Below is the update posted by the Journal about the option-arm MBS, which are back in favor.
The blogosphere had declared the option-arm recasts as the final death blow to the mortgage crisis, figuring that once the new and much-higher payments kicked in, foreclosures would be raining down from the skies. The recasts started earlier than expected too.
The Countrywide and WaMu option-arm loans have two re-cast triggers – either in five years, or when the loan balance reaches 110% or 115% of the original loan amount. As a result, most have already recast, based on the earlier schedule in gray:
With the Fed keeping rates ultra-low, the recasted-payment increases have been moderate, instead of toxic – and now MBS investors are seeing some light at the end of the tunnel (although the optimism expressed by this Chase analyst seems to be based on the higher-end market surviving). See below.
From the wsj.com:
A structured-finance product once excoriated as a prime example of dodgy mortgage-lending practices has become the hottest part of the $1.2 trillion market for privately issued residential mortgage-backed securities.
So-called option adjustable-rate mortgage bonds returned 6% in January alone, according to J.P. Morgan Chase & Co. That’s triple the return on subprime RMBS and about twice that of bonds backed by prime jumbo loans. It also was enough to erase the losses those “option ARM” securities suffered in 2011.
The performance of option ARMs is remarkable because the underlying loans let borrowers roll part of their monthly interest into the principal, increasing loan balances when home values were plummeting. The resulting loss of equity is a risk because borrowers could just walk away from homes if they become worth less than the balance on their loans.
But investors are finding things to like about the securities. One was prices well below 50 cents on the dollar after the slide last year. Another is that analysts think homes financed with option ARMs may hold their value better than other parts of the market. Most of the 5.5 million homes that could be dumped on the market after foreclosure will direct pressure on lower-cost properties, worth $299,000 or less, not on those tied to option ARMs whose average balance is about $450,000, said John Sim, a strategist at J.P. Morgan Chase.
“There’s a belief that higher-priced homes are not under the same supply pressure,” said Mr. Sim. That may make them more sensitive to a market rebound. “If you believe in a recovery, there are reasons to believe that (option ARMs) might do better.”
One perverse reason to like option ARMs is that so many are deeply under water, which means the homes are worth far less than the loan balance. Some investors may anticipate they could benefit from principal reductions pushed by the government, Mr. Sim said.
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