Adjustable loans spur new worries
Defaults are climbing among option ARMs. Many require minimal monthly payments and no proof of income.
By E. Scott Reckard, Los Angeles Times Staff Writer
January 14, 2008
The no-worries lending that inflated the housing bubble is resulting in a flood of soured option-ARM loans, adjustable-rate mortgages that allow borrowers to pay so little every month that their loan balances rise rather than fall, sometimes sharply.
Numbers from industry trackers suggest that these borrowers -- most of whom boast respectable and often top-tier credit scores and appear to have substantial incomes and home equity -- are starting to create a second tide of defaults for lenders swamped by the meltdown in sub-prime loans made to people with bad credit or overstretched finances.
Comment: Many of these 'prime' borrowers got their 'prime' status by taking out loads of credit, re-fi'ing their homes, and making those minimum payments 'on-time', allowing them to get yet more credit. many of these 'prime' borrowers will be nothing near their 'prime' credit scores soon.
Option ARM delinquencies are at double-digit levels in many areas of California, including the Inland Empire.
Calabasas-based Countrywide Financial Corp., the top option ARM lender, will be hit hard. Already reeling from the sub-prime mess, Countrywide was rescued from possible bankruptcy last week by Bank of America Corp., which agreed to acquire it for about $4 billion.
Comment: Bank of America's purchase of Countrywide at an assumed 'discount' of 66% of book value assumes that CFC actually has a book value. As one of the largest lenders of Option ARMS, and a holder of billions in 2nd mortgages with LTV (loan to value) levels in excess of 90%, much of this book value is already worthless. I would have thought BAC would have learned from their fist investment in CFC but I guess "stupid is as stupid does" may still apply here.
The option ARM trouble stems from the loose lending practices that inundated the sub-prime business. Loans often were granted on the basis of stated income, not proof of a borrower's income, giving rise to their nickname, "liar's loans."
"This is not a sub-prime crisis. This is a stated income crisis," said Robert Simpson, chief executive of Investors Mortgage Asset Recovery Co. in Irvine, which works with lenders, insurers and investors to recover losses related to mortgage fraud.
Comment: And this is the root of the housing issue. "Liar loans". While we have heard this term already, I predict you will be hearing a lot more about it as more loans blow up.
Option ARMs present borrowers with a choice every month: pay the interest due and some of the principal; pay interest only, leaving the loan balance untouched; or pay less than the interest due, making the loan balance rise.
After a specified time, typically five years, the options disappear and regular payment obligations kick in, often at a level two or more times the initial minimum. This jolt can occur after only three years if the borrower has been making the lowest payments and the balance rises high enough.
Traditionally, good candidates for stated-income option ARM loans were self-employed professionals, small-business owners and salespeople with complicated finances and fluctuating earnings. But many other people received them in recent years.
Simpson said loan officers routinely inflated earnings of workers with regular paychecks. On some written requests to confirm a borrower's employment, officers would specify that an employer should not provide a salary figure, he said.
Comment: And where were the 'checks and balances'? Or I guess one might as IF there were checks and balances.
Now the delinquencies are piling up.
The percentage of option ARMs with payments behind by at least 60 days in California is in double digits in the Inland Empire, San Diego County, Santa Barbara County, Sacramento, Salinas and Modesto, according to data provided to The Times by mortgage researcher First American Loan Performance.
The more recent loans appear to be faring the worst, reaffirming the conclusion that lending standards had become overly lax throughout the mortgage industry in the middle of this decade, as competition for fewer good loans intensified amid skyrocketing home prices.
Comment: As sub-prime became less of an option, Option Arms became the new sub-prime sale.
In Yuba City, north of Sacramento, 15% of option ARMs made in 2005 were delinquent at the end of October, the Loan Performance tally showed, and in Stockton-Lodi the delinquency rate on option ARMs from both 2005 and 2006 was over 13%.
"It is astonishing how fast the credit deterioration has occurred," said Paul Miller, an analyst with Friedman, Billings, Ramsey & Co. who follows the savings and loans that specialize in these mortgages. "It took me and everybody else by surprise."
Comment: Why should one be surprised. Many in the mortgage industry were not. Certainly others of us looked at houses increasing in price every year and questioned the sanity of it all. Viewing the growth in these 'teaser rate' loans, it wasn't hard for many of us to see it was all based on funny money.
Miller said Downey Financial Corp. was "the canary in the coal mine." The Newport Beach S&L has specialized in making option ARMs since the 1980s and keeps them as investments. Option ARMs make up about three-quarters of Downey's loan portfolio, with most of the rest being similar loans that allow interest-only payments during the first five years but don't allow the loan balance to rise.
Miller thought Downey had shown prudence in cutting back on lending in 2006, when home prices stopped rising and competition intensified from option ARM newcomers such as Countrywide and IndyMac Bancorp of Pasadena.
But a key indicator of loan troubles -- the ratio of nonperforming assets to total assets -- shot up from 0.55% to 3.65% at Downey over the last year, with the dud loans on Downey's books growing by $80 million in November, Miller said. That number, disclosed last month, was larger than the entire amount of non-performers Downey had a year earlier.
The quality of option ARMs appears to have deteriorated quickly when Wall Street began buying them to create mortgage bonds in the middle of this decade, drawing IndyMac, Countrywide and others into the business, Miller said.
Comment: At the same time, lenders were now able to 'off-load' risk into securitized pools of mortgages. No longer was there a need for strong oversight, as lenders no longer owned the loans. And even with recourse terms built into them, the assumption was that few loans would fail. As these early loans performed as expected, the sub-slime segment continued to grow and standards continued to deteriorate. It all looked great -- till it didn't -- as housing prices peaked and buyers evaporated.
Loan Performance's study, which looked at loans bundled up by lenders and Wall Street firms to back mortgage bonds, found that 8.8% of such option ARMs made nationally in 2005 were 60 days or more in arrears as of Oct. 31.
In California, the 60-day delinquency figure for securitized 2005 option ARMs was 9.5%, compared with only 2.1% of the option ARMs from 2003.
Falling home prices and exaggerated appraisals are exposing the risks of stated-income ARMs, experts say. And many option ARMs were done with stated income during the boom. "When you combine one of the riskiest loans -- the option ARM -- with one of the riskiest loan features -- stated income -- it's not exactly a model for safety," said Redwood City, Calif., mortgage broker Steven Krystofiak, president of the Mortgage Brokers Assn. for Responsible Lending, who has testified to the Federal Reserve about high-risk loans.
"Yet they were extremely popular in 2004, 2005 and 2006, and some people were telling borrowers and investors they were safe."
Stated-income loans made during the housing boom have proved to be riddled with exaggeration, according to the Mortgage Asset Research Institute in Reston, Va., which investigates lending fraud.
The institute said one of its customers checked 100 stated-income loans against tax documents and found that nine in 10 of them overstated income by at least 5%.
"More disturbingly, almost 60% of the stated amounts were exaggerated by more than 50%," the institute reported, saying the mortgages clearly deserve their "liar's loan" handle.
Comment: That last paragraph is an AMAZING number to comprehend. What is the probablity that 100% of those loans will default if they had to double their incomes just to get into the homes?
Among critics of recent practices in granting option ARMs is Herbert Sandler, former chief executive of Golden West Financial Corp. in Oakland. Sandler's World Savings, now part of Wachovia Corp., was among California S&Ls that pioneered the use of option ARMs in the 1980s.
World Savings was known for making stated-income option ARMs, often to borrowers with lower credit scores than other lenders would permit. But unlike newcomers to the business, World limited its loans to 80% of the property's value unless the loan was insured, conducted its own conservative appraisals -- and kept the loans on its own books so it retained the risk of loss. Defaults were few.
The new wave of lenders "destroyed that loan," Sandler said, "and that's what disgusts me."
The problem created by adjustable-rate mortgages made to borrowers with good credit is attracting attention in Washington, where policymakers are trying to restore stability to the financial system.
Treasury Secretary Henry M. Paulson Jr. told a meeting of securities analysts in New York last week that mortgage lenders and bill collectors, who have agreed to a plan to fast-track loan modifications for sub-prime borrowers, should adopt "a systematic approach for adjustable rate mortgages other than sub-prime if it will benefit homeowners and investors."