Alt-A Pain Still Ahead

I’ll just say up front that this is one of those lame blog posts that links to another person’s blog post and then appends a little extra commentary at the end, which is exactly the type of blog post that one might expect on a Friday afternoon in late June.

The linked-to blog post in question comes from local real estate luminary Jim “The Realtor” Klinge, and it offers up a host of data comparing subprime and Alt-A mortgages in California. The difference, to put it simply, is that while “subprime” describes mortgages given to borrowers with low credit scores, “Alt-A” describes high-risk mortgages granted to people with better credit scores.

I’ve long argued that subprime loans weren’t the only ones at risk of default, and Jim’s data (sourced from the New York Fed) shows that this is true. (For instance, 23.5 percent of Alt-A loans have late payments over the past two years.) But what interests me most about Jim’s post is that it suggests that much of the Alt-A pain may still be pretty far in the future.

Specifically, while 43.4 percent of California subprime mortgages are due to reset in the next 12 months, only 3.6 percent of Alt-A mortgages are in the same boat. However, 43.3 percent of Alt-A’s have resets 24 or more months in the future, versus just 6.2 percent for subprime loans.

Now, there’s more to this all than resets. As I’ve noted on the blog before, the evidence suggests that a lot of underwater loans are going into default well before the reset date.

This makes sense. At the peak, homes were so expensive that it cost more to make the monthly loan payments than it would to rent an equivalent home. So once borrowers who bought near the peak are underwater, they have an incentive to bail immediately and start saving money every month by renting.

Unless, that is, the borrower has a negative amortization loan. In this case, the borrower is actually paying less each month than is actually owed, and the excess is getting tacked onto the mortgage principal. For these folks, their artificially low mortgage payments might be lower than the rent on an equivalent house. In this case it would make sense to stay with the mortgage until the loan reset, but not afterward, both because neg-am loans typically reset sharply upward and because the all the extra debt that had been piled onto the principal would likely lead to a highly-underwater loan.

So the little theory I am advancing is that when it comes to predicting default, reset dates matter a lot more for negative-amortization loans than for fully amortizing loans.

I have no data to support this theory, but it makes sense.

Some related data, though, can be found in Jim’s table: 30.8 percent of Alt-A loans were neg-am, versus 0.1 percent for subprime loans.

So considering that a lot of Alt-A loans are negative amortization, and that a lot of them are a long while from resetting, we may be seeing high default rates among more creditworthy (to use a loose interpretation of the term) borrowers for years to come.

— RICH TOSCANO