ARM Recasts Starting Already? Delinquencies Gathering Speed
A: Let's be clear on what the real issue is here with these option ARM's and other negative amortizing loan products taken out at the height of the credit boom. It's not so much the rate reset that is the concern right now, with LIBOR and other index's that rate's reset to much lower than they were when credit blew out. Rather, its the loan recast that should be the concern. Let's talk about this once again now that it seems to be making headlines for struggling borrowers across the nation. And let us not forget about the delinquencies in Prime, Jumbo, and Alt-A that seem to be gathering speed right now.
I wonder whether we really will be able to carry trade our way out of this mess given the artificial nature of what is driving asset classes across all markets right now! The search for yield while balancing risk is getting harder and harder. Between artificially low rates, a huge expiring debt monetization experiment, artificial stimulus plans stealing future growth, artificial incentives to homebuyers and builders, removal of mark-to-market rules, easing of off-balance sheet accounting rules, surging budget deficits and treasury issuance, etc.., just how solid is this foundation of growth built on? That has always been something I questioned.
The story today from CNBC is that "More Homeowners Struggling As Option ARMs Reset Higher":
Thousands of American homeowners are starting to see their monthly mortgage payments skyrocket, dealing a fresh blow to the already shaky housing recovery.Don't mis-interpret a discussion here on UrbanDigs on how the Manhattan market improved to mean I no longer have concerns about the foundation this reflation trade is built on! Long time readers of this site know my stance on the bigger macro issues facing us.
The widely feared reset of thousands of option adjustable-rate mortgages-where both interest and principal payments rise sharply-is already leaving many homeowners struggling to keep a roof over their head. Terms of the loan usually allowed the borrower to make low monthly payments initially-sometimes by just paying interest only.
But as the terms of those mortgages now readjust, homeowners are facing much higher mortgage payments at a time when the value of their house has plummeted and many are out of work. In some cases, homeowners who chose a very low starting interest rate have actually seen the overall amount of their mortgage increase-known as negative amoritization-putting them even deeper in debt.
Loan recasts are one of them. As I talked about almost a year ago in my "You Worry About ARM Resets, I'm Worried About Recasts!" piece:
While LIBOR and other indexes that are tied to Option ARM resets have come down greatly, its NOT the reset I worry about; its the RECAST! 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.This took a seat on the backburner for many months while the headlines talked about reflation, rising stock prices globally, a turnaround in housing sales and prices across the nation, etc..But it never quite went away! We can hide all we want as the markets take an 'out of sight - out of mind' approach to things, but in the end the problem will resurface!
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
Think of all the borrowers, with Option Arms/NegAm/Cosi/Cofi/Pick-A-Pay loans, that chose to pay the bare minimum monthly payment in order to buy the house that otherwise they couldn't afford, and saw their original principal rise over time; and now the recast is near! You worry about the loan resets, I'm worried about the loan recasts!
According to a Sept 2009 report from Bloomberg,
"...About $134 billion of securitized “option” adjustable-rate mortgages will reset to higher payments over the next two years, worsening the performance of bonds backed by the debt, according to Fitch Ratings. Payment resets occur after five years or when the debt grows to a preset amount, typically 110 percent to 125 percent of the original principal. Recast payments are on average 63 percent higher than homeowners’ initial minimums, and can be more than double, Fitch said."Its all about when the tide changes folks. For much of 2009 after the March lows, both bad news and good news sparked higher highs and lower lows in equity prices and pretty much all asset classes. It continues until it doesn't anymore. Don't take your eyes off of rising Prime, Jumbo & Alt-A delinquencies which are really starting to gain some speed right now!
Just because you don't hear about much anymore, doesn't mean it isn't still lingering there!
Posted by Sechel
Tue Jan 12th, 2010 04:25 PM
Noah, have you looked at option arm loan mods, from what I can tell the fear over the neg-am limit triggering a recast is way over-blown. Banks are fully prepared to extend and pretend on this one and avoid the recast. I've seen a number of these converted to ten year io's.
Besides it could be argued the defaults have already occurred. Many of the pools have already experienced 50% losses with defaults beginning on day one.
Posted by Noah
Tue Jan 12th, 2010 07:36 PM
Sechel - well Im a bit out of the loop with all my time going to clients and new site development for you guys, but even still I would refer to a good friend of mine at a big HF who is right on the front lines. His answer to your question is:
"first part may be true. but it's not just negam limits that cause a recast - they have time limits too. second part may not be true:
'Besides it could be argued the defaults have already occurred. Many of the pools have already experienced 50% losses with defaults beginning on day one.'
delinquencies may have started on day one but losses only occur when the loan is liquidated which takes 16+ months now. I doubt these pools have seen 50% losses. In fact i'm sure of it. You dont even see that in subprime. But you do see 50% delinquencies in subprime."
Id take his response over anything I would have to say in response to your question any day of the week!
Posted by james
Wed Jan 13th, 2010 11:09 AM
Noah,
So, in your opinion, how would this affect the Manhattan market? Would the pricier residential units be buoyed by large financial institution bonuses and foreign money? Will the cheaper units fall in price?
If this causes a double-dip, seeing as the Fed can't realistically print any more money, will we enter a time even worse than the Great Depression?
Posted by Thisson
Wed Jan 13th, 2010 11:32 AM
Since 2007 was the peak, the 5 year recasts for the 2007 vintage will wash out of the system by the end of 2012. Maybe it will be "safe" to buy residential property then.
Posted by Scott
Thu Jan 14th, 2010 08:11 AM
The recast is definately the most worrisome. If banks are willing to "extend/pretend", what good does that do aside from pure speculation and further bleeding. Aren't there enough "good mortgages" to be written today if they just cut their losses now rather than delay what seems to be the inevitable?
That said, I know a guy in Bergen County NJ that just negotiated an extension on his house. IMO, he WAY overpayed for his house in 2007 at the peak. The new principal will never see that value in my near lifetime. He got a 2 year extension, which takes you into your 2012 year when the 07 recasts are expected to bust. Bad loan for the homeowner and bad deal for the bank. Do that x 1,000,000, and you have a new problem
Posted by Noah
Thu Jan 14th, 2010 09:07 AM
James - this is less a topic directly impacting Manhattan and more a topic about the general state of the banks and their loans/securities held...considering where we came from and the search for yield.
We know that everything was guaranteed and everything was changed to make this environment a recap one for the banks. Well, at some point those efforts will wear off and regulation comes in and acct tweaks get untweaked. Should these issues arise again, credit may reverse its amazing run and that could foreshadow a 2nd, less fierce wave. Of course that could indirectly trickle to Manhattan.
The point was, delinquencies are still gathering speed across all the big time stuff: prime, jumbo, alt-a, option arms, etc..it was never just a subprime problem, but an overall debt problem that affected higher quality debt classes.
I just wonder for how long this artificial policies taken to help the banks, well, no longer help or are removed. In the end, all the bad stuff does get properly marked and comes out. They can only hide bad stuff off balance sheet and at higher marks, for so long. Especially whole loans.
Posted by coach handbags
Thu Aug 12th, 2010 09:40 PM
Noah, have you looked at option arm loan mods, from what I can tell the fear over the neg-am limit triggering a recast is way over-blown. Banks are fully prepared to extend and pretend on this one and avoid the recast. I've seen a number of these converted to ten year io's.