In its most recent report, JPMorgan Securities analysts tried to understand the behavior of borrowers in what they defined to be the Alt-B sector.
The firm defined Alt-B as those loans having 620 to 680 FICO scores. In the report, analysts made several conclusions. The first was that modestly seasoned Alt-B collateral have a flatter S-curve compared to Alt-A (680 to 720 FICO scores) and prime (720 plus FICO scores) collateral. Aside from this, the aging ramps are faster for Alt-B collateral, especially when out-of-the-money or deeply in-the-money. The cumulative losses for Alt-B can be two to three times more than Alt-A, JPMorgan said.
JPMorgan further defined Alt-B as the low end of Alt-A and high end of subprime collateral from a credit perspective, which is based on several factors such as credit score, documentation status, LTV, owner occupancy, etc. Since there is no standard definition, Loan Performance simply maps loans according to the issuer. For instance, all of the loans in CWALT deals get classified as Countrywide and end up in the Alt-A partition of the Loan Performance database. However, in JPMorgan's attempt to carve out an Alt-B sector, analysts choose to use FICO to define the different segments. They also cross-referenced these definitions with the Loan Performance definition of prime, Alt-A and subprime. In short, analysts take all first lien loans with a FICO score greater than 720 from the prime, Alt-A and subprime shelf. They did the same for 680 to 720 FICO and 620 to 680 FICO, which, according to them, defines Alt-B.
In terms of market share, JPMorgan said that ARMs (hybrid, hybrid IO and MTA) represent 66% of all Alt-B loans, 64% of Alt-A loans and 58% of prime loans. They added that it is critical to separate out hybrids from fixed-rate loans when examining prepayment and credit performance as these products behave very differently. The Alt-B sector, as JPMorgan has defined it to be, is 25% of the non-agency market in terms of ARM and fixed combined.
Growth in the nonagency sector has the potential to be high, analysts said. This year, for instance, there are roughly $150 billion in ARM resets in the subprime market and about $50 billion in subsequent resets, they added. Subprime ARM borrowers currently in the 620 to 680 range could move into fixed-rates. The real growth would most likely be in fixed-rate IO. Additionally, borrowers may have been able to improve their FICO score during the subprime loan's fixed-rate part.
For prepayments, analysts said that ignoring documentation type and LTV, they can see a consistent relationship in the S-curves for Alt-B collateral versus Prime and Alt-A. High premiums are faster for prime collateral. However, at-the-money and discount speeds are faster for Alt-B collateral. This results in a considerably better convexity profile for seasoned Alt-A and Alt-B collateral (12 to 24 WALA), JPMorgan said.
In terms of the credit performance of Alt-B securities, analysts said that it is clear that delinquencies, defaults and, ultimately, losses are higher in the Alt-B sector, versus the prime and Alt-A markets. However, investors should consider that the subordination levels are also higher. Usually triple-A subordination levels have been 3.75% and 6% to 7% for 30-year fixed-rate prime and Alt-A collateral, respectively. Analysts expect Alt-B deals to have about a 15% triple-A subordination level.
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