The Picture of Recasts - Neg Am Speeding Up Recasts
A: The deleveraging process on the consumer and business side will continue. One pressure on the consumer side that should be of concern is the coming recast schedule for all those with Option ARMs. Those using negative amortizing payment schedules will see a recasting of their loan to the new higher principal amount, causing a 'payment shock' that was building up for years - the easier payment schedule was the clear choice for many with mortgages that were barely affordable to begin with. The rate reset schedule doesn't bother me so much given the dramatic improvement in LIBOR and other credit indexes that the reset is tied to. But now it seems the recasts schedule is approaching faster due to the rate at which borrowers are reaching their balance cap.
The new T2 Presentation out, some 155 pages of doomy charts and graphs, showing us a glimpse of the Option ARM recast schedule (sorry, the file is too large to upload here and I'm looking for a outside link).
First, let's revisit what this recast vs reset thing means:
LOAN RESET - when the RATE on your loan adjusts from an initial teaser levelThat last part is what is important to note here! One of the two ways a loan will recast to the new higher principal amount is if the balance cap is reached. Generally speaking, the balance cap is set to 110% - 125% of the original principal balance.
LOAN RECAST - when your loan is re-calculated with the new principal amount, to fully amortize within the previously agreed upon term; a.k.a, re-amortization of outstanding principal at the fully indexed rate. When the loan is recast, the payment required to fully amortize the loan over the remaining term becomes the new minimum payment, and the payment cap no longer applies.
It's the NEW PRINCIPAL AMOUNT that is the worry here, because of all the borrowers out there choosing the negative amortizing monthly payment option that causes the original loan amount to rise over time! There are two main reasons why your Adjustable Rate Mortgage will re-cast:
1) the loan reaches it's balance cap
2) the first scheduled re-cast date, usually 5 years from origination
According to the latest T2 report, "Option ARMs are Recasting Much Faster Than Expected Due to Negative Amortization":
Nobody is denying that the worst is likely behind us in terms of price destruction in many hard hit residential markets - a combination of government subsidies on the mortgage side, first time buyer tax credits, monetary stimulus, and a natural deceleration of unsustainable fierce price declines. The less-worse reality will be with us for a while given unprecedented measures taken by the Fed, the FDIC, and the government. But what we need to keep our eyes on are variables like this that contribute to the prolonging of the deleveraging process. The recast wave was thought to be a few years out but with more borrowers utilizing the negative amortizing payment option to keep costs as low as possible, the recast is hitting earlier than expected. This is one of many reasons why the side effects of this housing/credit crisis will feel like it never goes away.
Posted by Scott
Tue Sep 15th, 2009 10:27 AM
I think in NY/NJ you will see a good share of them, however, using Florida as an example as I always do, this is going to affect the higher end homes such as gated communities. Buyers speculated on future (higher) values and it seemed like every other home down here is in an ARM. I am taking a bath in a home I bought in a higher end community but I put 30% down. Although still underwater a bit, it can't be good for my neighbors and my value with the ARM's I suspect. Given the Florida collapse, there is no way the ARM owners will be able to refi or pay these off when looking at recasts and current values down 50% minimum
Posted by Noah
Tue Sep 15th, 2009 11:07 AM
speaking of refis, I wonder how many of these loans were refi'd in the last 8 months or so. not sure if this data takes that into account.
and do these products qualify for loan modifications? not sure.
Posted by Scott
Tue Sep 15th, 2009 11:24 AM
Noah, don't forget the Home Valuation Code of Conduct (HVCC). Guaranteed to kill the majority of refi opportunities. Homeowner may be willing to refi, but when they see their new values based on HVCC, it is going to be a knockout blow and now the decision sways more to "walking away". HVCC is ignorant and will be a major anchor on the housing market unless gov't does something. Loan mods? More and more banks are willing to reduce principals and work with buyers to make a refi off their books easier. What other solution is there?
Posted by Wallace
Tue Sep 15th, 2009 05:17 PM
Noah, As usual... great post! My views... the upcoming recasts issues are worrisome, but the potential upcoming unemployment figures could be devastating, especially for NYC. Note: The "complete" unemployment figures that take into account workers that are no longer looking for work and part time workers that want full time jobs. At the one year anniversary of the Lehman collapse, there are fewer financial institutions and some of the institutions that have survived are essentially in runoff mode. "[NYC] figures somewhat understate the income losses experienced by the unemployed in New York City, both because the city has more single-earner households than does the rest of the nation, and because New York State's unemployment benefits are so low relative to average worker earnings."
Although everyone maybe hopeful for the recent stock rally, including myself, I'm curious to know how many of us are preparing to speed dial their broker to sell everything or how many of us have limit orders in place in expectation of a potential double dip?
Posted by In Debt We Trust
Tue Sep 15th, 2009 05:51 PM
The divergence between equities and real estate keeps on growing larger.
I did at piece on the latest SIFMA data. Please be sure to read the whole report as they also cover bonds and fixed income arbitrage:
Secondary Offerings At All Time High
Second quarter secondary market issuance totaled at an all time high $107.9 billion, a ten fold increase from the previous quarter of $10.8 billion and nearly twice the amount of the previous record, set in 2008.
Equity Underwriting
Equity underwriting increased substantially this
quarter from the prior quarter, a 777.8 percent
increase to $111.6 billion from 12.7 billion.
http://debtsofanation.blogspot.com/2009/09/debts-of-spenders-secondary-offerings.html
Posted by MeekSheep
Tue Sep 15th, 2009 07:39 PM
Noah, don't forget that Fannie and Freddie were allowing refinances of 125% equity. While that might not help the top of the market it probably saved the low and middle markets in most of America. Do they speak about the Jumbo-prime loans? Very interested to hear about them.
Posted by Noah
Tue Sep 15th, 2009 09:00 PM
not familiar with the details of HVCC? going to research now...
default is the only thing I can think of
Posted by Noah
Tue Sep 15th, 2009 09:06 PM
Wallace - interesting you brought up NYC unemployment, working on a piece now. It seems NYC lost 73,181 jobs since peak in AUG 2008. Seems low to me. NYC comptroller estimated up to 270K job losses through 2011 I think.
crains has a job loss meter that is fed data from registered job cuts for businesses with 50+ employees. Will discuss it tomorrow.
as for equity surge, we all know that many are hoping to recoup all losses. of course everyone timed it right when you talk to them, selling the top, buying the bottom, long now, and if/when market turns, they miraculously sold longs and got short. happens all the time.
doubtful many have stop orders in place though.
Posted by Noah
Tue Sep 15th, 2009 09:10 PM
IDWT - interesting to see the mass issuance and capital raising going on. insiders are also selling at a frenzy pace. one thing I learned is that moves like this, that are base more on momentum and trading dynamics, can last way longer than many think. At some point, news will be very good and stocks will selloff and investors will buy more on dips thinking they got it right because data is great. Then stocks usually dont come back. But who knows when that is.
Its clear the path of least resistence is UP. Market is absolutely allergic to falling right now.
Posted by Noah
Tue Sep 15th, 2009 09:15 PM
meek - yep, they do. 155 pages of doomy charts. i do think its too bearish though and doesnt take into account some of the positive things that has happened as credit improved dramatically, massive writedowns taken, massive capital raised through equity and private capital, debt restructuring, failure of lehman that sped up the deleveraging process, changes in lending standards, elimination of exotic loans, tougher appraisal process, etc..
still much more needs to be done and yes, we still have problems on the books. but this rally in credit and equities is helping for a smoother unwind. Jeff will discuss this in detail and the massive deflationary wave that comes with realignment from the unwind of distress assets hitting the market. Those buying can operate way more freely and that will bring down costs and hurt competition. interesting general concept not talked about much
Posted by TJ
Tue Sep 15th, 2009 10:57 PM
Noah-
interesting stuff, as always. i look forward to reading the T2 report if you get it up. though i don't trust them, they always have a ton of data.
when i saw your chart - I saw it as good news. the recasts are being pushed up, the defaults are happening now, or soon, and the recovery won't be squashed in 3 years because of a new wave of defaults. prices are already depressed now, expectations are lower - certainly this is a lot better than prices going down again in the future after a false recovery?
also - i really wonder about the par amounts represented in T2's charts and whether they are overstating it based on original par. option arms have been defaulting like crazy - current serious delinquencies are now higher than sub-prime - at over 40% and foreclosures over 20%. while involuntary, these are (or will soon be)"payoffs" too, which means a lot fewer recasts and potential defaults in the future. i think that the number of borrowers who will have exposure to the recasts, after the refinances and the liquidations of the currently delinquent or in foreclosure homes, is likely to be rather limited. which is bad news for the borrowers and current economy, but good news for the future and good also that this awful loan product is being liquidated and deleveraged (hopefully for good this time).
in addition - i'm pretty sure option arms were heavily concentrated in the worst bubble states, especially california. this means they are unlikely to be a concentrated problem in new york, the negative amortization is probably being dwarfed by the decline in property values in the region, and they are probably being worked through the system more quickly in those disaster areas.
by the way, i've going to have a post on businessinsider.com tomorrow on the lessons of the Lehman collapse. if you get a chance take a look and let me know what you think.