Banks are taking the opportunity presented by historically low interest rates to assist borrowers in refinancing their mortgages in an effort to prevent foreclosure and keep payments on schedule. The main focus is modifying option-ARMs, or option adjustable-rate mortgages that were available to borrowers preceding the financial crisis. Large mortgage banks no longer offer the risky mortgage products, but there are many still active and of those many are on the edge of foreclosure. Banks help themselves by keeping more troubled assets from being added to their books, and help borrowers keep their homes. For more on this continue reading the following article from The Street.
Three of the "big four" U.S. banks still have significant exposure to option-payment adjustable-rate mortgages– or option-ARMs — leftover from the subprime mortgage boom.
But the prolonged low-rate environment has given borrowers a brief financial respite, and lenders are using opportunity to modify the mortgages and push homeowners into lower-risk financing.
Option-ARMs were among the riskiest of the innovative residential mortgage loan types that became so popular during the real estate boom, and are no longer being offered by the large banks.
The loans feature an "option payment" for the first several years, typically allowing the borrow the choice of making a full amortizing monthly loan payment of principal and interest, making a lower payment of just the prior month’s accrued interest, or making an even lower payment, with unpaid accrued interest tacked on to the principal balance. Some of the loans offer a different set of payment choices.
Some of the option-ARMS featured low initial teaser rates, which would rise after a year or longer, to an adjustable rate.
After the balance of a negatively amortizing loan reaches a certain percentage of the original loan amount or collateral value, the loan "recasts" to a fully amortizing payment, possibly with a much higher interest rate.
The recasting of the payment – now including a portion of the higher principal balance and possibly a higher interest rate – often leads to "payment shock." When combined with declining real estate prices, lenders were facing a "perfect storm" at the height of the real estate crisis.
But with rates still at historic lows some banks see the opportunity to modify the option-ARMs and move some homeowners from the precipice of foreclosure.
According to data from Federal Reserve filings provided by SNL Financial, Wells Fargo (WRC) led all U.S. banks with $48.1 billion in closed-end loans with negative amortization features as of March 31, with $2.2 billion of negative amortization included in that principal balance, with another $16.7 billion in possible negative amortization exposure. The company’s "Pick-a-Pay" portfolio of option-ARMs and also option-payment fixed-rate mortgage loans, was acquired when Wells Fargo purchased the teetering Wachovia for $12.5 billion in December 2008. Unlike some of the other large banks, none of Wells Fargo’s option-payment mortgages were securitized.
At the time of the Wachovia acquisition, Wells Fargo aggressively wrote-down its "purchased credit impaired" or PIC loans, including most of the PCI loans and thus "virtually eliminated Wachovia’s nonaccrual loans at December 31, 2008."
Wells Fargo said in its first-quarter 10-Q filing with the Securities and Exchange Commission that "due to the sustained positive performance observed on the Pick-a-Pay portfolio compared with the original acquisition estimates" the company had "reclassified $2.4 billion from the nonaccretable difference [established when the loans were initially written down, to absorb expected losses] to the accretable yield since the Wachovia merger," and that the credit improvement was "primarily attributable to the significant modification efforts as well as the portfolio’s delinquency stabilization."
As of March 31, the company said it had "completed more than 85,000 modifications" of Pick-a-Pay mortgage loans "since the Wachovia acquisition, resulting in $3.9 billion of principal forgiveness to our Pick-a-Pay customers." During the first quarter, the company completed more than 4,600 Pick-a-Pay modifications, including those made through the U.S. Treasury Department’s Home Affordability Modification Program (HAMP).
Wells Fargo said that even though most of the Pick-a-Pay modifications had resulted "in material payment reduction to the customer," Wells Fargo had not been forced to make larger provisions for loan loss reserves — which would have hurt earnings results — because of the aggressive write-downs taken when the loans were acquired.
Of course, a prolonged low-rate environment has also helped.
According to the Federal Reserve data provided by SNL, JPMorgan Chase (JPM) had $33 billion in closed-end residential mortgages with terms allowing for negative amortization as of March 31. Negative amortization included in the principal balance totaled $1.4 billion, with an additional $6.3 billion in potential negative amortization exposure.
According to the company’s first-quarter 10-Q report, JPMorgan had $24.8 billion in option-ARMS as of March 31 within in its $70.8 billion purchased credit impaired portfolio, acquired as part of the company’s purchase of the failed Washington Mutual from the Federal Deposit Insurance Corp.in September 2008. The PCI loans were written-down to fair value when they were acquired, and as of March 31, JPMorgan said that although it had set aside $4.9 billion in loan loss reserves for all of its PCI loans, "to date, no charge-offs have been recorded on PCI loans."
Outside the PCI portfolio, JPMorgan had an additional $8.2 billion in option-ARMS in its prime mortgage portfolio, and said that since these loans were mainly to borrowers with higher credit scores and featured lower loan-to-value ratios than the ones acquired from Wachovia, "approximately 7% of [these] option ARM borrowers were delinquent, 3% were making interest-only or negatively amortizing payments, and 90% were making amortizing payments" as of March 31. Interestingly, the company said that outside the PCI portfolio, "the cumulative amount of unpaid interest added to the unpaid principal balance due to negative amortization of option ARMs was not material at March 31, 2011."
JPMorgan said that as of March 31, "Approximately 38% of the option ARM PCI loans were delinquent." The company also said that $11.8 billion of the option-ARMs within the PCI portfolio had been restructured, as of March 31.
Bank of America
According to the Federal Reserve data provided by SNL, Bank of America (BAC) had $11.4 billion in closed-end residential mortgages with negative amortization features as of March 31, with $8.3 million in negative amortization included in the balance, and another potential $1.2 billion in negative amortization exposure.
Out of the $13.6 billion in total mortgage representations and warranties claims that Bank of America reported in its first-quarter 10-Q for March 31, $3.2 were putback claims for "pay option" mortgage loans.
The New York Times reported on Saturday, that out of 550,000 option-ARMS acquired from Countrywide, Bank of America "said more than 200,000 had been converted to more stable mortgages."
This article was republished with permission from The Street.