Tuesday, July 22, 2008

Looks like OPTION ARMS have done Wachovia in.

I knew Wachovia would be in trouble when I was still seeing their commercials for "Pick a Payment" Option arms as recently as this spring. You had to know that the ad wizards in charge of this company were not very bright when they continued to offer toxic mortgages well into 2008.

Check out this great article that explains it better than I can...

Almost a year ago I noted that you would be able to determine the banks that would recover the fastest from the mortgage crisis by identifying the ones that are ending their exotic loan programs, because it would indicate which banks actually learned their lesson around offering toxic mortgages. I.e. the banks that are still offering exotic loans haven't learned a thing, and are just going to get into more trouble in the future.

This brings me to today's news that Wachovia has "just" decided to stop offering option ARMs , despite the fact that mortgage crisis is well over a year old and we're coming upon the one year anniversary of the credit crunch.

(From the WSJ) "In a reversal, Wachovia Corp. said Monday it would stop making option adjustable-rate mortgages, which were why the bank bought Golden West Financial Corp. but is now stuck with more than $120 billion of the rapidly souring loans.

Wachovia also said it will let option-ARM borrowers escape prepayment penalties, but loan balances likely have swelled too big for many of these borrowers to refinance.

The changes effectively mean the dismantling of the core product of Golden West, the Oakland, Calif., thrift Wachovia bought for $25 billion two years ago. Option ARMs give customers multiple payment choices, including a minimum payment that may not be enough to cover the interest due. Borrowers who elect the minimum payment on a regular basis can see their loan balance grow.

For months, Wachovia had been dramatically curtailing its origination of option-ARM loans, so the moves weren't entirely unexpected. But the changes were still a blow at Wachovia, based in Charlotte, N.C., which has seen its shares fall 70% in the past year.

For years, the "Pick-a-Payment" option ARM was the core offering of Golden West's World Savings unit. But the company saw its market share slip as competitors such as Countrywide Financial Corp. and Washington Mutual Inc. aggressively marketed these loans to a wide variety of borrowers. In 2006, Golden West was the third-largest originator of option ARMs, with $31 billion of these loans, according to Inside Mortgage Finance. At the end of the first quarter, the company held $121 billion of Pick-a-Payment loans on its books.

But option-ARM originations have dwindled as the number of problem loans has climbed. Option ARMs accounted for just $4 billion of mortgage originations, or less than 1% of total loan volume, in the first quarter, says Inside Mortgage Finance. In 2006, their peak year, originations totaled $255 billion."

IF that doesn't spell: "Uh, we don't know why our mortgage investments went south and are bloody clueless" I don't know what does. Merely curtailing a toxic mortgage doesn't solve problem it just lessens the impact, and Wachovia should've been focused on a complete evisceration of the problem. Wachovia should've admitted that their Golden West Financial investment was a bust last year and ended its option ARM originations then, instead of continuing the practice and making things worse.

Finally the key metric on option ARMs to focus on this: "More than 18% of the option ARMs originated in 2005 and 2006 are already at least 60 days past due, says Barclays Capital, which looked at loans that were packaged into securities. The vast majority of these borrowers have yet to see their monthly payments recast so they begin making payments of principal and full interest, at which point payments can increase by 60% or more."

In other words the problem is about to get markedly worse because most option borrowers haven't hit the point where they won't be able to make their payments, and due to the nature of an option ARM very few of these borrowers are going to be able to refinance without a severe capital infusion or principle forgiveness.


The Wall St. Journal: "Wachovia to Discontinue Option-ARMs" -- Valerie Bauerlein and Ruth Simon, July 1, 2008

It is still hard to believe the greed and stupidity that so many of these banks had offering these products in the first place. Even during the housing boom when no one thought the good times would ever end, these loans did not make good business sense. How a bank can continue doing it for a year after the mortgage meltdown occurred is simply mind boggling...But in case you have been living in a cave and could not comprehend how Wachovia was able to post a 9 billion dollar loss today... Now you know :)

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