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.
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.
This was the year thousands of U.S. homeowners with option adjustable-rate mortgages were supposed to default as their payments spiked. Low interest rates and a surge of early delinquencies mean the numbers probably won’t be as bad as forecast, softening the blow to a housing market where prices have resumed falling.
Monthly payments on option ARMs reset after an initial low- rate period, usually five years, and researchers at CoreLogic Inc. in Santa Ana, California, estimated in 2009 that such recasts would peak at 54,000 a month in August of this year. In a 2006 cover story in BusinessWeek magazine titled “Nightmare Mortgages,” George McCarthy, a housing economist at the Ford Foundation in New York, compared the looming resets to a neutron bomb.
“It’s going to kill all the people but leave the houses standing,” he said at the time.
What he and other analysts didn’t anticipate was that so many option ARMs would go bad before resetting, and that interest rates would stay low enough to minimize the impact of the adjustments on borrowers who are making their payments. Still, a model developed by JPMorgan Chase & Co. analysts predicts that 70 percent of remaining option-ARM loans that were bundled into bonds will eventually default.
About $600 billion of the loans were made from 2005 through 2007, according to industry newsletter Inside Mortgage Finance. Of those packaged into bonds, some 20 percent have been liquidated at losses to investors, and almost half of the remaining ones are at least 30 days delinquent, in foreclosure or have been seized by lenders, according to data from JPMorgan.
“It’s not that option ARMs weren’t a bad way to finance homes, it’s just that the disaster already happened before the resets,” McCarthy said in a telephone interview last week.
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.
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:
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:
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