Worsening Credit Market Means Risk for Investors in Alt-A Mortgage-Backed Securities
The latest casualties in the credit crisis are investors in Alt-A residential mortgage loans – referred to as “liar loans†by industry insiders because borrowers don’t have to prove their net worth. As more and more of these mortgages go into default, the value of the securities backing these mortgages plummets, causing significant losses to investors.
Standard & Poor’s announced in late February it may drop its ratings on $13 billion in Alt-A mortgage-backed securities, including 1,887 debt classes issued in 2006 and early 2007, a direct result of loan delinquencies. This would come on top of a downgrade of more than 400 Alt-A securities issued in 2005, about 1,000 from 2006 and 900 issued last year. A sharp decline in valuations for securities forces investment funds to unwind or meet margin calls.
Meanwhile, investors in Alt-A mortgages may be at more risk than they realize.
Mortgage-backed securities head south
In the beginning, Alt-A mortgages attracted investors because of their diversity. While some lenders issued Alt-A mortgages to borrowers with less-than-desirable credit histories, others made the loans available to more creditworthy individuals, diversifying the Alt-A market as a whole. That made the market more attractive in terms of risk: Alt-A loans generally have fallen somewhere between prime and subprime. In addition, the market includes a good mix of fixed-rate and adjust-rate mortgages, or ARMs, which carry lower minimum payments for borrowers – and thus are more likely to be repaid.
In today’s economy, though, default rates have increased even among more creditworthy borrowers, putting more investors’ funds at greater risk.Â
Valentine’s Day 2008 may have marked the start of the current decline in Alt-A mortgage-backed securities. It’s when rumors that UBS would sell a significant portion of its Alt-A holdings began to spread.  One week later, AAA-rated securities backed by 30-year fixed-rate Alt-A loans exceeding $417,000 were valued at 12 cents less per dollar of principal than similar securities – more than double the 5.5-cent dip of just a few weeks earlier.Â
Firms act now to stem losses
Some firms already are trying to minimize their losses. London-based Peloton Partners LLP is liquidating a $1.8 billion hedge fund. Expect UBS and Merrill Lynch to take action soon. Merrill Lynch owns $2.7 billion of Alt-A debt, primarily securities. UBS, which owned more than $21 billion of top-rated Alt-A securities at the end of 2007, already has discounted them by $800 million.Â
With $950 billion of Alt-A mortgage-back securities outstanding in the market, these moves may be just the first of many.Â
Stuart Goldberg, a managing director at Marathon Asset Management LLC, cautions investors not to take too much comfort in the past performance of mortgage-backed securities. Today’s Alt-A securities are a riskier investment than securities backed by subprime debt because the latter may have more investor protection built in.Â
Investors in mutual funds and other investments backed by Alt-A mortgages would do well to take note of larger, like-minded investors such as Peloton. Unless they can afford significant losses, investors may want to consider taking steps now to protect their funds.
Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage related investment losses. Â
