subprime bonds underlying the ABX 07-1 index and 1.15 for BBB- bonds, assuming 40% severity. . . .

Key predictors of alt-A securities’ performance are borrower FICO scores, percent of limited or absent documentation loans, exposure to risky geographies – mainly California and Florida – and the loan-to-value ratios of the underlying collateral.

Subordination levels relative to expected losses suggest that most AA and A-rated alt-A bonds are behaving like single-Bs, according to JPMorgan, which tested roughly 30 deals late last month.