bubbleinfo.com

From our friends at the W-S-J:

The struggling housing market appears as if it will sustain less damage than expected this year from a spike in the monthly payments on hundreds of thousands of exotic adjustable-rate mortgages.

The number of such loans scheduled to adjust to higher payments this year has shrunk. Lower-than-expected interest rates, coupled with efforts to aggressively modify loans, are likely to mute payment shocks for some borrowers. Many others already have defaulted on their loans even before their payments adjusted upward.

“The peaks of the reset wave are melting very quickly because the delinquency and foreclosure rates on these are loans are already very high,” says Sam Khater, senior economist at First American CoreLogic.

The housing market still faces enormous challenges, and a full recovery is likely to take years. The threat posed by resetting payments, Mr. Khater says, is “a drop in the bucket” compared to problems posed by the sheer volume of borrowers who owe more than their homes are worth, known as being “under water.”

Still, for years, housing analysts have worried about the threat of an aftershock from a big spike in mortgage defaults from so-called option adjustable-rate mortgages, which require low minimum payments before resetting to sharply higher levels, and “interest-only” loans, for which no principal payments are due for several years.

Most option-ARM borrowers made minimal payments, so their loan balances grew. That sparked worries about what would happen when those loans “recast” and begin requiring full payments on larger loan balances, usually five years from when they were originated or when the balance reached a designated cap.

Option ARMs may be among the most likely to benefit from the White House plan, announced on Friday, to force banks to consider writing down loan balances when modifying mortgages. Until now, the administration’s Home Affordable Modification Program, or HAMP, has focused on lowering monthly payments by reducing interest rates and extending loan terms to 40 years.

A separate program could benefit borrowers who are current on their loans but under water by allowing investors to refinance those borrowers into loans backed by the Federal Housing Administration. Investors are most likely to refinance the riskiest loans that qualify.

The majority of option ARMs are set to recast over the next two years. But the volume of outstanding loans has fallen sharply because many borrowers, prior to facing higher payments, received modifications, refinanced or defaulted. Option ARM volume peaked at 1.05 million active loans in March 2006. At the end of last year, there were 580,000 loans outstanding, according to First American CoreLogic.

Fitch Ratings estimates that nearly half of all option ARMs that were bundled and sold as securities were 60 days or more delinquent at the end of December, even though just 5% of option ARMs had faced recasts. Fitch estimates that another 7% have been modified.

“The default process has already hit something resembling a peak,” says Christopher Thornberg, an economist at Beacon Economics. “How much higher can it actually go?”

The threat of defaults, to be sure, is not going away. It is likely to weigh for years on high-cost housing markets in California and other states that saw an explosion in option ARMs and interest-only loans during the housing bubble.

Today, more than three in four option ARMs are under water, according to Fitch Ratings, and one-third have a combined loan-to-value ratio of over 150%.

Another 500,000 interest-only loans will begin resetting in the next two years. Many have fixed rates and require interest payments only for a five- or seven-year period, then move to adjustable rates and require full principal and interest payments.

But because interest-rate benchmarks are currently so low, interest-only borrowers who face resets this year could see minimal payment increases or even decreases.

Nevertheless, interest-only loans are likely to stress markets for years because so many borrowers are under water and because payments will go up once interest rates begin climbing.

Martha Shickley and her husband, who own a four-bedroom home north of Los Angeles, decided to stop paying their interest-only mortgage last August because they figured they wouldn’t be able to afford their payments next year, when their loan will reset. “We’re paying expensive rent here on a home that might already be under water and certainly will be soon,” says Ms. Shickley.

Ms. Shickley says she has heard nothing from her lender, J.P. Morgan Chase & Co., which acquired the loan when it acquired assets from failed lender Washington Mutual Inc. “They haven’t even sent us the default notice,” she says. J.P. Morgan declined to comment.

For now, she and her husband are living rent free, using the savings to pay off debts. They have applied to their bank for a loan modification, and they hope to pull off a short sale, where the bank will allow the home to be sold for less than they owe. “We’re ready to move on with our lives,” she says.

Markets increasingly are discounting the likelihood of a default wave from option ARMs because banks with big portfolios have aggressively tried to refinance or modify them.

Wells Fargo & Co., which inherited $120 billion in option ARMs when it bought Wachovia Corp. in 2008, says it expects just 528 loans to recast with big payment jumps over the next two years. Wells says it modified loans for some 52,600 borrowers last year that included $2.6 billion in principal write-downs. Most of those borrowers were put into loans that have five- or seven-year interest-only periods.

That won’t completely fix borrowers’ problems because they will face yet another reset, but it does buy them time. Late last year, banking regulators began telling banks that they shouldn’t give borrowers interest-only mortgage modifications in most circumstances.

“There is no relaxing, really,” says Brenda English, a homeowner in Reseda, Calif., who had her option ARM modified into a loan with three-year interest-only payments at 4.25%. Her modified payments are around $25 less than what she paid before, but she says she’s worried about what happens in three years. “It’s just throwing it up in the air and hopefully the market will be better,” she says.

Our old friend Zach Fox has moved on to more illustrious things than the NC Times, he now works for a big-time financial publication back east.

But he hasn’t forgotten us little guys, especially the data geeks:

Jim,
 
We’re finally sending out some free links as we move toward getting our brand more to the public and not just Wall Street. I thought these stories might interest you and was hoping to piggy back on your ever-growing fame:
 
I got an update on that infamous Credit Suisse ARM reset chart, along with some interesting speculation from Greg McBride at Bankrate:
 
http://www.snl.com/interactivex/article.aspx?CDID=A-10770380-12086
 
I also thought this piece by one of our banking/insurance gurus was interesting. It runs through responses to FDIC’s securitization reform:
 
http://www.snl.com/InteractiveX/article.aspx?CDID=A-10788544-11055
 
Also, here is our bare-bones free site that has some TARP info. News is on the left-hand side, let me know if you see any links you can’t click on and would like to check out:
http://www.snl.com/Sectors/Financial-Institutions/FIG/Home/Tarp.aspx
 
 
Best,
Zach

Are you thinking, “Wait until the neg-am resets hit”?

I asked a major title company to tell me how many neg-am loans there were in Encinitas, Carmel Valley, and Ranch Santa Fe, a good cross-section of the higher-end properties.

Here was the response:

There are 29,488 properties

Neg-Am Loans
SFR (Detached) – 682
Condo/Duplex (Attached) – 288
Total = 970

Pay Option ARMs
SFR (Detached) – 440
Condo/Duplex (Attached) – 190
Total = 630

That’s it, 1,600 out of 29,488, or about 5.4% of the properties have either a neg-am, or option-arm.

They confirmed that they read every single trust deed and ARM rider that gets recorded, whether it’s a purchase or refinance transaction.

There were 10,268 adjustable-rate mortgages, so the remaining 8,668 must be mostly the interest-only, 3-year to 10-year mortgages, the ones that lenders are modifying. Today I heard of a homeowner who was coming up to the end of his five-year term, and called Countrywide for advice. He got a five-year extension at 4.75% interest-only, at no cost!

He was so happy he took his wife to Hawaii for a week!

You’ll see Option-ARM terms described like this:

$500,000 loan, 1.5% start rate, 2.80% margin over cost of funds, 11.95% lifetime cap, 125%/10-year reset cap

The initial MINIMUM payment is based on the 1.5% start rate, and changes +/- 7.5% per year. That is a mathematical formula that has nothing to do with interest rates.

When you first hear that, it’s hard to fathom how a mortgage payment can adjust with no regard to interest rates.  Because in every other case, it’s the interest rate that determines the payment.

The minimum payment is initially based on an artificially-low ‘teaser’ interest rate, but that’s the only time it has anything to do with interest.

In this example, that MINIMUM payment is:

1st year -  $1,725.60
2nd year -$1,855.02
3rd year – $1,994.15
4th year – $2,143.71
and so on.

(take the last payment X 1.075 to find new pmt.)

The FULLY-AMORTIZED payment IS figured by an interest rate, and it’s determined by adding the margin to the index. Today’s index is 4.11% + 2.80 = 6.91%.

The fully-amortized payment on the $500,000 is $3,296.35.

If you only pay the minimum payment, you ADD THE DIFFERENCE onto the loan balance. – In this case, add $1,570.75/mo.

Once you’ve added/deferred enough to reach 125% of the original loan balance, the loan resets and you then pay principal and interest monthly, amortized over the remainder of the loan.

In this example, the simple math shows that the reset kicks in around month 80, or between the sixth and seventh year. But remember that the minimum payment is going up every year, so if rates stay the same or go down, the gap is narrowed and the reset could be extended further out. In any case, the loan will reset after the tenth year – heck, you have to start paying it down sooner or later.

Obviously if rates go up, the deferred-interest gap widens, and the reset could kick in sooner.

This is your standard World Savings Neg-Am mortgage, also used by Downey Savings and Washington Mutual.

Countrywide and others tweaked the 125%/10-year reset cap to 115% or five years, and those borrowers who didn’t catch it are looking at a reset as soon as 30 months, if they aren’t careful.

There was an example in Business Week that showed a reset after 30 months, and the payment went from $1,600 to $4,000 per month. Ouch.

The mortgage industry better be working on a way to re-negotiate those terms (like raising from 115% to 125%), or they will be owning A LOT of houses in the near future. Not sure how they can re-negotiate on loans sold to MBS buyers, but somebody better do something.

John Dugan, the Comptroller of the Currency, was recently quoted as saying that when rates go from 6% to 8% on a Option-ARM, the payments will double.  That’s incorrect.

Payments could double (or higher) IF THEY ARE RESET EARLY – is the accurate fact.

Here’s the real change in payment when rates go up 2%:

$3,296.35 at 6.91%

$3,990.78 at 8.91%

A hefty $694.43 per month increase, but not double.

And you still have the MINIMUM payment available, or any amount in between.

An interesting fact: When interest rates dropped from 10% in 1990 to 7% in 1994, those who had these Option-ARMS experieced positive amortization.

Their minimum payment was only coming down by 7.5% each year, and the interest rates came down faster – and you HAD to pay the minimum payment.  As a result, a big chuck of the payment, in some cases, 50%, was going towards principal reduction.

Typically once you get past the first few years of an artificially low minimum payment (which was set by the teaser rate) the minimum payment and the fully-amortized payment tend to stay pretty close to one another.

That’s a lot of explanation, let me know if you have any questions.