Wachovia, Fitch And ‘The Pay Option ARM Implosion’

Somebody has got it wrong. Very wrong. I have written about Pay Option ARMs to death over the past year and a half and now it is widely expected that there is no putting off ‘The Pay Option ARM Implosion’.

Pay Option ARMs, in my opinion, were the most toxic loan program ever introduced and 99% of those borrowers in this program should have never been put into it.

Wachovia (WB), the single largest Pay Option holder in the world will be taking further write downs according to a new report by Sandler O’Neill.  “The bank is forecasting a 12% loss”. National Mortgage News covered it:

Wachovia Corp., the nation’s largest payment-option ARM investor ($122 billion at last count), is treating its portfolio like a “distressed asset” and will be taking more hits on the loans, according to a new report issued by Sandler O’Neill.  Wachovia inherited much of its option ARM exposure from Golden West Financial…Wachovia bought the lender two years ago, right before the housing market began its historic decline. Sandler analyst Kevin Fitzsimmons and other investors recently met with new bank chief executive Robert Steel, who indicated that Wachovia is trying to get foreclosures off its books as quickly as possible. The bank is forecasting 12% losses on its Pick-a-Pay portfolio.

At the same time Fitch came out with a report on Pay Options saying essentially ‘your 12% loss rate is a joke”.  Housing Wire reports on it below. Fitch is expecting a 20% to 48% default rate after hard recast depending on vintage.  With values down so much over the past year and a half and recovery rates after recast r foreclosure so low, losses could be staggering.

Now, keep in mind that Wachovia’s POA’s have a 125% maximum negative hard recast cap or 10-years, which should keep them away from outright implosion for a while. On the flip side, unlike those banks with 110% to 115% maximum negative recast caps, once a Wachovia ARM recasts the borrower has little if any chance to cure the deficiency.

Fitch Ratings on Tuesday released a wide-ranging look at option ARMs that paints a decidedly negative picture for the mortgage markets over the next 36 months. In fact, the picture is a downright scary one: the bottom line is that most outstanding neg-am mortgages won’t get out of 2011 alive, thanks to forced recasts.

“Though recent declines in the 12-month Treasury average rates have mitigated some risks, the majority of option ARM borrowers have elected to make the monthly minimum payment over the past 24 months,” Fitch said in the report. “As a result, a large number of these loans, especially those with 40-year amortization and 110% principal caps are expected to reach their recasts before the end of the five-year mark.”

The result? Fitch said it expects 90-day plus delinquencies — already ranging from 10 percent to 24 percent, depending on vintage — to more than double after recast for 2004-2007 vintage loans. It gets worse: Fitch also estimated that the potential average payment increase on the re-casting loans to be 63 percent, representing on average an additional $1,053 due each month.

The ‘Pay Option Implosion’ is upon us folks, like it or not. Like the ‘Subprime Implosion’ wiped out the more rural and inner city areas, the Pay Option Implosion moves the crisis into Suburia and Urbia.  It also moves the crisis upstream to better borrowers. Pay Option ARMs are a subset of the Alt-A universe where the average credit score is over 700.

In my opinion, this second stage of the overall ‘Mortgage Implosion’ will make the Subprime Implosion seem tame, as Pay Options know no socio-economic boundaries and can be found littering the most affluent areas in the nation.  The Pay Option Implosion should lead the ‘Jumbo Prime Implosion’ by six months to a year. The Pay Option Implosion does not peak until Dec 2009 and bounces across the peak for eight months before declining substantially.

See recast below.

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Comment by Mortgage Info

2008-09-04 00:54:18

This is going to be a very big problem much like the adjusting 2/28 subprime loans currently, where most borrowers were not prepared for the large adjustments.

We have created a pick a payment adjustable mortgage calculator that calculates the possible adjustments from these pick a payment mortgages.

A sample calculation of a 280K original loan with a 2.00% interest only loan with a 3.875% margin will jump from $1,035 to over $2,573.

The obvious results from such a dramatic increase in payments and decreased property values will be another explosion of foreclosures.

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