The Next Shoe to Drop - Pay Option ARM Defaults

Pay Option ARMs - Up to 48% Default Rate! First Federal Featured
August 5th, 2008
Mr. Mortgage

I have been preaching that the ‘Pay Option Implosion’ will make the ‘Subprime Implosion’ look like a hiccup in states in which this loan program was widely used such as CA. This is because this loan program knows no socio-economic boundaries and was very heavy used in more affluent areas because of its ultimate affordability feature, negative amortization.

The Pay Option ARM (POA) is the most toxic of all loan programs with up to 80% of borrowers making the minimum monthly payment and acruing negative. Combine that with a house price crash of 32% in the past 13 months in CA and most of these borrowers owe more than their home is worth and are at an exponentially greater risk of loan default. Remember, these were once PRIME borrowers in many cases.

Part of my day job is analyzing banks and mortgage lenders using proprietary data and tracking mortgage loan defaults and REO by bank. I can see near real-time what is happening on a bank level and it is not pretty. About four months ago I noticed the subprime defaults waning, which I have been telling all of you about ever since. Over the past four months subprime defaults in CA are down about 25% but total Notice of Defaults have remained near historic highs of 43k per month. This is because Alt-A defaults have filled the gap.

The Alt-A universe is much larger in unit count and dollar volume than subprime so even though we are just at the beginning of the ‘Alt-A Implosion’, they have already filled in the subprime default void. Scarier yet, roughly 65% of all Alt-A defaults are POA’s. (Pay Option ARMS) The ‘POA Implosion’ is upon us.

As a matter of fact, just last week S&P, Moody’s and Fitch all hit Alt-A hard with an emphasis on Pay Option ARMs....