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Tuesday, January 12, 2010

Option ARM Recast Update

by Calculated Risk on 1/12/2010 01:58:00 PM

Laurie Goodman and others at Amherst Securities released a new research note yesterday: Option ARMs - Performance and Pricing

They make several important points (quoted section are from Amherst):

  • Option ARM borrowers were a self selecting group: "option ARMs were the ultimate the ultimate affordability product, and borrowers who took them were a self-selected group."

  • Option ARMs have performed almost as poorly as subprime: "The cumulative default rate on option ARMs is higher than on any other category of loans except subprime. For 2006 securitized issuance, 61% of subprime loans have defaulted, as have 49% of the option ARMs, 39% of Alt-A loans, and 11% of prime loans."

  • Option ARMs are no longer experiencing negative amortization (this is because of the low index rates, and the annual increase in the payment.)

  • The two key problems for option ARMs are negative equity and the coming recasts (with payment shock). "Across all categories, option ARMs have more negative equity than other products." and "most of subprime pay shocks have already occurred, while most of the options ARM pay shocks are yet to come."

    Option Click on graph for larger image in new window.

    This chart shows the expected payment shock coming in 2010 and 2011 from Option ARMs. This chart includes projected increases in LIBOR (if LIBOR stays low, the shock will not be as high), and the recast due to reamortizing the loan over the remaining period.

    Update: There is question on the size of the payment "shock". The report suggests many payments will double, but other estimate are much lower.