- Even before this mortgage mess started, one person who
kept emailing me over and over saying that this is going to get real bad.
He kept saying this was beyond sub-prime, beyond low FICO scores, beyond
Alt-A and beyond the imagination of most pundits, politicians and the press.
When I asked him why somebody from inside the industry would be so emphatically
sounding the siren, he said, "Someobody's got to warn people."
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- Since then, I've kept up an active dialog with Mark Hanson,
a 20-year veteran of the mortgage industry, who has spent most of his career
in the wholesale and correspondent residential arena - primarily on the
West Coast. He lives in the Bay Area. So far he has been pretty much on
target as the situation has unfolded. I should point out that, based on
his knowledge of the industry, he has been short a number of mortgage-related
stocks.
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- His current thoughts, which I urge you to read:
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- The Government and the market are trying to boil this
down to a 'sub-prime' thing, especially with all constant talk of 'resets'.
But sub-prime loans were only a small piece of the mortgage mess. And sub-prime
loans are not the only ones with resets. What we are experiencing should
be called 'The Mortgage Meltdown' because many different exotic loan types
are imploding currently belonging to what lenders considered 'qualified'
or 'prime' borrowers. This will continue to worsen over the next few of
years. When 'prime' loans begin to explode to a degree large enough to
catch national attention, the ratings agencies will jump on board and we
will have 'Round 2¢. It is not that far away.
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- Since 2003, when lending first started becoming extremely
lax, a small percentage of the loans were true sub-prime fixed or arms.
But sub-prime is what is being focused upon to draw attention away from
the fact the lenders and Wall Street banks made all loans too easy to attain
for everyone. They can explain away the reason sub-prime loans are imploding
due to the weakness of the borrower.
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- How will they explain foreclosures in wealthy cities
across the nation involving borrowers with 750 scores when their loan adjusts
higher or terms change overnight because they reached their maximum negative
potential on a neg-am Pay Option ARM for instance?
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- Sub-prime aren't the only kind of loans imploding. Second
mortgages, hybrid intermediate-term ARMS, and the soon-to-be infamous Pay
Option ARM are also feeling substantial pressure. The latter three loan
types mostly were considered 'prime' so they are being overlooked, but
will haunt the financial markets for years to come. Versions of these loans
were made available to sub-prime borrowers of course, but the vast majority
were considered 'prime' or Alt-A. The caveat is that the differentiation
between Prime and ALT-A got smaller and smaller over the years until finally
in late 2005/2006 there was virtually no difference in program type or
rate.
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- The bailout we are hearing about for sub-prime borrowers
will be the first of many. Sub-prime only represents about 25% of the problem
loans out there. What about the second mortgages sitting behind the sub-prime
first, for instance? Most have seconds. Why aren't they bailing those out
too? Those rates have risen dramatically over the past few years as the
Prime jumped from 4% to 8.25% recently. seconds are primarily based upon
the prime rate. One can argue that many sub-prime first mortgages on their
own were not a problem for the borrowers but the added burden of the second
put on the property many times after-the-fact was too much for the borrower.
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- Most sub-prime loans in existence are refinances not
purchase-money loans. This means that more than likely they pulled cash
out of their home, bought things and are now going under. Perhaps the loan
they hold now is their third or forth in the past couple years. Why are
bad borrowers, who cannot stop going to the home-ATM getting bailed out?
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- The Government says they are going to use the credit
score as one of the determining factors. But we have learned over the past
year that credit scores are not a good predictor of future ability to repay.
This is because over the past five years you could refi your way into a
great score. Every time you were going broke and did not have money to
pay bills, you pulled cash out of your home by refinancing your first mortgage
or upping your second. You pay all your bills, buy some new clothes, take
a vacation and your score goes up!
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- The 'second mortgage implosion', 'Pay-Option implosion'
and 'Hybrid Intermediate-term ARM implosion' are all happening simultaneously
and about to heat up drastically. Second mortgage liens were done by nearly
every large bank in the nation and really heated up in 2005, as first mortgage
rates started rising and nobody could benefit from refinancing. This was
a way to keep the mortgage money flowing. Second mortgages to 100% of the
homes value with no income or asset documentation were among the best sellers
at CITI, Wells, WAMU, Chase, National City and Countrywide. We now know
these are worthless especially since values have indeed dropped and those
who maxed out their liens with a 100% purchase or refi of a second now
owe much more than their property is worth.
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- How are the banks going to get this junk second mortgage
paper off their books? Moody's is expecting a 15% default rate among 'prime'
second mortgages. Just think the default rate in lower quality such as
sub-prime. These assets will need to be sold for pennies on the dollar
to free up capacity for new vintage paper or borrowers allowed to pay 50
cents on the dollar, for instance, to buy back their note.
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- The latter is probably where the 'second mortgage implosion'
will end up going. Why sell the loan for 10 cents on the dollar when you
can get 25 to 50 cents from the borrower and lower their total outstanding
liens on the property at the same time, getting them 'right' in the home
again? Wells Fargo recently said they owned $84 billion of this worthless
paper. That is a lot of seconds at an average of $100,000 a piece. Already,
many lenders are locking up the second lines of credit and not allowing
borrowers to pull the remaining open available credit to stop the bleeding.
Second mortgages are defaulting at an amazing pace and it is picking up
every month.
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- The 'Pay-Option ARM implosion' will carry on for a couple
of years. In my opinion, this implosion will dwarf the 'sub-prime implosion'
because it cuts across all borrower types and all home values. Some of
the most affluent areas in California contain the most Option ARMs due
to the ability to buy a $1 million home with payments of a few thousand
dollars per month. Wamu, Countrywide, Wachovia, IndyMac, Downey and Bear
Stearns were/are among the largest Option ARM lenders. Option ARMs are
literally worthless with no bids found for many months for these assets.
These assets are almost guaranteed to blow up. 75% of Option ARM borrowers
make the minimum monthly payment. Eighty percent-plus are stated income/asset.
Average combined loan-to-value are at or above 90%. The majority done in
the past few years have second mortgages behind them.
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- The clue to who will blow up first is each lenders 'max
neg potential' allowance, which differs. The higher the allowance, the
longer until the borrower gets the letter saying 'you have reached your
110%, 115%, 125% etc maximum negative of your original loans balance so
you cannot accrue any more negative and must pay a minimum of the interest
only (or fully indexed payment in some cases). This payment rate could
be as much as three times greater. They cannot refinance, of course, because
the programs do not exist any longer to any great degree, the borrowers
cannot qualify for other more conventional financing or values have dropped
too much.
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- Also, the vast majority have second mortgages behind
them putting them in a seriously upside down position in their home. If
the first mortgage is at 115%, the second mortgage in many cases is at
100% at the time of origination - and values have dropped 10%-15% in states
like California - many home owners could be upside down 20% minimum. This
is a prime example of why these loans remain 'no bid' and will never have
a bid. These also will require a workout. The big difference between these
and sub-prime loans is at least with sub-prime loans, outstanding principal
balances do not grow at a rate of up to 7% per year. Not considering every
Option ARM a sub-prime loan is a mistake.
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- The 3/1, 5/1, 7/1 and 10/1 hybrid interest-only ARMS
will reset in droves beginning now. These are loans that are fixed at a
low introductory interest only rate for three, five, seven or 10 years
- then turn into a fully indexed payment rate that adjusts annually thereafter.
They first got really popular in 2003. Wells Fargo led the pack in these
but many people have them. The resets first began with the 3/1 last year.
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- The 5/1 was the most popular by far, so those start to
reset heavily in 2008. These were considered 'prime' but Wells and many
others would do 95%-100% to $1 million at a 620 score with nearly as low
of a rate as if you had a 750 score. No income or asset versions of this
loan were available at a negligible bump in fee. This does not sound too
'prime' to me. These loans were mostly Jumbo in higher priced states such
as California.
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- Values are down and these are interest only loans, therefore,
many are severely underwater even without negative-amortization on this
loan type. They were qualified at a 50% debt-to-income ratio, leaving only
50% of a borrower's income to pay taxes, all other bills and live their
lives. These loans put the borrower in the grave the day they signed their
loan docs especially without major appreciation. These loans will not perform
as poorly overall as sub-prime, seconds or Option ARMs but they are a perfect
example of what is still considered 'prime' that is at risk. Eighty-eight
percent of Thornburg's portfolio is this very loan type for example.
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- One final thought. How can any of this get repaired unless
home values stabilize? And how will that happen? In Northern California,
a household income of $90,000 per year could legitimately pay the minimum
monthly payment on an Option ARM on a million home for the past several
years. Most Option ARMs allowed zero to 5% down. Therefore, given the average
income of the Bay Area, most families could buy that million dollar home.
A home seller had a vast pool of available buyers.
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- Now, with all the exotic programs gone, a household income
of $175,000 is needed to buy that same home, which is about 10% of the
Bay Area households. And, inventories are up 500%. So, in a nutshell we
have 90% fewer qualified buyers for five-times the number of homes. To
get housing moving again in Northern California, either all the exotic
programs must come back, everyone must get a 100% raise or home prices
have to fall 50%. None, except the last sound remotely possible.
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- What I am telling you is not speculation. I sold BILLIONs
of these very loans over the past five years. I saw the borrowers we considered
'prime'. I always wondered 'what WILL happen when these things adjust is
values don't go up 10% per year'.
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- Now we're finding out. If you made it all the way to
the bottom, you can see why I decided to run this. Feel free to post thoughts
below. Mark will likely be personally responding to any comments.
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- http://blogs.marketwatch.com/greenberg/2007/12/straight-
- talk-on-the-mortgage-mess-from-an-insider/trackback/
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