Alt-A loans: New fear for middle-class subprime

We can't say we haven't been warned. The doom-mongers reckon America's property market is on the verge of a new crisis as big as the subprime disaster that began in 2007.

Bad outlook: Defaults by US middle-class homeowners are rising at an alarming rate

The fear is that borrowers with better credit histories, who took out Alt-A mortgages, are defaulting on a similar scale.

Global exposure to American Alt-A (it stands for Alternative-A) is estimated at $600bn - the same as subprime. Bearish observers think losses could hit $150bn. 'the performance of Alt-A is clearly deteriorating rapidly, and we believe that 2009 will see such mortgages worsen further,' says David Watts, an analyst at CreditSights in London.

Rising unemployment in America, where a record 598,000 jobs were lost in January alone, means many borrowers are struggling. Late payments and repossessions are soaring.

Rating agency Moody's said last month that it was revising upwards the expected losses on 90% of Alt-A mortgage securities. It describes the collapse as 'unprecedented for its asset class'. These are not the subprime households who would probably have been better off without a mortgage in the first place. Alt-A borrowers tend to be middle-income earners. While we don't use the term Alt-A in Britain, some mortgage brokers do talk of 'near-prime' or 'midprime'.

Ray Boulger, senior technical manager at mortgage provider John Charcol, explains: 'They are people who in the UK would probably have got a prime mortgage - at least back then. They would have had fairly minor indiscretions such as mortgage arrears of two months or a small county court judgment against them.'

The problem with Alt-A came at the height of the US housing boom as borrowers were encouraged to take out loans way beyond their means - say with a 'negative amortisation' mortgage where the borrower did not even pay off the interest each month, and the loan kept growing.

According to CreditSights, 9.2% of Alt-A mortgages from 2005 had been repossessed or were in foreclosure by December 2008. For 2006 mortgages, repossessions leapt to 17.1% by the end of 2008. The 2007 vintage is shaping up to be even worse, with 13.6% having already been repossessed (see graph).

Moody's reckons total losses from the 2006 Alt-A vintage could peak at 20%, and the 2007 vintage may average 24%. Some have 'performed similarly to subprime'. Historically, Alt-A losses had been just 1%.

Dozens of banks are affected because they bought parcels of Alt-A mortgages that were sold as securities and traded around the world. Britain's Lloyds Banking holds more than £7bn worth, Barclays has over £3bn and RBS about £1.5bn. the picture is bleak.

Falling US house prices mean negative equity and fewer cheap mortgage deals. creditSights says an alarming 60% of Alt-A borrowers from the 2006 vintage are in negative equity. no wonder there is much talk about the growing trend for ' walkaways' - that is people who are giving up repaying a loan because it is worth more than the value of their home.

However, experts say we should not be too hasty in assuming that Alt-A losses have to be as bad as subprime.

US lenders are now keen to avoid making more repossessions - because only 50% of the value of the property may be recovered. and trying to sell a repossessed home in some areas is nigh impossible in this climate.

Instead banks, and politicians, are pushing the idea of 'modifications' - in layman's terms, extending the life of the loan from 25 years to 30 or even 40. this makes monthly repayments smaller and more affordable. Lower interest rates also ease the burden.

'I don't buy the notion that america is facing moral turpitude with people walking away from their payments,' said Watts of creditSights. 'It still tends to be people with higher debt-to-income ratios who default.' In other words, Alt-A owners, with less daunting debts, are more likely than subprime borrowers to try to meet their obligations - especially now the Obama administration is keen to offer help.

But it's going to get worse first. Moody's reckons Alt-A defaults will not peak until the fourth quarter of 2009.

One key question is: could the Alt-A phenomenon happen here? There was certainly a rash of 125% mortgages and self-certifying loans during the boom. Charcol's Boulger is optimistic that our problems won't be as bad because regulation is tighter: 'Whereas in the UK we have a national regulator, in America it depended on individual states. There were clearly some very dubious practices going on.'

None of this is to dismiss the grave threats that face the property market here as well as in America in what is going to be a deep recession.

We will soon find out whether Alt-A is as bad as the pessimists fear.