FBR Sees No Fallout from Alternative Documentation

A report from Friedman Billings Ramsey & Co. here said adjustable-rate subprime mortgage loans with alternative documentation perform better than their counterparts with full documentation.

The report from Michael Youngblood and Jason Hu found that one in three subprime borrowers prefer an alternative-doc mortgage to a full-doc one. Furthermore, they prefer ARM loans by a vast majority. Nearly 85% of the subprime alternative-document loans originated in 2005 were ARMs. Over 96% of both the alternative- and full-doc loans originated in 2005 were indexed to Libor. The weighted average coupon of alternative-doc loans is 7.22%, compared with 7.04% for full-doc loans.

The average loan size for the alt-doc loan is $177,355, "substantially larger than the average full-documentation loan ($148,415)," the report said. Alt-doc loans have an average credit score of 640, compared with 618 for full doc, while loans with a credit score of 580 or less represent 16.9% of alternative, but 27.1% of full-documentation loans. However, the average loan-to-value ratio of alternative is slightly lower than that of full-documentation loans, 80.8% and 82.1%, respectively.

What the authors see as a major negative is the geographic concentration of the alt-doc subprime loans, with over 45% of them in the 42 metropolitan statistical areas considered to be in a housing bubble. Still, the report declares, "The higher credit scores and lower loan-to-value ratios of loans with alternative documentation should foster superior credit performance."

In the report's conclusions, the authors' state, "Lenders are underwriting subprime loans with alternative documentation diligently. They compare stated with average income for the position, seniority and location, and adjust it as appropriate. They underwrite the borrowers' ability to pay using trimerged credit bureau reports and credit scores.

"They originate loans with alternative documentation with significantly higher credit scores and lower loan-to-value ratios. We know that they are underwriting prudently: the credit performance of adjustable-rate loans with alternative documentation is superior to that of those with full documentation."

However, these alternative-documentation loans have been cited by Alan Greenspan and other regulators as being very risky for banks and other participants, especially if there is a housing bubble and it bursts.

The authors come up with their own solution. "To mitigate these concerns, we propose that subprime lenders obtain from each borrower and co-borrower the following critical information: name of business, type of business, position, full- or part-time status, union or non-union status, time- or incentive-based compensation and number of years in business."

SNAPSHOT: Alt Doc Loans

LIBOR Indexed 96%

Avg. Loan Size $177,355

Avg. FICO Score 640

Avg. LTV Ratio 80.8%

Source: FBR

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