Option ARMs Recasting Through 2011 Pegged at $134 Billion

U.S. payment option adjustable-rate mortgages set to see their rates recast over the next two years represent $134 billion in loan volume, according to Fitch, New York. Fitch said of the $189 billion in securitized option ARMs outstanding, 88% have not been through a recast event. The rating agency, which has rated about 5% of option ARM deals, said that of the loans yet to experience a recast event, 94% have used the minimum monthly payment to allow the loans to negatively amortize, allowing the loan balance to grow over time to caps that generally range between 110% to 125% of the original mortgage. A recast event generally occurs when the loan reaches that cap or has been outstanding for five years, at which point the borrower is obliged to stop making minimum payments and to instead make regular, fully amortizing principal and interest payments. This potentially creates payment shock for borrowers as the size of the fully amortizing P&I payment is on average 63% higher than the minimum monthly payment many borrowers have been making. Fitch expects this to put stress on recent vintage option ARM borrowers, creating expected losses that range from 35% to 45%, depending on collateral quality. Many option ARMs are secured by properties in states where values have declined by an average 48% since the second quarter of 2006. Even if these declines cease, Fitch believes the fact that many of these borrowers will be unable to refinance into alternative mortgages will cause a spike in option ARM defaults. Even though the origination of payment option ARMs has ground to a halt, the loans must still be serviced. As recently as the fourth quarter of last year Wachovia Mortgage - which is now part of Wells Fargo - was still originating the loans but did not offer the negative amortization option. In 3Q it funded $1 billion in POAs but by the fourth quarter originations had plummeted to just $40 million, according to the Quarterly Data Report.