Friday, September 11, 2009

Option ARMs - how did we get here?

Here is a quick follow-up to our earlier post called Option ARMs, beyond the hype. Fitch has been tracking the Option ARM mortgage market closely and here is the latest update from them:

Of the $189 billion securitized Option ARM loans outstanding, 88% have yet to experience a recast event, though it should be noted that Fitch rated only approximately 5% of Option ARM transactions. Of these loans that have not yet recast, 94% have utilized the minimum monthly payment to allow their loans to negatively amortize. 'Having not demonstrated their ability to make payments at the full rate, option ARM borrowers are at the greatest risk of default resulting from payment shock,' said Group Managing Director and U.S. RMBS group head Huxley Somerville.

Further evidence of option ARM underperformance in the last year lies in the number of outstanding securitized Option ARMs either 90 days or more delinquent, in foreclosure or real estate-owned proceedings, which has increased from 16% to 37%. Total 30+ day delinquencies are now 46%, despite the fact that only 12% have recast and experienced an associated payment shock. Instead, negative and declining equity has presented a larger problem: due to high concentrations in California, Florida, and other states with rapidly declining home prices, average loan-to-value ratios have increased from 79% at origination to 126% today. 'Negative equity and payment shocks will continue as Option ARM loans recast in large numbers in the coming years,' said Somerville.

The numbers above do not include loans that banks have not sold into securitization pools and are often carrying them on the books at par. As long as borrowers continue to make the minimum payments required, these loans are not classified as delinquent/distressed and many banks do not have to write them down. That is until the recast date, when monthly payments shoot up as the borrower will be required to pay on the full principal and can no longer play a negative amortization game.

Sometimes it's worth looking back to see how we got here. Below is a commercial from 2006 that said to the consumer: when it comes to buying a home, "you can do it!" - don't worry about being able to afford it.


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