Option ARM delinquencies continue to spike up; many borrowers are underwater

Indymac reported their first quarter losses today. They posted a loss of $184 million or $2.27 a share. Last quarter they announced that they expected to post a profit of $13 million for 2008. Today they reversed course announcing that they expect to lose money every quarter this year. They also released information on their non-performing assets.

In January, I had a detailed post on the intricacies of option ARMs. The delinquencies are continuing to surge. Countrywide's non-performing Option ARMs (non-performing loans are more than 90 days delinquent) jumped from 5.70% to 9.40% in just 3 months. In the beginning of the third quarter of 2007, Downey Savings launched a borrower retention program "to provide borrowers who are current with their loan payments a cost effective means to change from an adjustable rate loans subject to negative amortization to a less costly financing alternative. At March 31, 2008, approximately 91% of such borrowers had made all loan payments due." Any loans that were modified in that fashion are included in the Downey Savings' non-performing assets even they they may be current. Using this method, Downey Savings' non performing assets is at 11.90%. However that is more of an accounting measure than an accurate guage of delinquencies. Excluding those borrowers who are current but have received modifications, Downey Savings' non-performing assets jumped from 4.78% to 7.41%. 65% of Downey Savings loan portfolio is comprised of Option ARMs. This is down from December 31, 2007 when 74% of their portfolio was comprised of Option ARMs. Washington Mutual's non-performing assets went from 2.17% at the end of 2007 to 2.87% in the first quarter of 2008. 45% of Washington Mutual's portfolio is comprised of Option ARMs. Indymac's non-performing assets now total 6.51% up from 4.61% in the previous quarter. Option ARMs are now 29% of their portfolio held for investment, up from 22% last quarter. Wachovia's non-performing assets increase to 1.70% from 1.14%. As of the end of last year 46% of their residential mortgage portfolio was comprised of Option ARMs. Bank of America and Wells Fargo's non-performing assets increased more modestly rising to 0.84% and 1.16% respectively. Bank of America and Wells Fargo did not offer Option ARMs.

Since I posted the article on Option ARMs, there is some good news and bad news. The good news is the rates have come down quickly. A fully indexed rate on the Option ARM example I used is 5.125%. This is down from the peak of 8.375% where it was for seven months in the beginning of 2007. However, the 12 month MTA index is a 12 month average so it takes time to move up or down. The example loan with a first payment due in January 2005 in the previous post, had a beginning payment of $574.06 on a balance of $178,480. If the loan had a 110% recast and the borrower had made the minimum payments then the loan would have reset in February 2008 with new payments of $1,468.43. If the loan that had a 115% recast and assuming that rates stay the same as they are this month, then the loan won't recast until the end of five years (01/10). The payments at that time would be $1,196.80 (with a fully indexed rate of 5.125%).

The bad news is that the declining home prices have deteriorated faster. Using the Case Shiller CME futures to project future home prices, in January I posted that a borrower would owe 110% of what the house was worth at the end of 2009. Using the current futures prices they will owe 120%. The borrower in that example, will have been on a roller coaster ride. Their interest rate went from 5.375% to 8.375% and is now heading back down possibly to 5.125% or lower. Their house values went from $223,100 in January 2005 to $261,108 in June of 2006. In June of 2006 their CLTV was 79.2%. Their equity position went from their 10% down payment of $22,310 to an equity position of $54,359. Today, the example house would be worth $213,081 and if they made the minimum payments the whole time, they would now owe $221,226. They would have to bring in cash just to sell the property even without considering real estate commissions. The delinquency rates are spiking up on these option ARMs and the bad news is the majority of borrowers with these loans have not had their payments recast into fully amortized payments. At that point we will be moving into uncharted waters.

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