A Fundamantal Investor's Peek into the Alt-A Market

Submitted by Reggie Middleton on 01/14/2010 07:54 -0500

Here are some very interesting facts on the latest trend in Alt-a mortgages that have been in the news as of late. The following charts were culled from my mortgage default model which was built primarily from date gathered from the FDIC and the NY Fed.

As you can see, the current trend still has subprime at a significantly higher charge off, delinquency and foreclosure rate than Alt-A loans.

The issue is that the Alt-A loans are usually written for a much larger amount than the subprime loans, hence the losses from Alt-A shall be much larger.

Let's delve deeper into the Alt-A market... Click any of the graphs below to enlarge.

As you can see, Alt-A loans are a very small minority of the loan market, but since they are written on considerbly larger principals than subprimes, the potential losses will hit harder. In addition, they peaked in popularity at the exact top of the housing bubble...

See"If Anybody Bothered to Take a Close Look at the Latest Housing Numbers...", and in particular the shape of the bubble peak.

The average origination of the Alt-A loan in the use sits right atop that crest. You see where we have went from there...

As if the Case Shiller graph doesn't drive this point home hard enough, the average and mean CLTVs for Alt-A loans AT ORIGINATION hover around 82% to 93%. Those are loans written at the top of the bubble. What do you think happened a few years later???

This is the state of Alt-A loans as of November! Nearly all of them are underwater. Some are totally sunk! We're talking 150%, 175% LTVs. and that is statewide, not anecdotal high end cases!!! If you are not familiar with Alt-A loans Option ARMs which are a subset of Alt-A, they allow you to pay less than the amount necessary to amortize the loan, resulting in negative amortization. That means as time goes on, your outstanding principal gets bigger, not smaller. Many loans have a cap on this neg am amount wherein if it hits a certain level, the loan goes fully amortizing. What are the chances of this happening??? Well, you tell me.

California is such a strong contributory force to credit losses in the Alt-A category that it literally needs to be removed just to see what the other states are doing. Whoa!!!

This leads to a very important point. Exotic mortgage products were popular in CA and FL and NV becuase home prices outpaced rents and incomes. Home prices have come down, but they are still out of equilibrium with incomes, net assets, and rents. Unemployment is weigh up and household net worth is way down. Combine that with a dearth of available financing from the banks and the near total absence of loan exotica and there is only one way for house prices to travel. This fact has been masked and concealed by the Fed ZIRP policy, by trillions of dollars of securities purchases, primarily MBS, and by other ill-planned stimulus measures such as the $8k tax credit.

The chart below illustrates the seasonal ebbs of month to month price changes. On a month to month basis, we see hills in the spring and summer and valleys in the fall and winter. During the onset of the bursting of the (first) bubble, this cycle was compressed, but was still there. and lasted throughout the bubble. With the onset of the government stimulus (ex. housing credits and MBS market manipulation), the peaks were significantly exacerbated. Now we are entering into the winter months again, and guess what's happening, as has happened nearly every winter cycle before. The only difference is that this dip is extraordinarily steep! I would also like to add that the month to month price changes coincide exactly with the S&P 500 move downward and upward for 2008 and 2009, to the MONTH! What a coincidence, huh? If this relationship holds,,,, well you see what direction the month to month lines are going and how steep they are, don't you?

As you can see when we drill down into the month to month numbers, the improvements either weaken significantly or disappear into numbers that show further declines - and this is in the face of government bubble blowing! Also, be aware that the Case Shiller index is a three month average that is lagged. So a leveling off of values from a previous increase actually means that material negative inputs have entered the equation. If the housing prices don't spike higher in November and December, expect the index to fall. As housing falls, it puts even more pressure on credit quality.

This results in total risk to banks skyrocketing, despite many members of bank management saying that they believe things will peak in 2010. Every year since 2006, banks and home building management have proclaimed unsubstantiated optimism that flies in the face of what I have researched! Reference this excerpt from American Banker:

Over the past few months, Wells has been relatively upbeat about the portfolio. Chairman and Chief Executive John Stumpf said at a Goldman Sachs conference last month that it has been performing better than expected.

"I don't think they would have made the statements they did unless you saw continued improvement," said Joe Morford, an analyst at RBC Capital Markets.

Much of this optimism is a function of the banking sector's gradually improving expectations for consumer credit losses. Wells now expects them to peak before midyear.

That would allow the bank to take some accounting gains on the impaired portion of a major portfolio.

After writedowns, modifications and repayments, the Pick-a-Pay portfolio's carrying value is down to $88 billion. And negative amortization, the bete noire of the portfolio, has been dropping.

In Wells' prerecorded third-quarter earnings call in October, Howard Atkins, Wells' chief financial officer, raised the prospect that, beginning in the fourth quarter, Wells could begin "recapturing a portion of the life-of-loan purchase accounting marks" it took on the impaired portfolio.

Bush and other analysts said this quarter is likely too soon for Wells to "declare victory" on Pick-a-Pay — because of both macro concerns about the housing market and the difficulty of predicting how the $50 billion unimpaired portion of the portfolio will perform.

While those loans are still performing according to plan, she said, "If they're over-reserved, they're going to stay over-reserved over the next couple quarters."

I remind my subscribers to keep in mind what Wells has in their portfolio and how that class of assets have been performing according to the NY Fed and the FDIC.

WFC Investment Note 22 May 09 - Pro 2009-05-27 01:56:54 853.53 Kb

WFC Investment Note 22 May 09 - Retail 2009-05-27 01:55:50 554.15 Kb

WFC Off Balance Sheet Exposure 2009-10-19 04:25:53 258.77 Kb

WFC Research Note Sep 2009 2009-09-30 13:01:30 281.29 Kb

All subsribers can download the data that generated these graphs here:

File Icon Alt-A loans and credit trends - December 2009

Non-subscribers can view my historical analysis of Wells here:

I see Alt-A losses from banks being very, very significant. There is absolutely no way the Fed can allow rates to increase without literally destorying both those that wrote and hold these products and the mortgagees that need to pay them!

So banks are doing well. Of course they are! FASB has allowed them to absolutely ignore everything in all of the charts you see above.

For more on this, see "How Regulatory Capture Turns Doo Doo Deadly".

Other banks to look at with suspect portfolios:

JP Morgan Chase

(Free Preview) JPM Public Excerpt of Forensic Analysis Subscription 2009-09-22 14:33:53 1.51 Mb

JPM Forensic Report (092209) Final- Retail 2009-09-24 03:12:17 130.93 Kb

JPM Report (092209) Final - Professional 2009-09-24 03:13:31 550.72 Kb

Bank of America

BAC Swap exposure_011009 2009-10-15 01:02:21 279.76 Kb

All subsribers can download the data that generated these graphs here: File Icon Alt-A loans and credit trends - December 2009.

Click here to subscribe. The sheet contains a LOT of data to slice and dice, and is broken down by state, so you can actually back into your favorite bank's propsective portfolio performance if they give a geographic break up, like Wells. See the following screen shots. Click to enlarge...

Your rating: None Average: 5 (8 votes)

by KidHorn
on Thu, 01/14/2010 - 09:28
#193599

The banks won't crash. The FED will buy their bad loans at par and through some sort of accounting, they'll claim they profited from the purchases.

The printing presses will be running full tilt for the next several years. The FED has no choice. The alternative is a complete collapse of the bond market and 15% interest rates. Better a 10% drop in USD than a complete economic collapse.

by Reggie Middleton
on Thu, 01/14/2010 - 09:39
#193611

Well we've had 18% rates and the country made out just fine.

by bugs_
on Thu, 01/14/2010 - 11:25
#193755

But the crooks and ponzis got exposed. This is

a necessary precursor for any recovery.

by KidHorn
on Thu, 01/14/2010 - 13:08
#193934

True, but that was to fight off very high inflation in goods and salaries. Now we have headline unemployment at 10% (No wage pressure) and virtually no inflation. If real interest rates were left to the free market at this time it would cause a simultaneous heart attack in the bond, equity and housing markets.

Not that I'm against it. But I think the Democrats in Washington would be really PO'd at Bernanke.

by Green Sharts
on Thu, 01/14/2010 - 09:41
#193613

We're talking 150%, 175% LTVs. and that is statewide, not anecdotal high end cases!!!

The graph doesn't show any state at 175% LTV and only shows 4 states (the usual suspects NV, AZ, CA, FL) over 110% or so. Not good but not worthy of your hyperbole either.

If you are not familiar with Alt-A loans, they allow you to pay less than the amount necessary to amortize the loan, resulting in negative amortization. That means as time goes on, your outstanding principal gets bigger, not smaller. Many loans have a cap on this neg am amount wherein if it hits a certain level, the loan goes fully amortizing.

It appears you're not familiar with Alt-A loans because you're describing pay option ARMs.

by Anonymous
on Thu, 01/14/2010 - 09:57
#193627

What are you blind? Look at the chart closely. It clearly shows many states over 110% with the bad ones, NV, FL, CA, and AZ from 150-175%.

Alt-A loans include the grouping of pay option ARMs as well as neg am loans and interest only loans. Get off of Reggie!

by ghostfaceinvestah
on Thu, 01/14/2010 - 10:30
#193660

Yeah, the graph is hard to read, but NV is most likely at 175, that is consistent with some of the data I have. Even worse is if you look at it on a CBSA level, places like Vegas and Phoenix are brutal.

I agree about the grouping - see my note below, Alt A is always defined diferently. To some Option ARMs are Alt A, to some they are a separate category. In 2006 and 2007, the vast majority of loans could have been classified as Alt A, even the DU-approved GSE loans (70% of which got some form of doc waiver).

by Green Sharts
on Thu, 01/14/2010 - 10:43
#193672

I missed Michigan as an outlier with the other 4. Michigan's problems are more a function of not recovering from the 2000-2002 recession than from the subsequent housing bubble in other parts of the country.

It is inaccurate and misleading to describe the unique characteristics of a pay option ARM and call it Alt-A since a lot of Alt-A loans don't have negative amortization, interest only or pick a pay options. Pay option ARMs are much more toxic than other Alt-A loans. I don't know the share but believe pay option ARMs are a small percentage of Alt-A loans. They're very concentrated in California, Florida, Arizona and Nevada.

by Reggie Middleton
on Thu, 01/14/2010 - 10:56
#193690

I thought we had come to a mutual agreement that you would avoid my posts because you felt they were subpar. Don't you have somewhere else to be?

by Green Sharts
on Thu, 01/14/2010 - 11:04
#193705

I should stay away because your posts are still subpar, as evidenced by describing the characteristics of pay option ARMs and calling them Alt-A. It's a little bit rich to say most people don't understand Alt-A, as if you do, and then give an inaccurate description of them. Most Alt-A aren't nearly as toxic as option ARMs. I pointed out the mistake in case some think the information in your posts can be relied upon to be accurate.

by Reggie Middleton
on Thu, 01/14/2010 - 11:16
#193727

Well Thank Sharts. I will clear that up. Now, be on your way to one of those superior posts. There is no need for you to waste your time here, with all of this subpar material.

To all, Option-Arms are a subset of Alt-A loans. They are basically non-conforming loans and were very popular among the self-employed crowd and those who had difficulty verifying income.

And to clarify further as to how many Alt-A loans are allowed to go neg-am (negatively amortizing)...

Many loans have a cap on this neg am amount wherein if it hits a certain level, the loan goes fully amortizing. What are the chances of this happening??? Well, you tell me.

California is such a strong contributory force to credit losses in the Alt-A category that it literally needs to be removed just to see what the other states are doing. Whoa!!!

by Green Sharts
on Thu, 01/14/2010 - 11:19
#193740

I take it you prefer only cheerleaders comment on your posts so any inaccuracies in your posts can stand uncorrected and they'll be as effective as possible as marketing material.

Why would you use the term Alt-A and then describe the characteristics of pay option ARMs? I can only think of two reasons, either (1) because you don't know the difference or (2) your intent is to exaggerate and stir up fear.

The facts are bad enough without embellishing them.

by Reggie Middleton
on Thu, 01/14/2010 - 11:29
#193765

I have no problem with you not agreeing with me, but you are an asshole. I don't see why I should put up with you being an asshole. Be polite, courteous and professional and I would welcome you with both arms, whether you agree or not.

I put a lot of work up here for free, highy actionable work, and I am not necessarily in the mood to suffer people being assholes about it.

The phrase you indentified could have been stated clearer from a categorization perspective I admit, but was not very misleading as you can see from the charts the Alt-A category has significant neg-am - or do the facts not mean anything to you. I typed this at 3am, for free, and would think you would be appreciative.

So, seriously, if you have such a problem with my work - be gone!

by ghostfaceinvestah
on Thu, 01/14/2010 - 11:46
#193803

why don't you educate yourself, you stupid fuck, instead of attacking someone who actually contributes?

http://www2.standardandpoors.com/spf/pdf/media/subprime_547_alt-a_viewpo...

"Alt-A loans are first-lien residential mortgages that generally conform to traditional "prime" credit guidelines. However, the loan-to-value (LTV) ratio,
loan documentation, occupancy status, property type, or other factors cause
these loans not to qualify under standard underwriting programs for prime
jumbo and prime quality conforming loans. This review includes transactions
backed by payment option ARM (adjustable-rate mortgage) residential mortgage
loans which have, as a subgroup of Alt-A.........."

by Green Sharts
on Thu, 01/14/2010 - 11:52
#193814

Fuck you asshole. Do you have a reading comprehension deficiency?

There is nothing in there that contradicts what I've said or answers my question, which is what type of Alt-A mortgage OTHER than option ARMS has negative amortization?

by Green Sharts
on Thu, 01/14/2010 - 11:26
#193758

And to clarify further as to how many Alt-A loans are allowed to go neg-am (negatively amortizing)..

So you immediately turn around and do it again, using a broad term to refer to a type of loan that is a very small subset of that term.

Are there any other types of Alt-A loans besides option ARMs that can have negative amortization? What percentage of Alt-A's do option ARMs represent?

by Reggie Middleton
on Thu, 01/14/2010 - 11:31
#193771

You are difficult aren't you. A lot of loans under the Alt-A category are currently neg-am. Take an objective look at the data. I seriously can't believe I am wasting so much time debating with you on this. Ahhh, the dangers of discussion forums. I need to get back to work. You need to find some other place to be.

by Green Sharts
on Thu, 01/14/2010 - 11:37
#193783

Seriously, what other types of Alt-A loans beside Option ARMs are negative amortization?

I may be an asshole (to people like you) but I'm not a lying charlatan who claims he's made 400% in the last 2 years.

by RockyRacoon
on Thu, 01/14/2010 - 11:39
#193787

You guys are just arguing about the caliber of the bullet that will kill us.

One thing you and Reg can agree on: We're screwed.

by ghostfaceinvestah
on Thu, 01/14/2010 - 11:42
#193798

You really are a false expert on mortgages, aren't you? A lot of people consider Option ARMs to be Alt A, and by definition they are. What makes you the fucking expert? You have already proven in earlier threads you don't really understand the mortgage market, and yet you blab on here like you are Frank Raiter.

I hate to be a prick, but you consistently come on here and slam people for their posts on mortgages, when you don't fucking understand them yourself.

by Green Sharts
on Thu, 01/14/2010 - 11:55
#193821

Learn how to read, prick. I never said option ARMS couldn't be considered to be part of Alt-A, I said that most Alt-As aren't option ARMs so to describe the characteristics of an option ARM and to use the broader Alt-A is misleading.

Are you too stupid to understand that? I can't think of a way to say it any more clearly.

by Green Sharts
on Thu, 01/14/2010 - 11:57
#193828

And by the way, while you obviously have some knowledge about mortgages, you have demonstrated repeatedly that you are more interested in being a ZH cheerleader than in having any accuracy around here. If anybody crosses the ZH party line you're on them like white on rice. But if Tyler Durden says a 30 year mortgage has a duration of 30 years, you can't bring yourself to say anything. You'd rather be part of a dumb lynch mob.

by ghostfaceinvestah
on Thu, 01/14/2010 - 14:15
#194027

So now you are attacking me for something I DIDN'T post?

What a fucking loser.

by Neo-zero
on Thu, 01/14/2010 - 09:41
#193614

What an absolutely crap your pants frightening scenario when all this junk starts bubbling to the top of the swamp that is our financial system. As Kidhorn said I guess we can see the presses running for the forseeable future. Along with another expansion of the home buyer credit by April and a further takeover of the mortgage market by fannie and freddie as none of the banks would want anything to do with new loans.

Great article it must have taken alot of work to put together!!!

by jeff montanye
on Thu, 01/14/2010 - 09:57
#193628

reggie, i like your analysis, more because it confirms my own i'm sure, but one thing: it's have gone, not have went. english imperfect verbs are a bitch; personally i'd like to put my girlfriend's granddaughter in charge of regularizing english and we would go, goed and have goed (and be done with it).

by Anonymous
on Thu, 01/14/2010 - 10:18
#193649

Well Reggie that was 18 % when the market was at a relative low AND the 401k / IRA programs were just getting started in 1982 !!! Times have changed and so have the Fed's mis-doings (haha) !! Anyways excellent work - not that the market will ever care about the real numbers until its ready to !!

by ghostfaceinvestah
on Thu, 01/14/2010 - 10:24
#193655

Reggie, couple things:

I understand where you get your CLTV data, but it is most likely understated. There are a lot of unreported (or "subsequent") seconds out there that did not exist at origination. These will affect early vintages (2005 and prior) more than later vintages, as there was more opportunity to cash out via a second for the older mortgages, which is why those vintages are performing much worse than most people originally expected.

Secondly, the definition of "alt a" always bugged me. Normally it referred to conforming mortgages that were outside the GSE guidelines, either because of documentation, or product type, etc. But so-called "prime jumbo" loans were very Alt-A like: a vast majority were stated income, most were 5-1 IO hybrids, most had high CLTVs (a lot of 80-10s), etc. the major difference is the FICOs were usually higher. But we will see how much protection that provides when house prices are down 30% from peak and the IO payment switched to amortizing.

Also, a lot of the loans the GSEs originated were basically Alt A: DU doc waivers were supposed to be proactive, but everyone knew what to enter into DU to get a doc waiver, if you didn't think you could, you wouldn't, so a lot of those supposedly conforming loans are really alt a. And it is starting to show in the GSEs delinquency reports.

All that's to say that the mortgage meltdown is far from over, there is no classification of mortgage that is "safe", and it will be difficult to distinguish the performance of different classifications of mortgages, other than the period of time at which they reach peak losses. Since "subprime" lending was curtailed first, it will hit peak losses first, then Alt A, then prime jumbo, then prime GSE, the only exception being FHA, which is of such poor quality it will overlay all of the above.

by ghostfaceinvestah
on Thu, 01/14/2010 - 10:35
#193662

"There is absolutely no way the Fed can allow rates to increase without literally destorying both those that wrote and hold these products and the mortgagees that need to pay them!"

One comment on this - you are absolutely correct, this is one of the main reasons I move everything I have out of USD as fast as I can. If you do the math, you will realize that the Fed can't let 1 year LIBOR increase even 100bps, so have no choice but to keep o/n rates at zero through at least the end of 2011.

by ptuomov
on Thu, 01/14/2010 - 11:01
#193697

Is option-arm included in your analysis? That's da bomb.

See:

http://www.calculatedriskblog.com/2010/01/option-arm-recast-update.html

and specifically

http://1.bp.blogspot.com/_pMscxxELHEg/S0zEYEpaFyI/AAAAAAAAHPo/gLfcUyq6xJo/s1600/AmherstOptionARM.jpg

by Anonymous
on Thu, 01/14/2010 - 12:30
#193884

Wen you tired off arguing the minute detail try looking at the probability that the people who caused the problems know what they did and know how to fix it.

This is a plane wreck in slow motion. Has anyone seen any bank, financial institution, Treasure or Fed Reserve do anything right in the past 4 years?

By right I mean look out for shareholders, look out for taxpayers minimize losses!

by Anonymous
on Thu, 01/14/2010 - 13:12
#193936

I know here in Florida a lot of self employed people took these type of loans around 06 and have since either went out of business or are barely making it. Some have already walked away from these underwater mortgages even though they could have held on longer so what I see coming here in Florida is not a spike in foreclosures again but the rate staying extremely elevated for the next 2 years with more being Jumbo loans as these take the place of the subprime foreclosures. The Supreme Court of Florida also just put a 3 month extra delay on foreclosures by requiring banks (whoever they send to the meeting) to have a sit down with borrowers to see if some adjustment can be reached but it will just be a temporary delay as the people dont have the money to pay basically.

by Anonymous
on Thu, 01/14/2010 - 13:23
#193947

a post on CRE online:

Re: How do banks Logistically kick people out

[ Follow Ups ] [ Post Followup ] [ CREOnline News Group ]

Posted by Alex_FL on January 14, 2010 at 11:32:21:

In Reply to: How do banks Logistically kick people out posted by James on January 14, 2010 at 01:45:50:

James,

I was in the same situation as your brother. Due to hardship and ARM adjustment, I stopped paying mortgage and condo fees for over 12 months. I purchased my condo (my residence) for $289K in 2005, now it`s worth $168K. Never received any letter to foreclose from the bank besides statements and few calls. After 6 months, I applied for loan modification, no answer. After 12 months, receive notice to foreclose from bank (Chase) inviting me to submit another loan modification. Lo and behold, they modified my loan by cutting my payment in half from $2200/mth to 1062/mth after 2 weeks. We signed the final agreement knowing also that they have upped my principal to $246K and the terms to 36 years! They stopped all foreclosure proceedings and I could live with the new payments. A little afterwards, the condo association threatened to foreclose for about $12K of unpaid arrears. I called the bank and told them about the condo association`s foreclosure in process and that I risk losing my condo for $12K. The bank issued a payment to the condo association to settle all my arrears. I am still living in my upside down condo and making affordable payments to the bank. I am still trying to understand why Chase Bank is doing all this for me but it`s obvious. I am still stuck in my property. I am in South Florida.

by AR
on Thu, 01/14/2010 - 14:45
#194065

Thanks Reggie for the links. We especially think the regional banks are in a lot of trouble due to comments above, but upcoming yet to be realized, CRE losses in particular.

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