Although “sloppier” Alt-A fixed-rate bonds are attractively priced versus their prime counterparts, Amherst Securities Group (ASG) analysts said in a recent report that the collateral is converging.
ASG analysts explained that Alt-A product is cheaper when compared to prime collateral even without considering the additional potential upside of transition burn-out. They noted that the specific loans that are most likely to burn-out are those with higher cumulative loan-to-value ratios (CLTVs).
On the other hand, prime collateral is less likely to undergo a transition burn-out to the same extent. Additionally, even the underwater, always-performing prime mortgages are priced high enough so that the advantage of transition burn-out is significantly less, analysts noted.
Prime loans are also more likely to experience drops in voluntary speeds in the future, which will increase the average life of these securities and negatively affect value. Given that Alt-A speeds are already so low, it is unlikely that they will further decrease, analysts said.
However, after analyzing prime and Alt-A fixed-rate pools, they found some convergence despite the differences in these pools. They attributed this phenomenon to Alt-A collateral of worse quality already defaulting and the better-quality prime collateral already undergoing prepays.
In the remaining pools that analysts looked at while controlling for compositional changes, the burn-out in transition rates, which they expect to continue, is much more evident in Alt-A pools compared with their prime equivalents.
Analysts also said that there has been burn-out in prepayments, although this has been masked by the move to ever lower interest rates. The compositional changes and added burn-out have produced considerable performance convergence across the shelves, analysts said.
However, there is now less variance across the different prime shelves versus back in 2009, as are the various Alt-A shelves. They added that the standard deviation across shelves is a lot less versus how once was.
For relative value, the fixed rate Alt-A collateral seems cheap to prime collateral even without the transition burn-out benefit, they said. It is even cheaper if one values the possible upside from transition burn-out.