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Tuesday, August 12, 2008

Subprime and Alt-A: The End of One Crisis and the Beginning of Another

by Tanta on 8/12/2008 05:00:00 PM

Clayton has kindly given us permission to excerpt some information from their monthly RMBS performance newsletter, InFront. Clayton's report suggests that we may have now seen the beginning of the end of the subprime meltdown, but we are only at the end of the beginning of the Alt-A wave that is following it.

According to Clayton, subprime delinquencies appear to have peaked in December of 2007, and subprime foreclosure starts may have peaked in January of 2008. The volume of foreclosures in process will remain elevated for a long time as these things work their way through lengthy foreclosure timelines, but the peak in FC starts is good news.

Unfortunately, Alt-A seems nowhere near its peak yet. Clayton's report, based on May data, indicates that both new delinquencies and foreclosure starts in Alt-A pools are still rising. Fannie Mae's recent conference call suggesting that Alt-A deteriorated even more sharply in July is yet more evidence that the Alt-A mess is still ramping up.

These two charts from Clayton, on subprime and Alt-A ARM resets, tell the same tale.

Clayton Subprime

Click on graph for larger image in new window.

Based on remaining active loans, we are at about the peak for subprime rate resets. However, Alt-A is a different picture:

Clayton Alt-A

As Housing Wire reported yesterday:
When it comes to RMBS, it’s not about the sheer volume of securities issued; it’s about the credit enhancement that exists to protect investors once collateral defaults occur. And comparing Alt-A issues to subprime, it’s no contest: Alt-A is so much thinner in its padding for losses that a lower default rate could hurt investors in Alt-A deals far worse than anything we saw in subprime. The only saving grace here is reach; because Alt-A deals didn’t yield what subprime did, fewer got pulled into CDO issues.

There are large chunks of Alt-A that didn’t get securitized, but instead were held in portfolio for the interest income benefits: and that would be your option ARMs. Which means that while mushrooming defaults may not hit RMBS investors, they will hit the loan portfolios of more than a few commercial banks.
If the "subprime crisis" was about "exotic securities," the "Alt-A crisis" is going to be about bank balance sheets. And the fun is only beginning.