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Option-arm Mortgages Turning Worse Than Subprime

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Lifted without shame from Tickerforum,

NEW YORK (Dow Jones)--For the third straight month, option adjustable-rate mortgages are generating proportionally more delinquencies and foreclosures than subprime mortgages, the scourge of the housing crisis.

A further acceleration of troubles among the loans could mean higher-than-expected losses for Wells Fargo & Co. (WFC) and JPMorgan Chase & Co. (JPM), as well as the Federal Deposit Insurance Corp.'s own insurance fund.

"The realization of the issues related to option ARMs is just beginning," says Chris Marinac, director of research at Atlanta-based FIG Partners.

Known as Pick-A-Pays - a brand name popularized by Wachovia Corp. - the mostly adjustable-rate loans were typically issued to creditworthy homeowners, and allowed borrowers to make a range of monthly payments. The payment options include a partial-interest payment that adds the unpaid interest to the loan's balance. On many of the loans, balances have risen while values of the underlying properties have plummeted amid the nationwide housing crisis.

As of April, 36.9% of the loans were at least 60 days past due, while 19% were in foreclosure, according to data from First American CoreLogic, a unit of Santa Ana, Calif.-based First American Corp. (FAF).

By contrast, 33.9% of subprime loans were delinquent as of April, while 14.5% were in foreclosure.

The loans are heavily concentrated in the worst-hit regions in the housing market, including California and Florida, making option-ARM borrowers inordinately vulnerable to declining property values.

Option ARMs account for a much smaller portion of outstanding mortgages than subprime loans, but they occupy substantial tracts of certain banks' balance sheets.

San Francisco-based Wells Fargo holds a mountain of Pick-A-Pays, having acquired $115 billion of the loans in its purchase of teetering Wachovia Corp., which it agreed to buy late last year.

Due to complicated accounting rules, Wells Fargo assigns the loans a value of $93.2 billion, giving it room to absorb future losses on the loans. The bank, however, won't say whether losses from the loans have risen beyond the firm's original expectations.

The firm nonetheless said in May that borrowers accounting for 51% of its outstanding Pick-A-Pay balances made only the minimum payment.

"Our Pick-a-Pay customers have been fairly constant in their utilization of the minimum payment option," Wells Fargo said in a corporate filing.

Wells Fargo declined to comment further.

JPMorgan, for its part, holds $40.2 billion in option ARMs that the bank acquired when it purchased most of Seattle-based Washington Mutual Inc., which collapsed last year.

The New York company also said in a filing that it has some exposure to an additional $46.5 billion in option ARMs sitting in complex off-balance-sheet entities.

JPMorgan declined to comment.

The FDIC could also face future losses due to rising problems with the loans. The regulator agreed to soak up most future losses from about $5 billion in option ARMs once held by Coral Gables, Fla.-based BankUnited, which the FDIC seized and sold to private investors. The FDIC did not respond to a request for comment.

Troubles among option ARMs could well get worse, since the bulk are due to "recast" - industry lingo for reset - over the next three years or even earlier.

Most of the loans reset to a traditional mortgage after five or 10 years, depending on the contract. But borrowers can trigger an earlier recast if the loan's balance exceeds the property's value by a predetermined ratio - usually 110% or 125%.

Whereas subprime delinquencies have started to taper off, option ARMs' worst troubles may yet lie ahead.

"We're just beginning to enter the cycle of resets" on option-ARM loans, says Matt Stadler, chief risk officer of National Asset Direct Inc.

Senior lawmakers are also taking note of the looming storm.

In late June, 20 U.S. senators, including Banking Committee Chairman Christopher Dodd, D-Conn., sent a letter to Treasury Secretary Timothy Geithner to address the issue.

The senators asked Geithner whether he could assure the public that loan servicers are prepared for a "potential onslaught of requests for modifications" from option-ARM borrowers.

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TARP II - Return of the Pick-A-Pays coming soon to a screen near you.

They could do with another equity crash sometime to get it out of the blocks I would think.

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and NOBODY SAW IT COMING. We are run by fracking Goldfish.

apart from our wellbeloved Mr Mortgage, whos been ranting on about these for as long as I can remember.

http://mrmortgage.ml-implode.com/2009/01/3...osure-round-up/

from January 2009, and it was by no means the first mention.

Edited by Bloo Loo

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TARP II - Return of the Pick-A-Pays coming soon to a screen near you.

They could do with another equity crash sometime to get it out of the blocks I would think.

Apparently the Option-ARM defaults are already priced into the Dow and S&P500 - they've been expected for a while.

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Apparently the Option-ARM defaults are already priced into the Dow and S&P500 - they've been expected for a while.

It will still be shock 'news' on BBC Morning sometime in 2010, probably May 2010.

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Apparently the Option-ARM defaults are already priced into the Dow and S&P500 - they've been expected for a while.

I dont know how. The Dow would be far lower if it was. THis is going to nail the economy just when it should typically be entering recovery from the recession.

I honestly think traders are burying heads in sand and short term trading. You only have to look at price moves in the energy market and precious industrial materials market to see that. Look at:

Price of Oil

Price of platinum

Price of copper

(all future growth indexes for me as well as a uyseful gauge for sentiment)

pt0060lnb.gif

spot-copper-6m-Large.gif

clspot.gif

Compare to this:

monthly_%20mortgage_resets.jpg

and tell me traders werent betting on a huge recovery in global trade. It simply aint going to happen till late 2011. Its all sentiment driven IMHO and very little to do with long term fundamentals.

I am personally planning to invest heavily as long as we get a double dip somewhere around late 2010, when prices should be bottoming. Signals Iwill be looking for:

steady deterioration in bank writedowns from here on in

Tightening mortgage market

Gradual decline in equities with some sharp falls leading up to the big banks trading statements.

steady falls in GDP for the next 12-18 months.

All of this happens, it means my model of what is happening to the macro economy is correct and I will be set to profit significantly from the strong recovery post 2012 onwards.

Edited by mbga9pgf

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Guest spp
Apparently the Option-ARM defaults are already priced into the Dow and S&P500 - they've been expected for a while.

What!? Like subprime were?

....I don't think so!

Edited by spp

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Apparently the Option-ARM defaults are already priced into the Dow and S&P500 - they've been expected for a while.

You mean whilst they are high on coke?

Option ARM will show that subprime was just the starter, the losses from these are going to be immense.

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Banks: Here Come The OptionARM Blowups!

Sunday, July 12. 2009

Posted by Karl Denninger in Banking System at 11:52

Well well well.

From my 2009 Prediction Ticker:

Mortgages are not done. The story last year was "Subprime." This year's will be "ALT-A", "Option ARMs" and so-called "Prime". The Fed and Treasury know this, which is why they are playing games with "agency" debt in a desperate attempt to clear this market before the ticking nuclear devices go off. The amount of debt involved in these "bad deals" is vastly higher than that in the "subprime" space and if they fail to contain it (a near certainty) Round #2 of severe bank instability gets served up on us in the second half of 2009.

No really?

Guess what the WSJ said this weekend?

NEW YORK (Dow Jones)--For the third straight month, option adjustable-rate mortgages are generating proportionally more delinquencies and foreclosures than subprime mortgages, the scourge of the housing crisis.

A further acceleration of troubles among the loans could mean higher-than-expected losses for Wells Fargo & Co. (WFC) and JPMorgan Chase & Co. (JPM), as well as the Federal Deposit Insurance Corp.'s own insurance fund.

Yep. Bank-o-rama is not over. And by the way, this is what I said to Dick Bove on this subject well over a year ago:

Also note that we STILL haven't gotten entirely back to sound lending principles, which are 20% down payments, 36% DTI and a 30 year fixed mortgage. Until we do and prices adjust at that level we are not at a housing bottom.

There is much more, of course, if you care to review that article. Its actually pretty good.

Then there's this ditty that I wrote before (shortly before) WaMu blew up:

The Truth is that OTS should have demanded that these clowns eliminate the dividend back in April of 2007 and disgorge this paper, no matter the mark. I wrote about it back then and said they were toast, and now, with the stock trading at just over $2, it looks like their day is coming.

.....

Anyone who didn't recognize in April of 2007 that these OptionARM loans in California were underwater then and would only go FURTHER underwater, and as such this "capitalized interest" would never be paid, is absolutely unqualified to run a frapping lemonade stand, say much less a Federal Regulatory Agency.

Of course our fine government apparatus, instead of shutting these clowns down, played "shotgun marriage" with both them and Wachovia - exactly what it did with Fannie, Freddie and AIG. As such all that happened is that the ticking bomb got moved somewhere else instead of being put out in the desert where it wouldn't hurt "innocent bystanders" - oh no, instead, let's put it in the middle of a big city so that we can then shower taxpayer money on it in an attempt to keep it from blowing sky high!

That obviously didn't work as you can now see, and we're not talking small potatoes either.

Wells "acquired" $115 billion of these things when they "bought" Wachovia. They claim they're worth $93 billion. Oh really? A bunch of loans that were mostly at or near 100% Loan-to-value (that is, near zero equity) when originally written, in markets where prices have declined by half? Oh, and in May, the firm said that 51% of the balances out were being paid only on the minimum - that is, they are still negatively-amortizing even as house prices fall! Talk about double-screwed!

JP Morgan, for its part, has nearly $90 billion in exposure through both its "acquisition" of WaMu and a pretty set of off-balance sheet "vehicles" (which of course are being shielded from having to be accounted for, and who knows how well those are performing!)

Oh, and as I and others have noted, we're just starting to see "recasts" on these mortgages, which will continue for the next couple of years, and these "recasts", which cannot be avoided as the properties are deeply underwater and thus cannot be refinanced, often cause payments to double or even triple.

I've been warning people about this now for a long time; finally, the "mainstream media" is picking up on it. Indeed, if you go back to the origin of The Market Ticker you will find that I started writing this blog precisely because Washington Mutual (WaMu) reported "earnings" that were insufficient to pay their dividend, "paying" the rest with capitalized interest (that, is negative amortization amounts that were getting added to principal!) Of course that only works if the principal ever gets paid!

Indeed, go back to the very first articles on The Market Ticker and what do you find? They're all about Option ARMs! Examples?

How about right here, from April 18th 2007:

Let's use WaMu as an example, because they make a particularly good - or ugly, depending on your perspective - example of this.

In March of 2006, Washington Mutual recorded net income of $985 million dollars. 4Q06 they booked $1,058 mln. This last quarter, they booked $784mln.

But in those three quarters they booked $194mln, $333mln and $361 million, respectively, in PayOption ARM "Capitalized Interest." This was booked and recognized as EARNINGS.

Now here's the problem: In 1Q 06, 194 million out of $985 is 19.7%. In December, it was 31%. But this last quarter, it was FORTY SIX PERCENT, more than a DOUBLE over the year ago levels.

And what's worse, not one dime of that "income" can be spent! It is entirely phantom.

This is the same sort of crap that sunk Lucent and Enron - booking "income" that is not in fact spendable, as it has an impairment associated with it (the LTV is INCREASED by this negative amortization) AND it is not CASH!

And from the very first article in The Market Ticker archives....

Combined "loan to value" on ALT-A purchases in 2006 was 88% on average, with 55% of buyers taking out a second at the same time as the purchase.

Low or no-documentation (stated income) loans were 81% of total originations.

Interest only and option ARMs were 62% of purchase originations in 2006.

1-year hybrid ARMs were 28% of ALT-A originations in 2006 (these loans reset in just one year!)

Investors and second home buyers were 22% of ALT-A purchase originations in the last year.

Approximately 40% of purchases in 2006 involved second mortgages taken at the same time as the purchase. This is important because these "piggybacks" are how you get around loan-to-value restrictions! While the industry has tried to say that this is primarily a subprime thing, THAT IS A LIE - 55% of ALT-As had piggypacks in 2006!

TWENTY FOUR PERCENT OF ALL NEW ALT-A ORIGINATIONS WERE INTEREST ONLY OR NEGATIVE AMORTIZATION IN 2006!

Generational buy on banks eh, when their entire "valuation" is predicated on balance sheets where one can't possibly assign an honest value to huge parts of their loan portfolio?

I think not, and I've been pounding the table on this since The Market Ticker began - literally, from the first posting.

SHUT THEM ALL DOWN.

http://market-ticker.org/archives/1206-Ban...owups!.html

:ph34r::ph34r::ph34r:

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Guest spp

A good reply to the above article on the market ticker- :ph34r:

Are "interest-only" loans considered pay-option, or is that a completely separate class of mortgage that can be expected to blow up spectacularly?

No -- I/O loans are loans where one pays only the interest on the principle and were offered with both foxed rates and variable rates

An option ARM is a loan that in the begining of the laon gives the borrower 4 different payment choices. The choices are a part of the interest only payment with the rest of the interest payment due is added onto the loan principle, an I/O payment, a 30 yr fixed payment (which really in itself is quite deceiving as the loan itself is not a fixed rate loan) and a 15 yr fixed payment

One retains the 4 choices until the principle equals a certain loan to value (LTV) with the value beginning the value at orginiation and then the loan does what is called recast. The LTV's are either 110% or 125%. (note it is huge that it is 110% or 125% of the orginiation value because at recast since values have gone down, the borrower is going to be HUGELY underwater, with the better situated borrowers being 150% underwater) One can see how the whole premise of the loan was that property values would go up, thus on recast, the borrower would be able to refinance into another option arm.

On recast, the borrower is immediately required to make a fixed rate payment that amortizes the principle over the term of the loan left -- ie if one is 5 years into the laon when it recasts, they will be making a 25 yr amortized payment. The fixed rate would be the prime rate plus the margin they bought into when doing the loan. Of course since the loans were never supposed to see recast, most people went for real ****ty margins because that was another way they could have the lowest minimium first payment option.

The borrowers were qualified by looking at their debt to income ratio considering just the interest only payment. Thus I have no problem saying 85 to 90% of people (if not higher) in option arm loans have no prayer in hell to make the new recast payment and because they are hugely underwater have no other ways to resolve the loan but foreclosure -- no one is going to refinance a property that is well over 150% collateralized or be able to sell for the price they need to cover the loan

I was in the mortgage business for a long time. I do not care what anyone says, this was the stupidiest loan program ever thought up. It was solely built on property always appreciating so no thought was given to anyone still being in the loan when it recast. Yes, there may be 1 to 3% of the population where an option arm loan might be something to look at but it was instead offered as a great way for everyone to buy a lot of house for a low payment -- dumb da dumb dumb dumb dumb

As far as the option arm tsuanmi, I had said this last winter the sea was starting to pull back. Now we are to the point where the idiot who ran to pick up the bared marine life is noticing his toes are wet and is just starting to look up.

If 36% of them are now foreclosing, we have a very long way to go. These will make the people who bought subprime paper look like rocket scientists. I personally expect to see at least a 75% non-performance rate within the loan class.

Edit: Things get better for california by the day (good map) -

http://tickerforum.org/cgi-ticker/akcs-www?getimagenr=36272

Edited by spp

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"Our Pick-a-Pay customers have been fairly constant in their utilization of the minimum payment option," Wells Fargo said in a corporate filing.

Troubles among option ARMs could well get worse, since the bulk are due to "recast" - industry lingo for reset - over the next three years or even earlier.

says it all. credit crunch part deux

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There is no exit from this mess.

the feds gonna need a big carpet.

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Option ARM's are once of the coming financial bloodbaths.

Commercial real estate is also going to break down piece by piece over the next 3 years.. and there lending is even more reckless than in residential. Each month the vacancy rate ticks higher.

The PE firms are starting to blowup, as they loaded the companies they bought with debt that those companies could barely handle in the boom years.

Corporate failures are going to pile up as they run down their cash and what equity they can sell to keep their head above water. The loss percent is horrific, like in the GM bankruptcy. The corporate debt is as big as the whole mortgage market.

Edited by aa3

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