Bill thinks our concerns–and the concerns of all those who have viewed the Credit-Suisse chart nearby showing the impending crush of Alt-A resets (green)–are unfounded. Bill is a bit more worried about the Option ARM (“POA”, yellow) resets. Here’s Bill…
The forecast of a coming “wave” of Alt-A loans resets reflects significant confusion about these loans. Alt-A loans became popular during 2001-08. They offered a full array of fixed and hybrid ARM programs. Alt-A loans were specifically labelled as such on rate sheets and do not include the pay option ARMs (POAs) offered primarily by WaMu, Countrywide, World, and their correspondents.
Hybrid ARMs had an initial fixed period of 3, 5, 7, or 10 years. After the fixed period, they would “reset”, adjusting every 6 or 12 months for the rest of the term; most used the 6 or 12-month LIBOR or 1-year Treasury, with margins of 2.25 -2.75%.
A typical POA (e.g. 1% type) had four payment options: 15-year, 30-year, interest-only, and minimum payment (less than interest only so it “negatively amortized”, increasing principal). The minimum payment, utilized by most borrowers, was fixed for 12 months (but rates changed monthly). Each subsequent year payments could increase by 7.5%. After 5 years, the loan would “recast”, jumping to a fully-amortizing payment, based on then-current rates and the term remaining. However, if the loan balance rose to a limit, such as 110%, it would immediately recast, even if sooner than 5 years.
Some specific misunderstandings cause confusion about a possible “reset wave”:
- Differing fixed terms mean hybrid ARMs reset over a 15+ year span in a less concentrated manner than projected.
- Hybrid ARM resets currently often go down, not up.
- Many ARMs due to reset or recast have been refinanced, modified, foreclosed, or paid from sale. This includes many POAs that recast well before schedule.
- Where resets would increase the rates, lenders often just extend (or modify).
It does not appear that dire forecasts of a huge, concentrated wave of Alt-A resets are examining the whole picture.
However, there is a significant problem with POA recasts, as those payments can double or triple at recast, and – due to negative amortization – an estimated 80% or more may owe more than the value at the time of recast. So the risk of POA defaults is both larger and more concentrated than the risk from Alt-A.
— William Matz, president, MastersTough Mortgage
Jody Shenn of Bloomberg cites a similar argument made by Barclay’s analysts about the Option ARM reset bomb: It won’t be as bad as feared because Option ARM homeowners will have defaulted long before the payments reset:
The wave of “option” adjustable- rate mortgages recasting to higher payments, projected by some economists to represent a looming source of foreclosures that will hurt housing markets over the next few years, will be smaller than “feared” because many borrowers will default before their bills change, Barclays Capital analysts said.
Option ARMs offer initial minimum payments that fall below the interest borrowers owe, creating growing balances and potential spikes in monthly bills. Payment resets occur after five years or when the debt grows to a preset amount, typically 110 per cent to 120 per cent of the original principal.
About 40 per cent of borrowers with option ARMs are already delinquent, and “many” of the others will start missing payments before their obligations change, the Barclays mortgage- bond analysts wrote in a July 24 report. Recasts of securitized option ARMs will peak at about $6 billion a month in mid-2011 and include “volumes lower than feared” overall, they said.
“The additional risk really will only be for borrowers who manage to stay current over the next couple of years and might default due to a payment shock,” the New York-based analysts including Sandeep Bordia and Jasraj Vaidya wrote.
Whitney Tilson‘s hedge fund, T2 Partners LLC, in a presentation dated July 3 said option ARM recasts may peak in the second half of 2011 at more than $16 billion a month, citing Credit Suisse Group data. While the lower number from Barclays analysts suggests an earlier end to the foreclosures contributing to record home-price declines, investors and some analysts including at Barclays and JPMorgan Chase & Co. have said the U.S. government’s effort to have more bad mortgages reworked will delay some defaults.
NOW WATCH: Money & Markets videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.