Friday, December 28, 2007

Option ARM Tightening

by Tanta on 12/28/2007 08:45:00 AM

A quite decent piece on Option ARMs in the LA Times. I liked this part:

Despite such risks, the initial low payments on option ARMs have kept a lid on serious delinquencies -- 3.7% of all option ARMs, Standard & Poor's analysts said in a report last week. That's higher than before, but still low compared with the 6.3% delinquency rate on loans to good-credit borrowers with so-called hybrid ARMs, which have a low fixed rate for two to 10 years before becoming adjustable-rate loans.

At Calabasas-based Countrywide Financial Corp., which S&P said made about a quarter of all option ARMs last year, 3% of such loans held by the lender as investments were delinquent at least 90 days, up tenfold from 0.3% a year earlier. Delinquency rates were even higher on option ARMs from other lenders, including Pasadena-based IndyMac Bancorp and Seattle's Washington Mutual Inc., S&P said.

Countrywide and other lenders tightened their lending standards last summer to ensure borrowers could afford loans after the interest rates adjusted upward.

Had those guidelines been in effect previously, Countrywide recently said, it would have rejected 89% of the option ARM loans it made in 2006, amounting to $64 billion, and $74 billion, or 83%, of those it made in 2005.
I made an argument a while ago that focussing regulator attention exclusively on disclosure documents can be just a touch beside the point if lenders are no longer offering the product in question. You have to wonder, if we just cut off 80-90% of the OA borrower pool, whether the remaining 10% really need those new and improved disclosures, or can muddle along with the ones already in use. If you take the OA out of the mass market and put it back into the high-net worth, high-income crowd it was originally designed for, you might find that your borrowers are already selected to be people who either read and understand disclosures, or who hire an attorney or financial planner to read them. I can certainly think of better uses for regulators' time and energy than fooling around with disclosure documents that would be clear to borrowers who are now in a rather different kind of trouble than not understanding the teaser rate on their OA.

The other thing to notice is that the obligatory example borrower supplied in the article is having trouble with her first payment increase (the typical 7.5% annual increase in the minimum payment), which is still not enough to cover all the interest due. As that sort of situation increases (as more and more 2005-2006 vintage OAs get to their second or third payment increase), we'll start seeing defaults long before the recast date.

Speaking of which, when I am not making cartoon pigs I have been creating some spreadsheets to show examples of how to project the recast date on Option ARMs. That's total and compleat Nerd territory, but if anyone is interested I'll post them (as spreadsheets or as images thereof). You tell me whether that's more detail than you can stand or not.