Fears of rising delinquencies and defaults on home loans that crippled the secondary market for subprime mortgages this summer have also caused a dramatic slowdown in issues of securities backed by so-called alt-A mortgages.
A new report by Standard & Poor’s Ratings Service shows quarterly issuance of securities backed by alt-A mortgages plummeted 64 percent in the third quarter of 2007, falling from an all-time high of $109.5 billion during the previous quarter, to just $39.3 billion in July, August and September.
Standard & Poor’s said it expects the trend to continue into the fourth quarter and into early 2008, as investor demand for mortgage-backed securities has fallen sharply and loan originators are focusing on loans eligible for sale to Fannie Mae and Freddie Mac.
The simultaneous tightening of underwriting standards and reduced demand from investors for alt-A loans “poses a threat to many borrowers who may be faced with the risk of loan rate reset or loan recast in the near term,” the report concludes.
While monthly alt-A issuance volume fell by more than 75 percent from June to September, the loans still accounted for 28 percent of total mortgage originations during the third quarter — about the same as two years ago, the report concluded. Refinance loans made up an increasing share of alt-A issuance during the third quarter, 25.1 percent, up from 15.1 percent in the same quarter a year ago.
Although alt-A borrowers typically have better credit than those considered subprime, the characteristics of the loans themselves — which often involve low or no documentation and high combined loan-to-value ratios — can make them riskier, Standard & Poor’s said.
Hybrid interest-only and pay-option adjustable-rate mortgage (ARM) loans continue to dominate the alt-A market, the report found, although borrowers are opting for longer initial fixed-rate periods of 5-10 years. During third-quarter 2007, more than 60 percent of pay-option ARM loans carried initial fixed-rate periods of five years or longer, compared with 48 percent in the previous quarter and 5 percent during third-quarter 2006.
Evidence that loan originators are tightening underwriting standards includes rising average FICO scores, falling combined loan-to-value ratios, and an increased percentage of loans requiring full documentation.
The average FICO score for alt-A borrowers was 712 during the third quarter, compared with 702 at the end of 2006. The percentage of alt-A borrowers with FICO scores below 650 dropped from 12.1 percent in all of 2006 to 8.5 percent in the third quarter of 2007.
The average combined loan-to-value ratio fell from 94.7 percent at the end of 2007 to 91.6 percent during the third quarter 2007. That means the average borrower with a second mortgage was required to have more equity in their home — 8.4 percent — compared with 5.3 percent at the end of 2006.
Loan originators required full income documentation on 22.1 percent of alt-A loans in the third quarter of 2007, up from 16.8 percent in the previous quarter, Standard and Poor’s found.
Although it’s too soon to draw conclusions about how alt-A loans made in 2007 will perform, the report said, delinquencies are up sharply. Early data suggest “the 2007 deterioration may be the worst ever for the alt-A market,” the report found.
Citing numbers from First American CoreLogic Inc.’s LoanPerformance, Standard & Poor’s noted that 4.71 percent of alt-A loans made in 2006 were 90 days or more delinquent after 18 months of “seasoning.” That compares with a 1.97 percent severe delinquency rate for loans made in 2005, and 1.07 percent for 2004 loans.
Given the limited seasoning of loans made in 2006 and 2007, “the spike in severe delinquencies is unprecedented,” Standard & Poor’s analysts said. “We remain concerned that an extended housing downturn could lead to a prolonged period of high delinquencies and, ultimately, high cumulative losses.”
In 2007, Standard & Poor’s downgraded 677 classes from 217 alt-A mortgage backed securities (MBS) transactions, and placed on “CreditWatch negative” 547 additional classes of MBS and net interest margin securities backed by alt-A mortgages.
The Dec. 27 report, RMBS Trends: Third-Quarter Alt-A Issuance Drops Dramatically From Its All-Time High, is available at no charge to registered users from Standard & Poor’s Ratings Services.
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