Alt-A Mortgage Class the Next Shoe to Drop?

For credit rating purposes, the class above subprime is known as "Alt-A". It is likely Alt-A bonds is the next shoe to drop… that is if it hasn't already.

Issuances of Alt-A mortgages has tumbled, according to a Dow Jones report, however, "the mortgages still made up 28 percent of all mortgages originated in the quarter, the same level as two years earlier." The lending industry's continued appetite for these loans is still alarmingly high considering Alt-A delinquencies are rising at a rapid pace:

After 18 months, Alt-A loans originated in 2006 had a delinquency rate of 4.71 percent, versus 1.97 percent for such loans from 2005 and 1.07 percent for 2004. The trend for 2007 loans is even worse than 2006, suggesting last year could be "the worse ever for the Alt-A market," S&P said.

This is terrible news for hedge funds, fund-of-funds and individual investors that have billions invested in Alt-A bonds. In 2006 alone $400 billion Alt-A loans were originated and likely sold to investors.

The fall-out of a collapse in this market will likely mirror that of the subprime loan market. Amidst the subprime rubble, allegations of hidden risks and omissions have been commonplace as well as accusations that Wall Street unloaded toxic subprime debt on unsuspecting investors. We could see a similar legal landscape in the near future.

According to our sources, Alt-A investments were pitched in a comparable fashion as subprime. Brokers and managers told clients Alt-A investments were backed by secure assets and were steady gainers, unlike tech stocks of the late 90s. Alt-A securitized investments in reality are backed by loans requiring little documentation regarding salary and other assets that would determine a consumer's credit worthiness. The phrasing is interesting: "Alt-A mortgages typically got to borrowers whose credit is deemed good enough to forgo proof of claimed assets or income."

Analysts are also eyeing the Alt-A market suspiciously. In a Marketwatch story from earlier this month, Mark Adelson, head of structured finance research at Nomura Securities International, calls "Alt-B" products:

"The Alt-A market has absorbed and disguised a portion of the subprime space," he said. "You can debate how to define these loans, but many have ended up being an Alt-A product with subprime deficiencies…"In the past few years, Alt-A loans were made to weaker and weaker borrowers and the sector expanded downward along credit spectrum," he said. "In doing that, you draw up into the Alt-A space some of the problems that are affecting the subprime space."

In other words, "Alt-A" isn't simply the next subprime, it could be subprime.