It turns out we were on to something in the last post and all the comments questioning Wells Fargo's assumptions on Option-ARMs.
Above is the latest version of the Credit Suisse mortgage reset chart. The Orange County Register states:
Note that the chart uses both resets, when interest rates change, and recasts, when payments change. Resets and recasts often happen at once, but not always. Credit Suisse, an analyst told me, used resets in the chart for all loans except option adjustable-rate mortgages, when borrowers can choose a minimum payment that may be less than interest owed (option ARMs are in yellow on the chart… see how they are rising!). For option ARMs it used recasts, which can happen either when the loan amount expands to a maximum allowed — often 115% or 125% of original principal — or a set period, such as five years.
Funny how Wells Fargo assumes virtually no recasts before 2012. Remember, Wells states that they expect only $325 million to recast before 2012 assuming flat rates. This on a portfolio of over $100 billion.
Is Credit Suisse taking this into account? Or are we going to get another wave in 2015? Either way Wells Fargo's assumptions are insane. CalculatedRisk asks the same questions and promises a follow up post.
Also, I have a request for readers. It has been mentioned in the comment section that banks have been automatically extending the teaser rate periods for up to 5 years on loans. One reader wrote saying the low rate on their Option-ARM from WaMu had been automatically extended for another 5 years last fall. There are some really perverse incentives here as A) the new low rate keeps people paying but just pushes the day of reckoning out and B) banks get to book this additional negative amortization as revenue (this has been called "phantom revenue" see more here).
Does anyone have access to a copy of one of these letters that is automatically extending low rates another 5 years? If so, I'd love to take a look at a copy and post it. You could black out all the names and account information to make it anonymous. If you could obtain something like this please send it to healdsburgbubble@gmail.com.
Remember, Sonoma County is ground-zero for Option-ARMs. These loans will no doubt be a driver for the high-end housing market for years to come.
I agree, WF's assumption of minimal recasts before 2012 doesn't make a whole lot of sense.
ReplyDeleteBear with me, if I bought with an Option ARM in 2005 with a 10 year initial period, then WF is correct...my loan wouldn't recast before 2012. BUT, if I've been making the minimum payment, and incurring negative amortization, I have to believe my loan would recast before the 10 year period is up, as my loan balance would be increasing with every month I make that minimum payment.
My understanding is that most folks with these loans make the minimum payment, thus adding to their loan balance. And once a loan hits 110% or 125% of the original loan amount, then it's blow up time, no?
I don't get it. This should be the atomic bomb hanging over the Sonoma RE market.
If you make the minimum payment and interest rates (i.e. LIBOR) stay under 1% then it might not recast in the 120 month time frame.
ReplyDeleteThe article from the New York Times states that for the "Pick-A-Payment" loans currently on the Wells Fargo books: "Virtually all of the pick-a-pay loans were for less than 80 percent of the appraised value of the home, and the average was just 71 percent."So on a $700k appraisal in 2005 World Savings would write a $500k option-arm loan. In order for this to hit the 125% cap the principal owed would have to reach $875k. That’s a lot of negative amortization and probably won’t happen even over a 10-year period if rates are low (key assumption).
That said, you're still right that this is an atomic bomb they are hiding on the bank balance sheet.
Let's say paying the minimum payment after a 10 year period you now owe $650k. This would be recast into a 20-year, fully amortized loan. Assuming 6.5% mortgage rates your payment goes from around $1,600 a month to $4800 a month!!!!
Quite a jump (although it will get there in steps as there are limits on the yearly increases).
People will simply walk away, and probably do so sooner rather than later once they realize they are never going to get out from under these mortgages. Appraisals were inflated in 2005 so there really isn't a huge equity cushion. And on top of this rates can't stay low forever. When they start heading up you know what is going to hit the fan well before 2015.
"The article from the New York Times states that for the "Pick-A-Payment" loans currently on the Wells Fargo books: "Virtually all of the pick-a-pay loans were for less than 80 percent of the appraised value of the home, and the average was just 71 percent."
ReplyDeleteOkay, so some Option ARMs were re-fi's with a decent equity cushion to start with. But I'd be willing to bet a chunk of the purchase loans were piggy backs (Option ARM at 80%, plus a 2nd mortgage, and either a small down payment or no down payment). So now you've got the atomic bomb + HELOC + underwater on home value.
I agree completely, people at some point will just walk once they realize they are in for decades of debt serfdom, and their golden goose isn't going to lay an egg.
Personally, I'm waiting for the higher rates, as I'm hoping that's the next leg down in home prices.
Downey Savings was very big on these loans. While it is true you can book anticipated revenue, it isn't real money. They got into trouble and were taken over and shut down. The problem for Wells Fargo will be if people start taking out real money and they run low on reserves. Think this can't happen? Bear Sterns had 18 Billion in CASH 5 days before it went under.
ReplyDeleteI do know someone who had the fixed/teaser period on their hybrid loan extended 5 years by their lender unilaterally and will ask if they will give me a copy of the letter they recieved.I know that they were relieved to get the extension,their 20% down had evaporated and they had no possibility of refinancing.They are renting from the Bank at 3x the cost of renting from a private landlord but do not see it that way.
ReplyDeleteA slice of me always thought the banks would play this card. Extension of the teaser rate in hope that their notes continues to get income instead of resetting (which 99% of borrowers and taking back properties (in which they lose a lot of money). In 5 years, I wouldn't put it past them to do another 5 year extension if they feel that it's a better deal for them.
ReplyDeleteForeclosures/short sales would be limited to people who realize that they are in negative equity and want out or from people who lose their income source and must walk away. There will always be the home-debtors who will continue to pay the teaser rate because some day it might pay off for them (in 50 years?). How big of a slice of the pie is that?
Will the big foreclosure wave through 2012 be much smaller than we anticipated?
Are they still going to recast with 125% principal balance as promised or find some way out of that? Continuous principal reduction over the 100%? They better book the loss correctly by retro-actively removing revenue.
Accounting rules should never allow for booking of revenue for postponement of payment. I forget if this is fixed or still on-going.