Pay Option ARMs Imploding…Right on Schedule

Posted on June 13th, 2008 in Daily Mortgage/Housing News - The Real Story

Downey Savings can be used as a Pay Option ARM proxy and the news below just released is very bad for the firm. Data available through our subscription service, which tracks on a per bank level, all Notice-of-Default, REO (loans coming back), wiped-out second mortgages and estimated losses, also confirms that Pay Option lenders are among those presently experiencing the largest acceleration of REO.

As a matter of fact, I will throw you all a DSL freebee. As of 5/15/2008 the total loans (REO) that came back to banks was already equal to all of 2007. Many individual banks followed the trend and were also equal to all of 2007 by 5/15. However, banks that specialized in or hold the most Pay Option ARMs are already at 200% of their 2007 totals.

Our report shows DSL has taken back $337 million in loans through 5/15/08 and only took back $186 million in all of 2007. More facts… DSL may recover 40%-50% of the original note amount by selling the REO if they are lucky; DSL has booked shadow income (negative-amortization/CINA/deferred income) that now must be taken as a loss somewhere on their balance sheet; an estimated 80% of all Downey’s REO are from Pay Option ARMs; finally, loans taken back through 5/15 were from Notice of Defaults 4-5 months earlier… yet the Notice of Defaults have surged since. The Pay Option ARM Implosion is upon us indeed.

Downey Savings news…

Update – 2008-06-13: In their press releaseof “Thirteen Month Selected Financial Data” today, Downey Financial Corp. reports total non-performing assets (NPA’s) have hit a new high of 14.3%. The percentage has been steadily increasing every month, most sharply since November of 2007 when it began jumping up by as much 2% each month.

The Orange County Business Journalsaid “Concerns about mortgages at Downey have driven down the company’s shares some 90% in the past year.” Reutersnoted NPA’s amounted to “one seventh” of Downey’s total assets, a “nine-fold rise in bad loans for May from a year ago.” Assets were reported at $12.78 billion, also down from $15 billion in May of 2007.

About 6 weeks ago, The Wall Street Journalabsolutely nailed the Pay Option ARM story. It is about time the mainstream picks up on this. In my opinion, this is “the big one.” The “Subprime Implosion” may have been only the “pre-quake” with The Pay Option/ALT-A Implosion being the “big quake” and “The Prime Implosion” being a long series of scattered aftershocks.

Don’t you love what the banks /ratings agencies consider “Prime?” I have said for a long time now that the Pay Option Implosion will make the Subprime Implosion look like a bad earnings report because these loans cut across all socio-economic boundaries.  Now the data are proving my point. This bailout will be the mother of bailouts (if it comes… if its possible). At least with a subprime loan, the balance does not rise each month (before the loan defaults), thank goodness. Not so for Pay Options.

The Pay Option ARM never should have existed. Unless values continue to rise, most of these loans will fail. This loan was never intended for holding for any significant length of time or in a massively declining value environment.

Pay Option and ALT-A loans are defaulting at an accelerating pace in recent months. A couple of months ago, I made an ALT-A video with real data from the Fed comparing the total subprime vs. ALT-A universe’s. Click here or the link below. The ALT-A universe is much larger than the subprime universe in the higher priced states like CA and even nationally, it is somewhat larger. But due to the sheer exotic nature of many ALT-A loans, such as the Pay Option ARM, the crisis will likely be that much more devastating.

In related news, Wachovia Bank shares hit a 16-year low. WB is one of the largest Pay Option ARM holders in the world. -Best, Mr Mortgage  <>


Journal Story recap

-recent reports from mortgage securitizations suggest that subprime delinquencies have started going bad at a lower rate while delinquencies on option ARMs are speeding up.

-On Tuesday, Countrywide Financial Corp. said that 9.4% of the option ARMs in its bank portfolio were at least 90 days past due

-Unlike subprime loans, which went to people with weak credit, option ARMs were generally given to borrowers considered to be lower-risk.

Washington MutualInc. reported earlier this month that option ARMs account for 50% of prime loans in its bank portfolio, but 70% of prime nonperforming loans.

Wachovia Corp., non-performing assets in the company’s option ARM portfolio, which was acquired with the company’s purchase of Golden West Financial Corp., climbed to $4.6 billion in the first quarter from $924 million a year earlier.

Reference: Wall Street Journal

35 Responses to “Pay Option ARMs Imploding…Right on Schedule”

  1. But Greenspan just said the worst was over…


  2. And the jerks at Blackstone Group concur. They have to these crooks. They have to. Everything is just going fine. 🙂

  3. The REAL story that should be explored immediately is: In what world is an Option Arm borrower that pays the neg-am payment every month, in a rapidly declining market, considered to be “current” on their mortgage? I’m sure that’s how they’re being reported though. Truth is we have no idea how big this thing is really going to be because we don’t know those figures. Can anyone get ahold of those numbers for us? It’s really important to know those numbers.

    Can you imagine if the number of people paying the neg-am payment every month is 75% or the like? Holy smokes, talk about crisis in the making!

  4. He will just stop paying JRB. I appouve of this. Bankers, these psychopaths, want to continue lying to investors. Well a borrower in this condition has no reason to continue paying. He will walk away.

    Even if you don’t know the figures, the stocks will be going down like Wachovia today, and the insiders at these banks will be selling like crazy.

    It’s like the phoney “core” inflation rate fabricated by your fascist Labour Department in Washington. Bloomberg and all the bunch can boast all they want about the core, nobody believes them or is listening, except these really stupid foreigners.

    Hey you really stupid foreigners from China, Africa, South-America, Russia and Saudi-Ariabia, are you listening ? The numbers are phoney. You will regret buying Lehman Brothers today.

  5. oh wonderful! the fannie/freddie ceilings are raised as home values decline and altA mortgages begin to implode. so when the GSEs and the FHA require a federal bailout, we can expect the 6 trillion in their books of business to be tagged onto the 9 trillion of existing public debt. all this at a time when the nation’s manufacturing base has been obliterated. simply wonderful.

  6. I think the bank recognizes the full payment of an option arm, even if the customer only makes minimum payment.

    That will make nice write down on prior years banks income statement for taking a invisible payment over minimum.

  7. I took advantage of the 14% LEH pop today to buy some Oct $26 Put options. It’s going to be an exciting ride. I’m either going to look really smart or really dumb 🙂

    But I do feel that the majority of people that bought LEH today are going to feel really stupid, maybe very soon if the DB $15 rumor is true.

    BTW, when these rumors come out they’re usually true. Remember the Yahoo/Microsoft talk from last summer? Investment bankers have a hard time keeping discussions quiet, and when there’s smoke there’s usually fire.

    I also have some Nov $2.5 Put options on downey that I bought about a month ago. I think that dog is going to zero, soon.

  8. I’ve been saying the SAME thing about the option arm problem since that loan was concocted-in Michigan, it’s not our big issue, but California is going to lead the way-builders were selling house, telling the buyers “this is just how the deal is structured”-I sat on a plane next to a stranger from the Bay Area-I think I freaked her out-I was the FIRST person (after 6 months of being in a pay option) to tell her what she REALLY got herself into!!

  9. It is not the LOAN that is bad, it is the borrowers that don’t know how (or what) to use the loan they have.

    I can’t count the times people that have these loans think their neg-am payment is their P&I payment. They now say they want a P&I payment instead of interest only or neg-am and I have to let them know that an OPTION Arm has (wait for it……OPTIONS). Just pay option #3 instead of #1. Then they get mad and say that payment is too high.

    Then they blame the lenders and the industry. They don’t want to know the truth and don’t believe it when they here it.

  10. I can’t remember ever seeing as much outright market manipulation as there’s been in the past 6 months. It’s always been there, but it’s just plain blantant and out in the open for all to see now, and not a single person is doing anything about it. It’s just chaulked-up to “free markets” I guess.

    Marc – Lying psychopaths is putting it lightly.

  11. JRB-

    In response to your: In what world is an Option Arm borrower that pays the neg-am payment every month, in a rapidly declining market, considered to be “current” on their mortgage?

    -It makes little difference…the borrower is screwed whether their credit remains solid or not. If they have been making neg-am payments (as I implored my borrowers that wanted option-arms NOT to do) they have no chance of refinancing a jumbo loan amount, as their LTV is in just about every case, too high…and that’s if they aren’t completely upside down. The minimum payment will just about double, if it already hasn’t. Their credit score will be decimated soon enough, when the NOD hits. The only good news, as Mr. M pointed out months ago, if they apply for a nice rental before they walk away, their credit will probably still be good enough. I guess my point is that just about every option-arm loan where the borrower is conditioned to making a minimum monthly payment will go bad in the next 12-18 months, with very few exceptions where the LTV was very low to begin with.

  12. Hey looka hereeeee.

    Just for laugh. A résumé of todays exciting and very bullish news fot friday the 13th. Scary ! indeed. Is there a chainsaw somewhere ?

    The Economy

    06/13 Foreclosures Rose 48% in May as U.S. Bank Repossessions More Than Doubled
    06/13 U.S. Michigan Consumer Sentiment Index Drops to 56.7
    06/12 U.S. Import Prices Increased 2.3% in May, Gained 0.5% Excluding Crude Oil
    06/12 Oil Prices, Unemployment Will Limit a U.S. Economic Rebound, Survey Shows
    06/12 Inflation Fear Sends Mortgage Rates to 8 Month High
    06/12 U.S. Jobless Claims Jump in Latest Week
    06/11 Fed’s Kohn Says Risks of Inflation Psychology Higher
    06/11 Concerns on Economy are Shifting to Inflation
    06/10 Trade Gap in U.S. Widens as Record Oil Imports Overshadow Rise in Exports
    06/10 Fed’s Fisher Says Any Move to Increase Interest Rates Should Be `Gradual’

    Financial Markets

    If it walks, flies and it quacks like Stagflation.
    Then it’s stagflation. You bet ! The bastards from the Plunge Protection Team are at work covering the manure.

  13. All Ya, especially Mr. Mortgage, have a wonderful weekend. Relax, and count fresh earned cash next week.

    This week, I sold SKF@129 with purchased price@98, 117; SRS@92, bot@84; FXP@82, bot@78; DBA@39.7, bot@37.2. My Newzealand Dollar sucks ass, while my Chinese Dollar keeps rising steadily.

    My GLD still under deep water, with average purchasing price@89. We will see how inflation ignores GOLD, if we have a special recession.

    By the way, anyone who can recommend some stocks with good dividends? Maybe including Canadian trusts.

  14. No they are buying time for a couple of weeks. It’s clear they are trying to prop the market. This businees Lehman had, was a nice little racket. I am sure somebody will try to keep it alive. First they have to get rid of the junk by dumping the sh-t at the FED on the back of the taxpayer.

    After that, they will start all over again selling new crap to those stupid foreign investors. They just love getting screwed by Wall Street. Japaneese, Arabs, Canadians,Swiss, Germans, we are just suckers for the New-York junk. We can’t get enough of the crap. Keep on coming Lehman with your good bond manure. No it’s not going to zero this time. They have your US checking account to back them now. This week they borrowed another 25 billion fron the FED. Boy investment banking is one great racket and your financing is almost free.

    If you want to know Lehman’s faith, look at the spreads on the credit default swaps, asked for this piece of speculative junk filled with crooks. Poor Lehman employees. So sad. They lost 10 billion on their stock options. Will they have a nice mega dilutive reset for the other shareholders ? 🙂 Life is really tough for them.

  15. I trust Christopher Dodd and all his “friends of Angelo Mozilo” who got good deals
    while working for the federal government. CORRUPTION! CORRUPTION! CORRUPTION!
    Make sure you vot for McObama, either way, our banks are bankrupt!

  16. Bastards? Sure! Stupid? No way, they are doing this on purpose because of greed
    and because the U.S. is over a barrel. SWF’s and foreign banks control this country
    now. Look for martial law this fall so they can get rid of red state Americans.
    Looks like their paranoid fantasies weren’t so paranoid after all. Blue staters,
    once they get rid of the south, you will be next, or maybe they will let you live
    as slaves.

  17. McObama with an ex Fannie Mae ceo as organizer.
    Wow ! Now that’s change ! 🙂 You are like Italy.

  18. Red or blue. Strange we have the same colors in Canada. Except the blue here is red and the red is blue. You see.
    No difference. Nobody is going nowhere.
    Red state or blue state. It doesn’t make any difference. Clinton had Rubin at the treasury a good fellaw from the Goldman’s Sachs mafia.
    And Bush has Paulson another good fellaw from Goldman’s Sachs cosa nostra. Boris Yelstine had a good fellaw from the same mafia working him. Hell! Even the Chineese at one time had good fellaws from Goldman’s Sachs working in the commie government. The guys in power are the good fellaws from Goldman’s Sachs. Ok some of them come from Fannie Mae too.

  19. A huge issue with these option ARM’s is that the dollar amounts are going to be even bigger than the subprime. Most of these loans were used to secure borrowing of a million dollars or more…so that the borrower could live like Donald Trump but make payments of the average middle management. Right now Countrywide is DUMPING these option ARMS at a huge discount off their books..BofA doesn’t want them..I agree this will be the next doesn’t matter if you are in a declining market like CA or Fl..this OPTION will not be available to just anyone like before..good luck to those who will see their payment skyrocket by as much as 77%! I hear some jingle mail coming..

  20. Bah! Sell the crap to stupid foreigners, to the FED and to these slaves called taxpayers. This week the investment banks and all these crooks borrowed another 25 billions from the FED. A nice program of exchanging their toxic waiste for tresury bonds. You are already footing the bill. Does somebody knows what is going on with M3 ? These fascists from the FED eliminated the measure to hide what is going on.

  21. Greenspan is still living a bubble,

    “US financial markets, roiled by the collapse of the subprime-mortgage market, have shown a ”pronounced turnaround” since March, former Federal Reserve Chairman Alan Greenspan said today. The worst is over for the credit crisis, or will be soon, and there’s now a ”reduced possibility” of a deep recession, the former Fed chairman said in remarks via satellite to a conference in Mexico City. He added that he has a ”sense” that tax rebates have helped retailers.”

    I bet he used the same ‘sense’ when he was creating all that liquidity by having rates at 1% pa, looks like someone needs a sense rewiring…

  22. I am a mortgage professional who has 3 pay option arm loans on rental properties and advised my investor clients to use the product to their advantage. What I don’t understand is how everyone is stating that these loans will double when the loan resets. I bought down the margin (the fixed portion of the loan) and I also advised all my clients to do the same. My interest rates on my 3 investment properties are 5.625%, 5.75% and 6% and they will continue to drop for the next 10 months as the other component of the interest rate, the index continues to drop due to interest rate cuts. By December, (assuming the Fed doesn’t increase rates before then) the rates will be 4.625%, 4.75% and 5%. Very attractive rates. Let’s assume someone is about to have their MTA pay option arm reset. A principal and interest loan at the rates above even paying principal and interest over 25 years isn’t going to make their payment double.

    The index on a pay option MTA arm is determined from a 12 month average so each interest rate cut takes 12 full months to have the full effect. There is debate of when the Fed will start raising rates to increase the value of the dollar. When they do start raising rates it will offset the decreases in the 12 month averaging. For now however, there have been 7 cuts since September with the last one in April. As the overall fully indexed interest rate (Margin + Index) continues to drop, my interest only payment will actually be lower than my minimum payment thus reducing principal. This happens since the monthly minimum payment was increased by 7.5% each year and over time, with lower rates, my interest only payment will be lower than my minimum payment. You have to pay at least the minimum payment, therefore, I will actually be paying down principal even when I am only paying the minimum payment option. I have calculated what my payment will be when these loans reset in 2 years and my payments will only go up about $300 per month. But with that increase I am going to be paying off the house in 25 years with a principal and interest payment. If I was in a 30 year fixed principal and interest loan from the beginning, I would have been paying that. On google you can type in “Monthly Treasury Average”. Click on the second link that comes up. Go to MTA Rate Forcast and scroll down and you can look at what is predicted for future index rates. You simply add this rate to your margin (fixed portion of loan)from your mortgage note to determine where you might be. There is always a couple of month delay from your current mortage interest rate and the current MTA rate forcast index. For instance, my marin is 2.125% on one of my houses, The MTA index is currently at 3.29 for May. My current rate is 5.75%. You have to go back 2 months when the MTA was at 3.528. So my May rate is 3.528 index plus my margin of 2.125 with the rate rounded to the nearest .125 pts. If you had a responsible loan officer that advised you to buy down the margin, (it was cheap to do so and made financial sense) your fully indexed rate (margin + index) at the time of reset could be very attractive. Yes, your payment will go up and will fluctuate from month to month, but not by double. Afterall, you will be paying principal and interest over the remaining 25 year loan term.

    Every one of my clients who I have explained this too, even with potential evaluation risks have decided to stay in their loans. We have been moditoring the MTA rate forcasts and they have been “spot on”. Yes, it would have been easy to get them to refinance due to all the fear that has been created about this loan. I could have used the income on these refinances. However, I did the loans right and protected my clients by having them buy down the margin on each loan they generated and now they can benefit from the low interest rates that these mortgages provided then, as well as long term, even when the loan resets. Some of my real estate professionals paid the negative am loan each November having the cash flow all year and then catching up on the mortgage interest deduction at the end of the year by paying the interest owed that accumulated throughout the year as they paid the minimum payment that was less than the interest only payment.

    I am aware that everyone that sold the product did not protect their clients and was only after making a buck. Most people selling the product couldn’t explain how it actually works. However, there are many of us who did, and my customers love the loan and its flexability.

  23. Greenspan is psychotic. All these central bankers are psychotics. Look at numbers. California is finished.

  24. DW – you are absolutely the exception. Perhaps 5% of these loans were used properly. Especially those in CA. The reason nobody paid attention to these is because they are relatively safe when values always go up, financing is readily available and interest rates are relatively stable. Tell me how you and your clients will do if short-rates soar due to the global hyperinflationary effects brougt upon by Bernanke’s policy, after real estate tumbles another 50% and when they can’t refi because they can’t prove their income for a new full-doc 30-year fixed or they are upside down in the property. Eveeryone in an option arm is a gambler subject to the day to day swings in the volatile markets. Unlike those in a 30-yr fixed, they could end up like trapped and walking.

  25. «Hey you really stupid foreigners from China, Africa, South-America, Russia and Saudi-Ariabia, are you listening ? The numbers are phoney. You will regret buying Lehman Brothers today.»

    These guys know very well that they numbers are phoney, and are not buying assets, they are buying influence. A lot of influence, by making sure they solve troubles on behalf of this administration.

    Then one day they will come to collect, and they will remind the USA politicians (the Republicans in particular) that they did help when help was needed, and those politicians constituents did not. Who put up the money to make those problems better and not blow up on your watch? The SWFs did, not your constituency. Screw the latter, you know who your real friends are, your fellow plutocrats abroad, not those parasitical, whining voters.

    Acting as Mssrs. Fixers can buy a lot of influence.

  26. «My interest rates on my 3 investment properties are 5.625%, 5.75% and 6% and they will continue to drop for the next 10 months as the other component of the interest rate, the index continues to drop due to interest rate cuts.»

    Sure, but what matters also is the cash flow situation, and that relates to the size of the loan.

    If one’s cash flow can only service a $200,000 loan at 5%, having a $400,000 loan at 5% is not going to help, even if the interest rate is good. Apparently 80% of option ARM debtors have only ever made minimum payments, which means that their cash flow cannot support that $400,000 loan even at 5%.

    So if current cash flow cannot support even the 5% loan, the obvious alternative is to liquidate the asset and pay off the loan — but try and do that.

    That 80% has the very nice option of selling a $200,000 house on which they have a 5% loan for $400,000, and then continue paying the low rate of 5% on the $200,000 balance remaining for the next 20-50 years. Their cash flow can probably support that, but it will be very painful.

    The problem with option ARMs is not that they are expensive (though many are), it is that thanks to the initial minimum payment period they have been used as a leveraging vehicle to speculate on the appreciation of an asset that was way beyond the affordability of the buyer. During the option initial period, the cash flow hit was way lower than that of a 5% payment, and even a rise to a modest rate like 5% is a huge problem for most option ARM customers.

  27. Todd, et al:

    Ariel Sharon to S. Peres: “Don’t worry about the Americans. We, the Jewish people, control America and the Americans know it.”

    When Ariel said “Jewish people”, he meant Zionists (they are NOT the same!). The Zionists want everyone to think that Zionists are Jews – “They are not Jews but are the synagogue of Satan”. The Zionist Billionaires Club that controls America counts the money in Shekels as well as Dollars.

    Greenspan is not psychotic – he is EVIL (Satanic is also a good word for him, Ben and their Zionist ilk). Ever notice how ‘Lucky’ Larry (Silverstein) looks just as nasty as Sir Alan? (you need a close-up to appreciate it). But nobody is scarier than Chertoff.

    Ever wonder what life was like on the Titanic after it hit the iceberg and their fate was sealed and known? Were they also tracking their investments until they submerged in the icy water?

  28. PS At what point did they stop counting and start praying, do you suppose?

  29. PPS To Whom did they address their prayers, I wonder? – to the president, perhaps? 😉

  30. I only recommended my investment clients purchase homes that cash flowed from day one on the interest only payment calculation. The minimum payment was an option for borrowers with fluctuating income. To cash flow a property, the client needed to keep their home purchases at $220,000 or less. In Arizona, values have fallen, but so have the rates on the MTA option arm since I had my customers buy down the margin on their loans to 2.5% or less. If they can’t refinance due to values dropping, they can ride out until real estate recovers. Per my estimates, even after my customer’s loan resets, they can ride out the market for at least four more years. I believe in real estate as an investment. Everyone I know that has money, has made that money in real estate. Timing is important, but so is patience. Being calm when everyone else is scared and selling or leaving when they should be holding is critical. The best example I can give – is one of my current customers who had 50 rental properties in 4 states, that she accummulated over 38 years. She followed the four rules for rental real estate – 1)She bought in good locations, 2) She made sure she cashed flowed the rental property from day one, 3) She held on to the property as a long term investment, 4) She made her money on the purchase – long term profit was gravy. She recently sold 10 of these properties for 1.5 millon. She originally paid $400,000 for those 10 properties. Even with the depreciation recapture expense, she still made a nice profit plus she had positive cash flow on each property for the last 38 years.

    For the mortgage professionals out there, do not forget why you are in this business. We help people live the American dream. It is unfortunate that some abused this privilage. Investors, who do it right, help people as well by being able to offer safe and clean places for people to live. The pay option arm is not the problem. It works for many people. We all must put the client first and help them properly purchase homes through proper education. I am for licensing of mortgage professionals. Proven wrong doing – you lose your license. However, those out of the business are receiving the hardest punishment – the inability to find a job.

  31. DW-

    If you read my post, I stated that I implored my option arm clients to make the IO payments…when a property in an option arm gets to 95% of the value (this can vary) the loan “re-sets” and the borrower is forced to make 30 year (in some cases 15) fully amortized payments. So, on a 1 million dollar primary residence, the neg am payment, based on the 1% start rate, is $3216. When that property re-sets itself, even if the borrower bought down the margin, and it sitting in your 5% range, that same borrower is looking at $5368 a month, and it has less to do with the neg-am nature of the loan, and everything to do with the values dropping like stones. Your speculation borrowers are not immune to this, even if they are making IO payments right now. If the values drop, the loans can and will reset. I would get these people out and into IO loans as soon as you can if the properties are located anywhere where values are falling.

  32. […] Pay Option ARMs Imploding…Right on Schedule – MR Mortgage  […]

  33. […] Pay Option ARMs Imploding…Right on Schedule – MR Mortgage  […]

  34. Oh my, Naked Cap breaks Leh open…

  35. It’s amazing

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