Option ARMs are no longer being ignored

In January I posted that Option ARMs would be the next storm in the mortgage crisis. At that time, I felt that the dangers of Option ARMs were being ignored. Six months later, the situation is quite different. The Non-Performing Assets (NPAs) have nearly doubled from 2007 Q4 to 2008 Q2. Moreover, the deterioration seems to be accelerating.

Here is an update of the top 10 of Option ARM lenders of 2007. 5 of out of 10 no longer in the business: Countrywide (bailed out by BofA), American Home Mortgage, IndyMac, Capital One (shut down mortgage division), and Luminent Mortgage. Most of the others are struggling for their existence.

On Tuesday Wachovia announced $6.1 billion in writedowns. However, two analysts called the bottom on the stock and the stock rallied by nearly 30%. I think it is too early to call the bottom for many reasons:

The deterioration of the Option ARM portfolio is accelerating. Non-Performing Option ARMs grew to 5.8% in Q2 (pg. 15). In addition 3.9% of the Option ARMs are more than 30 days past due and 1.3% are more than 60 days past due.

Wachovia has a portfolio of $122.026 billion in Option ARMs (pg. 16). The average LTV at origination was 71%. It has deteriorated to 85%. With falling housing prices, Wachovia projects the LTV to reach 99% at the bottom. 58% of Wachovia's Option ARM portfolio is in California ($71.211 billion). The average LTV was 70% at origination and is now 90%. Wachovia projects the California LTV to deteriorate to 104%. Any second mortgages or further negative amortization will further increase the problem.

Wachovia's commercial division is also experiencing a surge in Non-Performing Assets. Their Real Estate Financial Services division has seen an increase in NPAs from 0.46% in Q2 2007 to 3.95% in Q1 2008 to 5.1% in Q2 2008 (pg. 47). This division has $48.355 billion in assets.

In June of 2007, Wachovia was touting their 10 year recast and 125% balance limit. As chronicled in this post, other lender's Option ARMs are starting to recast. The loan Wachovia used as an example until 2011. However when it does recast, the ramifications will be a lot worse. The balance will have grown from $250,000 to $325,000. The payment will jump from an initial payment of $804 to around $2500.

Wachovia's Option ARM borrowers are already struggling as reflected in their rising delinquencies. Their credit scores are also deteriorating. The average Option ARM borrower's FICO at origination was 675 compared to the current average FICO of 661 (pg. 34). For Wachovia's traditional mortgages, the FICO improved slightly from 731 at origination to 732 currently. If borrowers are struggling during the low payment period, how are they going to react when their payments triple and Wachovia projects that many will be underwater?

Sphere: Related Content