A Fitch Ratings report on the outlook for increasing delinquencies in option ARMs resulting from recasts was released today.
The study said that there is still a ways to go before a bottom is hit in this housing crisis, which is "a significant cause for concern for investors in option ARM RMBS," according to the rating agency.
Fitch calculates that around $29 billion, 16% of the total option ARMs outstanding, will recast by the end of 2009. Of this amount, the rating agency said, $6.6 billion consists of 2004 vintages that will reach their five year anniversary, but $23 billion consists of 2005 and 2006 vintages that will recast early due to hitting their balance cap limits.
Option ARMs are subject to negative amortization and when these loans reache a certain level, typically 110% to 125% of the original balance, the loan is "recast" and the new payment becomes fully amortizing to the loan maturity.
In 2010, Fitch projected that around $67 billion of loans will recast, $37 billion of which are 2005 originations that will hit their five-year anniversary, and $30 billion of 2006 and 2007 vintages that will have hit their neg-am limit.
Specifically, option ARMs with 40-year terms are especially at risk given the size of their payment increase. Fitch's report estimated that 30-year term payments will increase $700 to $1,400, which is about 58% higher on average, while those with 40-year terms will increase in the range of $1,300 to $2,200, or 102% higher on average than the minimum monthly payment.
Analysts also said that many of the loans were underwritten to a stated income program and this increases the odds that the borrower will be unable to meet the new payment. They said that 83% of the loans from 2004 to 2007 originations were underwritten with less than full documentation. Furthermore, many of the option ARMs from 2005 to 2007 vintages were originated with simultaneous second liens, which suggests low to no borrower equity in the homes, Fitch analysts said.
These loans are already experiencing high delinquency rates, according to Fitch, as the collapse of non-agency mortgage originations, the secondary market, and housing prices have made it difficult for borrowers to refinance.
As a result, borrowers have very few alternatives other than foreclosure. Fitch said it "anticipates performance to deteriorate further as the 2004 and 2005 vintages begin to recast over the next 18 months and borrowers are faced with sizable payment increase." Analysts said that data suggests delinquencies are likely to double after recast.