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Option ARMs Threaten U.S. Housing Rebound as 2011 Resets Peak

By Brian Louis

June 11 (Bloomberg) -- Shirley Breitmaier’s mortgage payment started out at $98 when she refinanced her three-bedroom home in Galt, California, in 2007. The 73-year-old widow may see it jump to $3,500 a month in two years.

Breitmaier took out a payment-option adjustable rate mortgage, a loan popular during the housing boom for its low minimum payments before resetting at higher costs later.

About 1 million option ARMs are estimated to reset higher in the next four years, according to real estate data firm First American CoreLogic of Santa Ana, California. About three quarters of those loans will adjust next year and in 2011, with the peak coming in August 2011 when about 54,000 loans recast, the data show.

Option ARM borrowers hit with unaffordable monthly payments are another threat to the housing recovery and the economy, said Susan Wachter, a professor of real estate finance at the University of Pennsylvania’s Wharton School in Philadelphia. Owners who surrender properties to the bank rather than make higher payments for homes that have plummeted in value will further depress real estate prices and add to the inventory of properties on the market, she said.

“The option ARM recasts will drive up the foreclosure supply, undermining the recovery in the housing market,†Wachter said in an interview. “The option ARMs will be part of the reason that the path to recovery will be long and slow.â€

Option ARM recasts will mean more pain for California, the state with the most foreclosures in the U.S.

$750 Billion Problem

More than $750 billion of option ARMs were originated in the U.S. between 2004 and 2008, according to data from First American and Inside Mortgage Finance of Bethesda, Maryland. California accounted for 58 percent of option ARMs, according to a report by T2 Partners LLC, citing data from Amherst Securities and Loan Performance.

Shirley Breitmaier took out a $315,000 option ARM to refinance a previous loan on her house.

Her payments started at 3/8 of 1 percent, or less than $100 a month, according to Cameron Pannabecker, the owner of Cal-Pro Mortgage and the Mortgage Modification Center in Stockton, California, who is working with Breitmaier. The loan allowed her to forgo higher payments by adding the unpaid balance to the principal. She’ll be required to start paying principal and interest to amortize the debt when the loan reaches 145 percent of the original amount borrowed.

Hoping for Help

Breitmaier, who has been in the home for 45 years and lives with her daughter, now fears she will lose the off-white stucco house that’s a hub for her family.

“I wish the government would bail us out like the banks and the car businesses,†she said. “I’d like to go from here to the grave next to my husband.â€

Paul Financial LLC originated the loan and it was sold to GMAC, Pannabecker said.

“This loan is a perfect example front to back, bottom to top, of everything that has gone wrong over the last five to seven years,†Pannabecker said. “The consumer had a product pushed on them that they had no hope of understanding.â€

GMAC is working with Breitmaier and will review all of her options, said Jeannine Bruin, a spokeswoman for the company. Bruin declined to be more specific, citing the firm’s customer confidentiality policy.

Inexpensive Payments

Peter Paul of Paul Financial, based in San Rafael, California, said he wasn’t familiar with Breitmaier’s loan agreement but disagreed with Pannabecker’s characterization.

“The problem is, real estate values went down,†Paul said. Paul said he’s winding down the company and hasn’t made any loans since the fall of 2007.

Option ARMs typically recast after five years and the lower payments can end before that time if the loan balance increases to 110 percent or 125 percent of the original mortgage, according to a Federal Reserve brochure on its Web site.

These home loans were primarily marketed to people with good credit scores, said Dirk van Dijk, director of research at Zacks Investment Research in Chicago. They were also sold to the elderly and immigrants who were lured by inexpensive payments, said Maeve Elise Brown, executive director of Housing and Economic Rights Advocates in Oakland, California.

Refinancing is impossible in many states given the nationwide drop in prices. In California, the median existing single-family home price dropped 37 percent in April to $256,700 from a year earlier, according to the state Association of Realtors.

Late Payments Soar

“Once you start amortizing that loan, the payment is going to shoot up,†said David Watts, a London-based strategist with research firm CreditSights.

The delinquency rate for payment-option ARMs originated in 2006 and bundled into securities is soaring, according to a May 5 report from Deutsche Bank AG. Over the past year, payments 60 days late or more on option ARMs originated in 2006 have almost doubled to 42.44 percent from 23.26 percent, Deutsche Bank said. For 2007 loans, the rate has climbed from 10.1 percent to 35.25 percent.

“We’re already seeing much higher levels of delinquencies of these option ARM loans even before you reach the point of the recast,†said Paul Leonard, the California director of the non- profit Center for Responsible Lending.

The threat of soaring payments has counselors at Housing and Economic Rights Advocates busy.

“There’s a level of hopelessness to the phone calls now,†said Brown.

To contact the reporter on this story: Brian Louis in Chicago at blouis1@bloomberg.net.

Last Updated: June 11, 2009 00:01 EDT

Bondholders Face Commercial Mortgage Losses as Principal Is Due

By Sarah Mulholland

June 11 (Bloomberg) -- Investors in bonds that packaged $62 billion of debt for U.S. offices, hotels and shopping malls are bracing for more loan defaults through 2010 as Bank of America Merrill Lynch says landlords’ monthly payments may jump 20 percent or more.

Principal is coming due on the so-called partial interest- only loans as an 18-month-old recession saps demand for commercial real estate. About $179 billion of such loans were written between 2005 and 2007 and bundled into bonds, according to data from Bank of America Merrill Lynch.

With soaring vacancies and falling rents, some cash- strapped borrowers will fail to cover the higher costs, said Andy Day, a commercial mortgage-backed securities analyst at Morgan Stanley in New York. About 87 percent of mortgages sold as securities in 2007 allowed owners to put off paying principal for several years or until maturity, compared with 48 percent in 2004, Morgan Stanley data show.

“The worst is yet to come,†MetLife Inc. Chief Investment Officer Steven Kandarian said yesterday in a Bloomberg Television interview. “Typically there’s a lag between when the economy softens and when the defaults actually occur.â€

Investors have already seen prices on top-rated senior debt drop below 70 cents on the dollar from 95 cents a year ago, according to Aaron Bryson, a commercial mortgage-backed securities analyst at Barclays Capital in New York.

Just a Stopgap

Interest-only mortgages were designed as a stopgap to allow owners to do renovations and absorb other costs. Owners delay paying principal for the first several years, lowering their initial monthly expenses. Partial interest-only loans allow for postponement of principal payments for a portion of the term. Full-term interest-only deals require the principal at maturity.

Loans that postpone principal payments had become the norm by the time the commercial-mortgage bond market peaked two years ago, said Frank Innaurato, managing director of analytical services at Realpoint LLC, a Horsham, Pennsylvania-based credit- rating service.

“The proliferation of interest-only loans was symptomatic of the loose underwriting standards of that time,†Innaurato said. “Borrowers were taking advantage of the best terms possible.â€

Property owners turned to Wall Street to finance office towers, apartment complexes and hotels as banks bundled the debt and sold it to investors. A record $230 billion in commercial mortgage-backed securities were sold in 2007, up from $93.3 billion in 2004, according to Morgan Stanley data. About $750 billion of such debt is outstanding, bank data show.

Subprime Losses

A similar type of loan fueled the U.S. residential housing boom, allowing people to borrow more than they could afford as they assumed home prices would keep going up. The collapse of the subprime mortgage market, which led to almost $1.5 trillion in losses since the start of 2007 at banks and financial companies worldwide, was triggered in part when owners defaulted as their payments rose.

Interest-only loans raised concerns “as an example of excessively aggressive underwriting during 2006 and 2007,†said Kent Born, senior managing director at PPM America, an investment manager in Chicago. “But commercial real estate fundamentals were good, and there was a huge demand for these bonds.â€

The jump in monthly payments on commercial property won’t be as severe as in the residential market, though it will still sting, according to a May 1 report from Bank of America Merrill Lynch in New York. The mortgages may be one of the “significant contributors†to delinquencies on loans in commercial mortgage- backed bonds, the analysts said.

Investment Grade

Concern that commercial real estate is poised for a protracted slump comes as credit markets thaw. Borrowers have sold a record $615 billion of investment-grade U.S. corporate bonds this year, according to data compiled by Bloomberg. Junk bonds, which are rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s, have rallied 33 percent since March 9, Merrill Lynch & Co.’s U.S. High-Yield Master II index shows.

The yield gap, or spread, relative to benchmark interest rates on top-rated bonds backed by commercial real estate has fallen 3.8 percentage points to 7.8 percentage points since the Federal Reserve said on March 23 that it would lend to investors to purchase securities sold before Jan. 1, 2009, as part of its $1 trillion program to unlock credit, according to Bank of America Corp. data. Spreads on the debt have widened 1.5 percentage point since before S&P said on May 26 that it may cut ratings on top-ranked commercial mortgage-backed debt, rendering the bonds ineligible for the program.

A year ago, the debt was trading at about 1.6 percentage point more than the benchmark.

Unemployment Effects

While the U.S. services industry contracted at a slower pace in May and the number of Americans collecting jobless benefits shrank for the first time in almost five months, unemployment will continue to depress non-residential real estate, said Mitchell Stapley, chief fixed-income officer for Fifth Third Asset Management.

“The notion that the rate of decline has slowed, and that we are seeing improvement, doesn’t change the fact that the consumer is retrenching,†said Stapley, who oversees $22 billion in Grand Rapids, Michigan. “We need job growth, not just slowing job losses. There are massive fundamental issues.â€

Defaults More Likely

Delinquencies on commercial mortgages placed into securities have climbed to the highest levels ever, according to data from RBS Securities Inc., the Royal Bank of Scotland Group unit based in Stamford, Connecticut. The late payment rate on them is 2.77 percent, up from 0.47 percent at the end of 2007.

“Interest-only loans will be a problem for borrowers who can’t reach targets on rent growth, or have been hit by vacancies,†said Morgan Stanley’s Day, who is based in New York. “The added burden increases the likelihood of these properties defaulting, translating to losses on CMBS investments.â€

Scaffolding surrounds the ground floor of a 26-story tower at 1775 Broadway in New York. The 1928-vintage building on 57th Street is being refitted with a glass facade and renamed 3 Columbus Circle in a $60 million renovation.

Newsweek, the magazine that’s cutting the circulation rate base of its U.S. edition by 42 percent to 1.5 million by January, vacated 203,000 square feet of the building last month. The unit of Washington Post Co. accounted for 34 percent of the space, according to loan documents. The publication relocated downtown to 395 Hudson St. in Greenwich Village.

Cheaper to Wait?

“Filling that much space will be extremely difficult in this environment,†said John Levy, a principal at John B. Levy & Co., a real estate investment banking firm based in Richmond, Virginia. “That will require several good-sized tenants in a market where most people aren’t making decisions. There is no penalty for indecision. There is no pressure to do anything, and people think it might get cheaper if they wait.â€

Overall occupancy has decreased to about 30 percent, according to loan documents. The building was 98 percent occupied in January 2006, when the Moinian Group took out a $250 million interest-only mortgage, according to loan-service documents reviewed by Bloomberg. When principal starts coming due early next year, the monthly bill will climb by $225,000, or 18.4 percent, to $1.45 million, the documents show.

$3.9 Billion Bond

Joseph Moinian, 55, the chief executive officer of Moinian Group, declined to be interviewed, said Roxanne Donovan, president of Great Ink in New York, which represents the firm. Moinian Group owns more than 20 million square feet of space in office, residential, retail and hotel properties, 13 million of which is in Manhattan, according to the company’s Web site.

New York-based Moinian Group’s mortgage was wrapped into a $3.9 billion bond with 304 other commercial property loans across the U.S. and marketed in February 2006 by Wachovia Corp., now part of Wells Fargo & Co., according to the prospectus. More than half of those contained in the bond delayed paying principal for part of the term, the documents show.

Across the U.S., office vacancies climbed to 15.5 percent in the first quarter from 13.3 percent a year earlier, according to CB Richard Ellis.

The U.S. government has made reviving the market for commercial mortgage-backed bonds a cornerstone of the program to get credit flowing and end the recession. Sales of the bonds plummeted as investors shunned the debt and the cost to sell them became too high for investment banks to profit, choking off funding to borrowers that need to refinance.

No Sales

There have been no sales of the bonds so far this year, and only $12.1 billion were sold last year, according to Morgan Stanley.

The portion of the plan aimed at creating commercial mortgage-backed bonds is intended to avert a wave of defaults because “getting refinancing for existing commercial projects is very, very difficult,†Fed Chairman Ben S. Bernanke said in congressional testimony on June 3.

“Even with government support, the commercial real estate fundamental picture will continue to get worse before it gets better,†said PPM America’s Born, who holds about $7 billion in commercial mortgage-backed bonds as part of a fixed-income portfolio. “Interest-only loans that start to amortize in this environment are one more piece of that picture.â€

To contact the reporter on this story: Sarah Mulholland in New York at smulholland3@bloomberg.net

Last Updated: June 11, 2009 00:01 EDT

More pain to come for the US, especially the West Coast...

Edited by GARCH

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Shirley Breitmaier’s mortgage payment started out at $98 when she refinanced her three-bedroom home in Galt, California, in 2007. The 73-year-old widow may see it jump to $3,500 a month in two years.

How the ********************* is that meant to work.

What sort of an idiot would allow a product like this to exist, yes I can see the "MAY" but that's just insane.

She's an idiot for taking the loan out but equally stupid are the people who gave it her.

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How the ********************* is that meant to work.

What sort of an idiot would allow a product like this to exist, yes I can see the "MAY" but that's just insane.

She's an idiot for taking the loan out but equally stupid are the people who gave it her.

It's insane.. can't believe there's so much of the stuff out there, in all the wrong places as well (i.e. prices down so can't remortgage). They'll have to be renegotiated or it will be straight to repo for most of them.

On another note, I think we can kill the comparison to UK teaser rates at this point - different planet.

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but equally stupid are the people who gave it her.

Theyre not stupid. They made their fat commission and have since probably moved on to the next con.

Although most of them probably are stupid too, and bought a home in 2006. :lol:

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I hear that 70% of the WHOLE ARM market is expected to default. About the same (maybe more) than the subprime losses. Then there is also the Alt-A market on top of that.


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