'Alt-A' Performance Surprises Some.(Brief Article)

Analysts with Nomura found some surprises in the performance of "alternative-A" credit quality loans. The assumption that these loans have slower prepayment speeds than "prime" quality loans may be out of date. This viewpoint is an excerpt from a recent Nomura Fixed Income Research report on alt-A loans.

Alt-A mortgage loans have recently shown noticeably fast prepayments. This development has several implications. First, unanticipated fast prepayments potentially have disappointed investors who bought Alt- A MBS to partially shield themselves from prepayment risk. Second, the fast prepayments might reflect the demise of previously accepted "conventional wisdom" about the lesser negative convexity and baseline prepayment characteristics of alt-A mortgage loans. Third, the erosion of alt-A conventional wisdom can arguably be ascribed to secular changes in the mortgage-lending environment. Foremost among these is the growing involvement of the GSEs in the alt-A mortgage sector. However, other important factors include the heightened consumer sophistication and increasing consumer use of the Internet. Indeed, those factors may be the dominant ones explaining recently rising prepayments on hybrid ARMs.

Looking ahead, the market's most recent prepayment experience with alt-A product is probably going to be more representative of what the future holds than the experience of year's past. Alt-A borrowers today face lower refinancing barriers than they did just a few years ago. Unless unforeseen developments cause refinancing barriers to rise, refinancing will remain easy for alt-A borrowers and alt-A MBS will experience greater negative convexity than in the past.

All things being equal, the yields of alt-A MBS and regular jumbo MBS should converge because part of the value in the alt-A's perceived call protection has eroded.

Arguably there are three approaches to defining the alt-A sector.

The first is to define alt-A mortgage loans by reference to what they are not. In this vein, alt-A loans are those that do not satisfy the regular criteria for conforming or jumbo loan programs but which are first lien mortgage loans to prime-quality borrowers. By itself, this definition implies that alt-A loans possess roughly the same credit quality as conforming or jumbo loans and that alt-A loans bear that designation ...