Option-ARM Mortgages Turning Worse Than Subprime

[Joseph Burkeson, CMI]

Just sayin'. This was predicted last year and has now come into fruition.

Option-ARM Mortgages Turning Worse Than Subprime

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.

[Michael Larson]