Potentially more toxic than sub-prime: the £6.6bn of 'Alt-A' that spooked HBOS investors

HBOS has £6.6bn of "Alt-A" securities, a US mortgage bond that the market fears could be more toxic than sub-prime debt.

These securities, known more fully as Alternative-A, represent debt secured on mortgages that are said to be as good as prime, even if they did not pass all the tests to be classed as top grade. They sit between prime and sub-prime, but default experience is showing they are almost sub.

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The existence of the debt is said to be one of the reasons why investors had become so spooked about HBOS's financial health over recent weeks. HBOS holds only £90m of sub-prime debt, but the £6.6bn of Alt-A dwarfs even the bank's £2bn portfolio of prime US mortgage-backed securities. It has marked down the value of the bonds by 20 per cent, but rivals such as Royal Bank of Scotland have written down their Alt-A holdings to half their face value.

Lehman Brothers admitted that it had cut the value of its Alt-As by 71 per cent – a deeper writedown than it made on its sub-prime securities. The cut left Lehman less exposed to Alt-As than HBOS.

The securities are known as "liar loans" in America because borrowers give no proof of income. Many applicants exaggerated their earnings to obtain larger loans to buy bigger homes, but were unable to pay the interest – especially when the low initial "teaser" rates charged in the initial years jumped later to market levels.

Default rates have quadrupled in the past year and are five times greater than the arrears on prime loans. Although sub-prime defaults are worse, there are twice as many Alt-A loans outstanding, making them potentially more dangerous.