Tuesday, September 08, 2009

Fitch on Option ARM Recasts

by Bill McBride on 9/08/2009 05:58:00 PM

From Fitch: $134B of U.S. Option ARM RMBS To Recast by 2011

Of the $189 billion securitized Option ARM loans outstanding, 88% have yet to experience a recast event ... Of these loans that have not yet recast, 94% have utilized the minimum monthly payment to allow their loans to negatively amortize.
Further evidence of option ARM underperformance in the last year lies in the number of outstanding securitized Option ARMs either 90 days or more delinquent, in foreclosure or real estate-owned proceedings, which has increased from 16% to 37%. Total 30+ day delinquencies are now 46%, despite the fact that only 12% have recast and experienced an associated payment shock. Instead, negative and declining equity has presented a larger problem: due to high concentrations in California, Florida, and other states with rapidly declining home prices, average loan-to-value ratios have increased from 79% at origination to 126% today. 'Negative equity and payment shocks will continue as Option ARM loans recast in large numbers in the coming years,' said Somerville.
Fitch is just looking at securitized Option ARMs, not loans in bank portfolios like Wells Fargo with all the 10 year Pick-a-Pay recast periods.

The second paragraph is key - many of these borrowers are defaulting before the loans recast! From Bloomberg on a Barclays report in July: Option ARM Defaults Shrink Recast Wave, Barclays Says
The wave of “option” adjustable- rate mortgages recasting to higher payments, projected by some economists to represent a looming source of foreclosures that will hurt housing markets over the next few years, will be smaller “than feared” because many borrowers will default before their bills change, Barclays Capital analysts said.
About 40 percent of borrowers with option ARMs are already delinquent, and “many” of the others will start missing payments before their obligations change, the Barclays mortgage- bond analysts wrote in a July 24 report. ...

“The additional risk really will only be for borrowers who manage to stay current over the next couple of years and might default due to a payment shock,” the New York-based analysts including Sandeep Bordian and Jasraj Vaidya wrote.
More than $750 billion of option ARMs were originated between 2004 and 2008 ...
The real problem for Option ARMs is negative equity, and the surge in defaults is happening before the loans recast. As Fitch notes, modifications haven't been helpful for Option ARM borrowers because many are too far underwater:
To date, 3.5% of the approximately one million 2004-2007 vintage securitized Option ARM loans have been modified, in an attempt to mitigate effects from the payment shock. Modification types have included term extension, conversion to interest only loans, interest rate cuts, and others. These modifications have been somewhat successful, with 24% of modified Option ARM loans being 90+ days delinquent, compared with 37% of the overall Option ARM universe. However ... Fitch expects a high default percentage for modified Option ARM loans.
This is a somewhat confusing press release. The recasts will probably lead to higher defaults, but negative equity is the real problem.

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