Wednesday, August 13, 2008
option ARM recasts, revisited
By and large, the biggest danger for Option ARMs and IO ARMs is the recast date, not the first or subsequent rate reset dates. However, for any ARM borrower who qualified at the highest possible debt-to-income ratio they could manage, any payment change, even one not quite as shocking as the recast on an OA or an IO, can tip the balance. As we are talking in this specific context about Alt-A, I for one believe that most of these loans did stretch too far in the beginning, and so even first rate resets on IOs or fully-amortizing ARMs will cause a marked increase in delinquencies in the absence of the borrower's ability to refinance at reset into a new discounted ARM, which will be the case for some time.
recast dates are moving targets for negatively amortizing loans, so the charts included should be viewed as updates of older charts. (note too that the credit suisse chart is of resets, not recasts.) as was known some time ago -- well before the relatively recent mainstream awareness -- there is indeed a second wave on the way and it has been creeping closer as borrowers choose to allow LTVs to reach recast triggers by paying even less than the accruing interest. calculated risk reports on the ever-further-deteriorating countrywide portfolio of pay-option ARMs:
"People still don't understand what a catastrophe this is," said Christopher Whalen, senior vice president and managing director at Institutional Risk Analytics of Torrance, California.
whalen is speaking particularly of commercial banks, who retained much more alt-a (including option ARMs) than subprime on their balance sheets.
it's only likely to become moreso, with FNM/FRE backing off the secondary market, a point reiterated in passing by doug noland.
Earnings reports this week from Freddie Mac, Fannie Mae and AIG – three of our largest financial institutions – were horrendous. Financial sector hemorrhaging has actually accelerated, and definitely do not underestimate the impact of tightened Credit in the pipeline from Fannie, Freddie and others. With limited “capital” quickly evaporating, Freddie stated that its aggressive retained portfolio growth has come a conclusion. Fannie intimated about the same. Fannie will curtail purchases of alt-A loans, and it is clear that both companies have lost the capacity to provide the speculators a “backstop bid” in the MBS marketplace. This major additional tightening of mortgage Credit Availability and Marketplace Liquidity will further depress housing markets and bolster the headwinds buffeting our vulnerable economy.
in other words, strap in -- this could be a bumpier ride than most anyone now expects.