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.
-By Marshall Eckblad, Dow Jones Newswires; 201-938-4306; marshall.eckblad@dowjones.com
I know what this story means for the future: “Woohoo! Foreclosures for everyone!”
Oh, does this bring back memories! In 2006, a mortgage broker told me about these new “negative amoritization” mortgage loans. Her whole sales pitch was that I could “pick” each month what to pay and how cool was that? I could choose to just pay the minimum! I remember the teaser rate was like 2%. But as soon as she said the word, “negative” I said how could that possibly be a “positive” for me? She said it was even better ‘cuz she would credit me $5,000 back at closing. I didn’t take her up on her “kind” offer, as I was looking for a 30-year fixed.
It gets sillier as a RE agent (with 30 years “experience”)had shown me the house twice and never checked to see that it was already in escrow ($750K list). It closed at $740K and it’s now worth about $550K. I walk by the house every day. Someone up there likes me…
Tick, tick, tick, tick, tick, tick…
BOOM!
Option ARMs account for a much smaller portion of outstanding mortgages than subprime loans, but they occupy substantial tracts of certain banks’ balance sheets.
Key statement there. People didn’t use OpARMs for the low-end.
“The realization of the issues related to option ARMs is just beginning,” says Chris Marinac, director of research at Atlanta-based FIG Partners.
OMG people aren’t repaying their neg-scam loans? I’m shocked I tell you, shocked! This is totally unexpected.
If this is true, finally, here comes reality pricing for $700k and up (today’s values). Many will most likely be in the $1MM+. I see lots and lots and lots of folks with these. The lowest payment is the choice for almost all I see just to hold on.
Most of these people will continue to go negative until they get recast. Then they will stop paying all together. Sometimes it feels like it will never end. So depressing. I talked to a couple today who had a pick a pay loan. They bought a home for $920,000 in 2007 from the builder. It was $770.000 and they added an array of upgrades. The same model just sold on their street for $280,000. Now I ask you…. what would you do? I know the right thing is to continue to pay but really, when you are that much upside down, it is scary. He is a doctor she is a nurse. Perfect credit and now they are faced with financial disaster. There really are some good people with very bad timing.
Irene,
$920,000 to $280,000 in two years?????
Hey, JtR, Jonathan Sanchez threw a no-hitter against the Padres in SF? Had a perfect game into the eighth. It was the first time his dad had seen him pitch! It’s “breaking news” in the LA Times online…
WAIT!!! Are you telling me it was a bad idea to offer loans with payment options that don’t cover the interest and principal? Wow.
$920,000 to $280,000 in two years?????
Yeah, I call BS.
Anecdotal story for anyone who is interested…In 2006 I refinaced a rental property using an Option Arm with an interest rate that adjusts monthly and is calculated by adding a rolling 1 year average of short term treasuries (I don’t recall exactly which treasury term) plus an index. The minimum payment adjusts annually by a pre-determined amount (approximately 10%) with a full 30-yr recast at 5 years or 110%. Intially there were 4 pay options…minimum, Interest Only, 30 YR Amo and 15 Yr Amo. However, due to the the plunge in short term rates and the adjusted mimimum payment I noticed that in month 28 the minimum payment exceeded the IO and therefore the loan would begin to positively amortize even if you were only making the miniumum payment. The IO option did not remain (it’s still on the statement but it’s equal to the minimum) as a payment option even though it would have resulted in a lower payment than the minimum.
Assuming most Option ARM’s were tied to a similar interest rate index and that the GOV can continue to control short term interest rates I think the biggest conclusion that can be drawn is that most Option ARM’s should not recast before the predetermined date. At that point, net negative amortization may or may not have occurred but regardless they are likely faced with the same scenario as all bubble era ARM loans…a substantial payment increase without sufficient equity to refinance.
Thanks NoCoCivil.
Nothing really new here.People overbought and now paying the price.
-dude,
can you add more quality, and not quantity?
Yes … Jim $920,000 to $280,000 in two years.This is in a neighborhood in the East Bay where every house on the street is in foreclosure. On a Sunday afternoon, you can see the builders working overtime to continue to build and every house they sold is now in foreclosure.This home is 4300 sq ft and has every ammenity you can think of.
Yes I can work on that.Seems like we are talking about stuff that we have hit on before.
Holy Cow Irene!
Next time I visit my parents I’ll have to swing in there for a video – can you tell me where it is?
arizonadude – the neg-am is a familiar topic here, and a bullet train to disaster unless something is done quick. I thought this article showed the progress (or lack thereof) pretty well. I think you know what I’m referring to – I appreciate your loyality here, but don’t feel that you have to comment incessently to demostrate it.
What city Irene?
NoCoCivil’s comment reminds me of a subject to loan situation on a property a group of investors I’m involved with have taken back on a foreclosure. It is not an option arm, but an adjustable based on the 12 month average of 3 month CD rates index and rate adjusts every two weeks. The payment amount adjusts once a year. So the rate is currently at 5% and dropping every two weeks, but the payment will not change until September. Currently, the payments are about half interest, half principal paydown because of the huge drop in CD rates.
I find it hard to believe that anything purchased in that price range in 2007 has depreciated by 70%. If so that’s incredible and very unfortunate for your friends. I live in an area of San Diego (Kensington) where most homes are in that price range and it seems like we’re off about 10-15% since early 07. I would imagine that making the decision to walk away when you are 10,20 or even 25% underwater might be tough, but 70%? That seems like a no-brainer unless you’re betting on hyper-inflation.
The city is Brentwood. There are two developments that sold in the upper $900,000….. Last week we had Wachovia come to our Board meeting. They are pushing us to do short sales. They cannot legally give us the names of all the people who have these neg-ams but they told us to look at the NOD’s and then go after the owners. They will work with us but they still will have the verbage about recourse in the docs.I cannot see them attempting recourse, since they will probably be counter sues for placing all these people in these things in the first place. They claim they can close these short sales in 30 days.
“They bought a home for $920,000 in 2007 from the builder. It was $770.000 and they added an array of upgrades. The same model just sold on their street for $280,000.”
My aunt and uncle are in this same situation. They bought in an upper-end tract near Naples, FL.
There are many areas that have been harder-hit than even the subprime areas of San Diego. My aunt and uncle had the unfortunate timing of “retiring” right at the peak of the boom and buying a house in what is now called “Ground Zero” of the housing bust.
We visited them a couple years ago and had fun counting the banks. I commented that 50% of these tiny banks (there were 3-4 in every strip mall) would be out of business in 5 years. This caused my uncle to grimace. As the former CEO of a small bank, he knew all too well what kind of margins most of these banks were operating on.
My aunt and uncle were devastated by the financial crisis. Probably got hit worse than anyone I know (I don’t know any Madoff victims, however.) They are still living in the house, but you can see the strain in their faces and voices.
-Erica
P.S. I will testify to Brentwood. I worked in Pittsburg and had a boss who lived there. Prices have dropped some 70-80%, and everyone who once lived there is gone. Who can afford the A/C bill on a 4500′ house in the middle of a desert that requires a 150mi round-trip commute to most jobs?
Irene,
Do you pay mello roos tax? If so, do you know the assesment district name?
Thanks for the information.
Hi Ginger,
Fortunately I don’t live in Brentwood. I do business there…. or used to until the bottom fell out. There is a city tax. They don’t call it Mello Roos .It is just collected by the city of Brentwood and amounts to about an extra $1000 a year in property taxes. There is no HOA.
Pick-a-Pays, otherwise known as “renting from the bank”. And that’s if you manage to pay the interest. Pay less than that, and it’s “a new HELOC every month”. Good luck!
Now I wonder if my LL had a Pick a Pay Loan. Interestingly enough, LL bought the place around March of 06 and we just found out via public records that LL stopped paying in March of this year. Would make sense.
If our LL is in this situation, how many others are in the same? This December (suspect when the bank will finally get around to completing the foreclosure) and early next spring may be a very bleak time for the 700k plus market unless you are a qualified buyer….
If you look in Riverside county over the past year or so you can see quite a few properties going at 75% off. They aren’t what I’d consider common, but they are out there.
Here’s one in Brentwood for ~60% off:
http://www.redfin.com/CA/Brentwood/2037-Sage-Sparrow-St-94513/home/2108375
Leading indicator or exception? We’ll find out soon enough.
Looks like Stockton-Merced-Tracey pricing is working its way west.
Jim
Did you just read CR and see the article on there are few preventable foreclosures. They talked about postponing the inevitable trough modification, which in the long run will lose the bank more money not less. I would lump increasing max loan to pick a pay with that analysis.
I read you were excited about NoCoCivil who found a pick a pay that starting to amortize in a short period. If this happened most of the time why would you want any extension of total balance owed (ie move to 125%) wouldn’t it just create few properties for sale ad infinitum. If his example was most of the loans there would be no problem at all.
The last point is that banks don’t print money. Banks borrow money and pay staff. Right now with Option ARMs banks continually need to borrow money to pay lenders and employers cause pick a pay does not cover their (the banks) borrowing expense. So yes there is no foreclosure loss with the extension, but the bank can still run out of money and go out of business like WaMu or Wachovia.