Archive for November, 2009

What’s Really Up With Wells’ Option ARMs?

Monday, November 30th, 2009

An interesting at Mike “Mish” Shedlock’s web site on the World Savings Option ARM Mortgages that were “picked up” by Wells Fargo with the merger of Wells and Wachovia (Wachovia bought World Savings at the end of 2006). The discussion pivots on whether the World Option ARMs are a “ticking time-bomb” for Wells in the short term, or if the “10 year” recast period is going to allow Wells to weather the on-coming storm easier (or completely).

Stoking the controversy is an iStockAnalyst which argues Wells will be OK, after it was by one writer that Credit Suisse’s well-known projections for Option ARM recasts made an erroneous, blanket 5-year recast assumption. However, that writer with the iStockAnalyst conclusion that Wells is out of the woods, even though it is based on his own data!

So who is right?

Here, I will attempt to shed light on the recast portion of this argument, and hopefully clear up confusion and add to the general understanding of the subject.

The World (Savings) Option ARM differed from most other Option ARMs in the following details:

  • The Option ARM had a 125% Negative Amortization cap, which meant that if you had a loan of $400,000, the actual balance with Negative Amortization could increase to $500,000. Most other Option ARMS had 110% to 115% caps, with ABC offering some to 120% and Washington Mutual having a few at 125%, but these were minimal in numbers.
  • The maximum recast period could extend out to 10 years for the World Savings loans. Washington Mutual had a few loans that could also extend out to 10 years, but all other loans extended out to only 5 years.

What is most important to remember is that the 5 year and 10 year recast periods are only estimates. The periods are subject to variations based upon the index value, the start rate, and the margin offered. For a complete background on this, you can refer to a I have written on the Option ARM implosion at IamFacingForeclosure.com.

For a better understand of the recast, I have calculated payment schedules for a World Savings Option ARM and an Option ARM found with most typical lenders. So as to compare apples to apples, I am using a Start Rate of 1.5%, Margin of 3.45%, and the CODI Index Value of 4.3183% for the World Loan and the MTA Index Value of 4.2187% for the generic Option ARM. The Index Month is May 2006. Amortization Caps are 125% for the World Loan and 115% for the standard loan.

World Savings Generic Loan
Months Payments Months Payments
12 $1,725.60 12 $1,725.60
12 $1,855.02 12 $1,855.02
12 $1,994.15 12 $1,994.15
12 $2,143.71 12 $2,143.71
12 $2,304.49 4 $2,304.49
12 $2,477.33 307 $4,293.15
12 $2,663.13 1 $4,294.15
2 $2,862.86
273 $4,896.86
1 $4,899.75

As can be seen, for the first 52 months, the minimum payment schedule would remain the same. However, at month 53, the regular Option ARM would find itself recasting to the fully amortized payment, but the World Savings Option ARM would take until the 86th month to recast, far short of the 120 months that the article stated.

There are certain factors related to the recast dates that do not appear on the above payment schedule. The primary factor is that the CODI and MTA Index adjusts monthly, so each and every adjustment will affect the month that the actual recast occurred. For example, the CODI Index is now 0.8642% and the MTA Index is now 0.5442% for Oct 2009. The lower the Index, the longer the loan takes to recast, so it is likely that the loans would now approach the recast dates of 120 or 60 months. However, if the Indexes go up, then the recasts will be on track to occur quicker.

On the face of it, the articles and the Payment Schedule would tend to support the arguments that Wells Fargo will be better off with the World Option ARMS than other lenders would. However, this is NOT simply an academic exercise, so the Real World must be factored in.

Underwriting

The World Savings loan was treated differently than most other Option ARMs. That is because World was a “portfolio lender” and held these loans instead of selling them to Wall Street. This had profound implications for World underwriting.

World Savings underwrote loans using a “Make Sense” decision criteria. This underwriting allowed for most loans to be stated income, and credit scores into the upper 500’s, with mortgage lates allowed. All that needed to be done was to “document” the late with a “good” letter of explanation. Do that, and the loan was approved, no matter the issues.

The reason that World was able to embark upon their “Make Sense” underwriting was their appraisal process. Whenever the World underwriter received a loan with an appraisal from a non-World appraiser, a World appraiser would review the appraisal. Usually, this resulted in the World appraiser reducing the value of the appraisal by 10%. This gave World an “added cushion” to the loan to value and loan amount, to protect their interests. In reality, this meant that World was extending the loan offer based upon the foreclosure value of the property. How this helped World Savings is shown in the following example.

  • Appraisal Value of $500,000
  • 80% loan to value = $400,000
  • With 125% Negative Amortization, World would loan at a 100% loan to value.
  • By reducing the appraisal amount to $450,000, World would do the loan at 80% loan to value, or $360,000. Add in the 125% Negative Amortization, then World would be back at $450,000.
  • The end result is that World has a 10% equity cushion in the loan (in theory).

It should be noted that most brokers knew the World Savings practice with regard to appraisals and if the loan to value was close to 80% and since the World procedure would likely result in the loan being declined, then the broker took the loan to another lender [Ed. note - or maybe they made sure they got a more favorable appraisal, first.].

A real problem with the Option ARM loan is in regard to the World Savings Fast Action Team. This was an underwriting program where an underwriter could usually make an approval without any upper management review. The teams were located throughout the state of California, and it was easy to simply take the original loan application and credit report to the underwriter, sit down and show the underwriter the paperwork, and the underwriter would tell you how to write up the loan, stated income or not, and other issues to address. Therefore, it was relatively easy to get even difficult loans approved.

(This was also the routine when going through the World Account Representative for the broker officer. It should be noted that the same was true of other Account Reps for different lenders. )

The reality is that most borrowers were approved for the Option ARM mortgages using Stated Income loans. The income was over-inflated, and as a result, the borrowers were never qualified for the loan. If they were lucky, they could only make the minimum payment and nothing greater. If they had been required to have impound accounts and make the impound payments as well, then they would have likely defaulted at a faster rate.

Summary

In the last two years, I have audited probably about 150 World Savings Option ARMs. These have mostly been from people in default, ready to lose their homes. The common characteristics of the borrowers reflect the following:

  • Stated Income loans, though the borrowers were W-2 employees who were capable of providing income documentation. If the documentation had been provided, then the borrowers would have been declined for the loan.
  • 80% loan to value first mortgages, with Margins of 3.25% to 3.45%.
  • Three year prepayment penalties.
  • Large Yield Spread Premiums paid to the brokers.
  • Loans originated from 2004 to 2007, with years to go before the recast of the loan payment.
  • All had no equity left in the homes. Between the drop in values and the Negative Amortization, each borrower was underwater.

Based upon my observations, the 10 year recast date in not worth considering as beneficial to Wells Fargo. What will be the determining factors with regard to whether the Option ARM is going to harm Wells earlier than the recast dates will be:

  • The Index Values and how long that they will continue to stay low. Once rates increase, then the greater likelihood of recast issues.   [Ed. note - and should the economy continue to recover anytime soon, as the is the hope, the Fed will once again raise rates.  Should the Fed keep rates too low for too long (again), it would trigger inflation or dollar devaluation, which would likely force market rates higher on their own.]
  • The steady increase in the monthly payments at the minimum rate will continue to erode the disposable income of the borrower each year, which will tend to undermine the ability of the borrower to make the payments, resulting in default.
  • Failure of the borrowers to be able to make taxes and insurance payments each year, which will result in the lender making the payments for the borrower and then tacking the amount onto the monthly payments, further eroding the borrower’s repayment ability.
  • Continuing falling property values, which will make the borrower even more underwater with the loan. Eventually, the decision will be made to consider strategic defaults for even borrowers who could make the monthly payments but no longer see the worth in doing so, since they could default, and then buy a “better” property in 3-4 years, at a much lower price.

A point that I should bring up regarding the Credit Suisse chart of Option ARM resets that is being discussed. I have been having discussions with Bill Matz of Master’s Touch Mortgage regarding this specific point. Bill is a licensed mortgage broker, real estate attorney, tax attorney, and financial planner. He is one of the few people I trust in the business.

It is the opinion of each of us that the chart has significant errors in it. Some of the errors relate to the issue of the 10 year recast periods. Other errors relate to how differing Index values will affect the recast times.

It is our conclusion that this chart has over-estimated the coming year’s recast numbers. A large part of this conclusion is based upon the number of Option ARMS that have recast or will recast prior to the five year term. Also, it does not factor in the number of defaults that have already occurred long before the recast period.

But whatever the final timing, Wells is surely not insulated, due to the many factors outlined above.

Disclaimer:  Pulatie and LFI are not attorneys and do not dispense legal advice. The purpose of LFI is to assist attorneys and homeowners in their fight.

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1 in 4 Homeowners Are Underwater

Monday, November 30th, 2009

The number of U.S. homeowners who owe more on their mortgages than what their homes are worth has ballooned to 23%, threatening the chances of a near term correction to the housing market.

According to First American CoreLogic, a real-estate information company based in Santa Anna, CA, some 10.7 million homes had negative equity during the 3rd quarter of the year.

Homes that are underwater are a serious threat to a housing recovery because these homeowners are more likely to walk-away from their mortgages.  They also affect the liquidity of the housing market as owners are not able to sell their underwater homes.  Prices have fallen so far that as much as 5.3 million homes are tied to mortgages that are worth 80% or less of their mortgage principal.

However, most U.S. homes have equity, and 24 million homes have no mortgages at all, according to the same First American report.

About 588,000 borrowers defaulted on mortgages last year, even though they could afford to pay, that’s 2x as much as in 2007.

Related posts:

  1. 10 Questions on the Sinking Housing Market

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