Though some market players are starting to find value in non-agency conforming Alt-A paper - these are Alt-A loans under the $275,000 agency limit found in non-agency pools - others are saying that there is just not enough Alt-A collateral left, as most of the supply is going the way of the agencies.

According to a recent report by UBS Warburg, non-agency, conforming, Alt-A paper is very cheap at current pricing.

UBS said that since Fannie Mae and Freddie Mac have been insuring an increased number of loans that traditionally fell under the Alt-A umbrella, conforming-sized loans in non-agency portfolios usually entail more risk factors and require more stringent underwriting because they don't have agency backing.

This higher risk profile causes non-agency conforming Alt-A collateral to be less refinanceable in a rally, which is one of the reasons why UBS finds value in them.

Conforming paper generally has less prepayment risk than its larger counterparts and significantly better prepayment characteristics compared to generic agency paper, one would assume that conforming Alt-As would be trading richer than non-conforming Alt-As, and with only a slight give to agency paper.

This is not really true, however. For instance, in the event that conforming-sized Alt-As are sold separate from large Alt- A product as a pass-through, the pass-through trades 14 ticks back.

UBS also compares the performance of conforming Alt-A loans to agency Alt-As.

It concluded that agency Alt-A paper usually trades, depending on the coupon, 4-12 ticks over TBA. On the other hand, conforming, non-agency paper trades 14 ticks behind agency paper.

According to an Alt-A investor, the current spread of conforming balance triple-As represents an opportunity for investors who are willing to entertain a substitute for Alt-A TBAs where one could pick up 18/32 to 26/32's in value or in the case of generic collateral, pick up 14/32's by investing in conforming-balance triple-As.

Therefore, with triple-A Alt-As, there is equivalent or superior convexity (to agencies) at a lower cost.

"Investors may want to consider increasing their allocation to Alt-A triple-A's that are currently trading behind either generic TBAs or Alt-A TBA collateral," commented the investor.

Better value,

but is there enough?

Conforming Alt-A loans have better convexity properties, UBS said. The researchers said that the pricing for this type of collateral does not reflect this.

The report thus suggests that non-agency, conforming Alt-A loans represent "excellent relative value."

However, though there is relative cheapness in the non-agency conforming Alt -A sector, analysts say that there is just not enough product out there to buy a purely conforming Alt-A deal.

"It is very difficult to go out and buy a package of conforming Alt-A at this point because there isn't enough production left over from what the agencies take up," said a mortgage strategist.

He explained that current Alt-A deals are usually made up of a big proportion of jumbo-sized loans. This is in direct contrast to the way it was done in the past.

Back in 1997, for instance, Alt-A deals were generally equally divided into conforming and non-conforming loans. And in 1998 to 1999, conforming and non-conforming Alt-A loans started being placed into separate packages.

"They have stopped doing that because the agencies are now so active in the Alt-A market and it has now become a matter of relative execution," said the strategist.

There is also the issue of Fannie and Freddie changing the maximum individual loan sizes, which increase every year. Currently it is up to $275,000. As the limits of conforming loans change, so do the corresponding prepayment risks.

"Breaking it out by conforming or non-conforming is kind of misleading because that changes over time," said the strategist. "What you need to do is account for the changing nature of the prepayment incentive as the loan limits go up."

He said that if a loan were non-conforming the previous year and then becomes conforming at the beginning of the following year, the pricing differential would be considerable - up to 50 basis points - and would serve as a refinancing incentive.

And as the size of conforming loans increase, the lines between conforming and jumbo loans are blurred. This may cause conforming loans to behave like jumbo collateral in terms of prepayment speeds.

Salomon report

According to a recent report by Salomon Smith Barney, some lenders prefer to sell eligible Alt-A loans to Fannie and Freddie due to better pricing and lower risk. Because of this phenomenon, the average loan size and average LTV of the loans in non-agency Alt-A transactions has considerably risen.

Salomon used Residential Accredit Loan, Incorporated (RALI) to exemplify this trend. The report said that the average original loan size in RALI deals has increased by 125% since 1995. This in contrast to an increase for Fannie 6.5s of roughly 30%.

The report stated that with the significant amount of eligible loans sold to the GSEs, jumbo loans are starting to comprise a bigger percentage of private-label Alt-As. The average original LTVs of Alt-A deals has also begun to rise since 1999. This is partly because of competition from Fannie and Freddie.

"The fact the GSEs have developed a bigger appetite for Alt-A loans means that Alt-A loans within the agency limit are more likely to go to the GSEs," said Mark Adelson, a director at Nomura Securities. "This leaves a greater proportion of loans with higher balances to be securitized in private transactions."

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