Wachovia, Fitch & ‘The Pay Option ARM Implosion’

Posted on September 3rd, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

Somebody has got it wrong. Very wrong. I have written about Pay Option ARMs to death over the past year and a half and now it is widely expected that there is no putting off ‘The Pay Option ARM Implosion’.

Pay Option ARMs, in my opinion, were the most toxic loan program ever introduced and 99% of those borrowers in this program should have never been put into it.

Wachovia, the single largest Pay Option holder in the world will be taking further write downs according to a new report by Sandler O’Neill.  “The bank is forecasting a 12% loss”. National Mortgage News covered it:

Wachovia Corp., the nation’s largest payment-option ARM investor ($122 billion at last count), is treating its portfolio like a “distressed asset” and will be taking more hits on the loans, according to a new report issued by Sandler O’Neill.  Wachovia inherited much of its option ARM exposure from Golden West Financial…Wachovia bought the lender two years ago, right before the housing market began its historic decline. Sandler analyst Kevin Fitzsimmons and other investors recently met with new bank chief executive Robert Steel, who indicated that Wachovia is trying to get foreclosures off its books as quickly as possible. The bank is forecasting 12% losses on its Pick-a-Pay portfolio.

At the same time Fitch came out with a report on Pay Options saying essentially ‘your 12% loss rate is a joke”.  Housing Wire reports on it below. Fitch is expecting a 20% to 48% default rate after hard recast depending on vintage.  With values down so much over the past year and a half, cure rates after default falling and recovery percenatges after recast or foreclosure so low, losses could be staggering. 

Now, keep in mind that Wachovia’s POA’s have a 125% maximum negative hard recast cap or 10-years, which should keep them away from outright implosion for a while. On the flip side, unlike those banks with 110% to 115% maximum negative recast caps, once a Wachovia ARM recasts the borrower has little if any chance to cure the deficiency.  

Fitch Ratings  on Tuesday released a wide-ranging look at option ARMs that paints a decidedly negative picture for the mortgage markets over the next 36 months. In fact, the picture is a downright scary one:  the bottom line is that most outstanding neg-am mortgages won’t get out of 2011 alive, thanks to forced recasts.

“Though recent declines in the 12-month Treasury average rates have mitigated some risks, the majority of option ARM borrowers have elected to make the monthly minimum payment over the past 24 months,” Fitch said in the report. “As a result, a large number of these loans, especially those with 40-year amortization and 110% principal caps are expected to reach their recasts before the end of the five-year mark.”

The result? Fitch said it expects 90-day plus delinquencies — already ranging from 10 percent to 24 percent, depending on vintage — to more than double after recast for 2004-2007 vintage loans. It gets worse: Fitch also estimated that the potential average payment increase on the re-casting loans to be 63 percent, representing on average an additional $1,053 due each month.

The ‘Pay Option Implosion’ is upon us folks, like it or not. Like the ‘Subprime Implosion’ wiped out the more rural and inner city areas, the Pay Option Implosion moves the crisis into Suburia and Urbia.  It also moves the crisis upstream to better borrowers. Pay Option ARMs are a subset of the Alt-A universe where the average credit score is over 700.

In my opinion, this second stage of the overall ‘Mortgage Implosion’ will make the Subprime Implosion seem tame, as Pay Options know no socio-economic boundaries and can be found littering the most affluent areas in the nation.  The Pay Option Implosion should lead the ‘Jumbo Prime Implosion’ by six months to a year. The Pay Option Implosion does not peak until Dec 2009 and bounces across the peak for eight months before declining substantially. See recast below.  -Best Mr Mortgage

14 Responses to “Wachovia, Fitch & ‘The Pay Option ARM Implosion’”

  1. While I agree that there will be blood in the water, the Wachovia estimate, 12%, is for the total losses on the entire portfolio. That’s about $15 billion on the $122 billion. The Fitch article addressed “defaults”, not losses. However, using the lower end of Fitch’s estimated defaults would put Wachovia’s losses at around $20 billion, and using the higher estimates at more than double the estimated $15 billion.

  2. I’m not sure if this was implied or not, but it’s worth mentioning that as borrowers opt for the lowest payment, their loan balance is climbing. I dont think it will take a “re-cast” to set off defaults. In other words, as borrowers see their balance’s rachet up, they may also notice that they’re underwater on the loan at some point. Then it will be “jingle mail” time.

  3. I think this next phase will be the beginning of the end for a lot of the shenanigans that have been going on. This is coming to a point where, as they say, the rubber meets the road. Bank failures to date have been tiny in numbers (10) and that has been at a very slow pace as well. That is all about to change and it will do so rapidly in my opinion. All the news out there is bad… really bad. There is no last bastion of hope for these institutions. They are all bleeding wealth by literally each and every minute that passes by. Many lenders have lost many years of past profits already and more losses will surely follow. The cost of the clean up will be astonishing in my opinion and easily in excess of 1 Trillion. The “Bail Out’s” for Fannie. Freddie & the FDIC that are coming will total close to that before all is said and done would be my guess. We are talking potentially 10’s of Billions of losses per transaction. I got a great question however… where is all of this money going to come from, and please don’t say the Tax Payer because we are all tapped out!!! Seriously, where is it coming from?

    This brings me to my next thought. Is it possible that it doesn’t come from anywhere? That the lenders that go belly up are just left to fend for themselves? I know that the FDIC insures these funds up to $100K but what about the rest? Can the government afford to print there way out of this? Can the tax payer afford a 10% bump to the federal wage tax? A 5% bump to the State wage tax? Who do the thousands of depositors turn to for help when they lose their money above $100K? How do they prepare if not by simply taking the money out of the bank and placing under their mattress? Who do we all trust and will we see massive runs on banks as soon as this starts heating up? I can tell you right now because we do not know who will fail, and when they will do so, I would take every penny above $100K out tomorrow if I was in that situation personally. It may sound silly, but it is better than the outcome if you guess wrong isn’t it?

    Mr. M. if this goes down the anticipated path you lay out, and I agree that it will, then are we not going to basically be blown up as a nation and stripped of our financial ability to maneuver our way through life? No credit, no loans? What will happen to companies if that were to happen? Will there simply be empty buildings all over the place with nothing for sale and nothing to eat? How far does this go? How bad will it get? To me this is looking grimmer and grimmer with each passing day and I honestly believe it is getting worse and will get a lot worse due to the involvement of the Fed and the Treasury.

    What amazes me is the lack of outcry from the public. Where is everyone on this and why are people not calling for heads to roll? Where are the frog marches of the people responsible and why has virtually nobody gone to jail over this as of yet? Pretty soon you may just not be able to buy a house unless you have cash. Maybe that is what we need to do and just stop lending for a while. There is no money anyway when you get right down to it, so why loan what doesn’t exist in the first place…

  4. “”What amazes me is the lack of outcry from the public.””

    Have you watched the news lately? Not much there IMO. I didn’t know anything until I found this and plenty of other news sources recently. I have learned more about economics in the last 4 months than I have ever known. IMO this is all the government media complex at work. They won’t say a word about how bad it really is, for fear of a panic.

  5. Most sheeple have no idea what’s going on. I have well educated friends, attorneys, VP’s, etc…that are just now starting to wonder if we’re really in for a recession!!! When I bring up global recession and deflation on a global level, they just dont get it. Main stream media had been very successful at keeping most people very uniformed and misinformed! We’re headed towards a “cash only” society due to massive defaults and credit destruction in general. Imagine the price of things in the USA when there’s no credit available? This is happening fast. The old saying,”Cash in a crash” is really becoming reality.

  6. Correct me if I am wrong here, but my read is that those homeowners with recourse Option ARMs with accreting balances on their principal residence have a “get out of jail free” card courtesy of the H.R. 3648, the “Mortgage Forgiveness Debt Relief Act of 2007” (assuming they walk away before the end of 2009.) Unless the Act is extended, we may see an acceleration of Option ARM forclosures at the end of 2009, at least for those loans which are recourse. Those with non-recourse Option ARMs have no incentive to walk away or default on their financially subsidized homes until the contractual payment reset in the loan is triggered. I do not think this is what legislators had in mind when they passed the ACT late last year. It would have made better sense to carve-out Option ARM loans outstanding beyond year-end 2008, or sooner, in order to eliminate this now glaring loophole.

  7. dr, News runs on a cycle. Right now we get political news, alternating with a smattering of natural disaster news (hurricanes). Stay tuned and it will come back in short order.

  8. I thought I was pretty informed before. More so than most of my friends. Now I realize how uninformed I really was. And I was the most informed of everyone I knew. What bothers me most is the lack of attention given to what is going on around the globe. When I look at that, well, I agree, I have cash on hand.

  9. The Fed is going to keep rates low, allowing banks to earn their way out of this mess. The interest rate spreads will allow for tremendous earnings power for most banks just looking at their deposit base. When BoA pays .3% on assets and earns between 2% and 4% depending on the investment it makes, it won’t take too long to repair its balance sheet. There will be bank failures, however I don’t see the worldwide deflation and depression that many commenting above suggest. The Federal reserve will print money if necessary to prevent deflation. Deflation is not in the cards!

  10. http://www.securitization.net/article.asp?id=1&aid=8313 Wachovia has been stuck with $120 billion of the loans, mainly left over from its 2006 purchase of Golden West Financial . The severity of the potential option-ARM losses remains to be seen. The loans don’t qualify for restructuring under an American Securitization Forum framework for fast-tracking debt modifications, so lenders who want to forestall defaults by reworking terms will have to do so on their own. Data isn’t readily available on the volume of option ARMs outstanding, so the extent of potential defaults is difficult to pin down. As a matter of perspective, there were far fewer option ARMs written than subprime mortgages in recent years, but defaults are likely to hit a far-greater percentage of the loans. “It’s a scary wild card,” said David Castillo, a senior managing director at broker-dealer Further Lane Securities.

    Further Lane projects that losses on securitized option ARMs could be as high as 75%. By comparison, projected losses on subprime mortgages generally range from 20-40%. http://www.securitization.net/article.asp?id=1&aid=8313

  11. as the Fed bails out banks, brokers, F&F and the Big 3 with fiat currency and the Federal gov runs half trillion annual deficits the interest rate paid on Federal borrowing will zoom and the annual debt servicing cost will become unmanageable and the choice will be either a US federal gov default or a payback in hyperinflated dollars.

    It’ll be hyperinflation.

  12. I’ve been wondering about your credibility, since your posts are always linked to by doom and gloomers. However, it’s clear by this post that you don’t do real analysis. If you did, you’d be fully aware that:

    1) Wachovia has been predicting a 12% loss rate since their Q2 release. This is not news.

    2) Wachovia’s Option ARMS have a 125%/10-year recast. They are not the 110%/5-year recasts that are likely to buy WaMu and Countrywide and others.

    This is not hard to find information. Anyone who analyzes Wachovia regularly is well aware of this.

  13. Hey Herbert – you did not read my post. I clearly said…

    “Now, keep in mind that Wachovia’s POA’s have a 125% maximum negative hard recast cap or 10-years, which should keep them away from outright implosion for a while. On the flip side, unlike those banks with 110% to 115% maximum negative recast caps, once a Wachovia ARM recasts the borrower has little if any chance to cure the deficiency. “

  14. On their latest quarterly filing, they indicate that (via the AVM), with respect to Pick-A-Pay loans, that the LTV was ORIGINALLY 71%. They indicate it is CURRENTLY 85%. This seems almost to be impossible (to me). Can someone help me with this? Do they mean to tell us that for people who went with PickAPAYs, the average downpayment was nearly 30% of the value??? c’mon. It’s on page 15 of the report. Anyone able to shine a light on this?
    >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
    Trends largely reflect the continued effect of declining
    home values, particularly in stressed areas such as
    CA and FL
    – Average Pick-a-Pay original LTV of 71%; current
    average LTV of 85% (b)
    – Focused on aggressive resolution of problem assets
    with accelerated disposition of foreclosed properties
    􀂃 Sold 1,151 properties in 2Q08 vs. 825 properties in
    1Q08; new inflows to REO of 1,445
    – Economic severity increased to 36% vs. 32%

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