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Top Forensic Loan Auditor Comments on Wells’ Pay Option Situation

As Pay Option ARM loans are a topic near dear to our hearts (having once been frivolously sued by a company that specialized in them), we at ML-Implode couldn’t help but notice the debate churning in the last few days over at Mike Shedlock’s blog regarding Wells’ situation with its inheritance of the notorious Golden West legacy portfolio of Pay Option ARM loans (via the Wachovia acquisition).    If you care to trace it back through the above link, you’ll find that a writer raised the point that Credit Suisse’s modelling of Option ARM resets erroneously assumed a 5 year recast, whereas the Golden West loans are supposedly “10 year recasts.”  Then IStockAnalyst picked that up and jumped to the conclusion that Wells was therefore (financially) “OK”.  Mish did not exactly agree.  The debate seemed to raise as many questions as answers.

To help clarify, we asked our friend, IamFacingForeclosure.com contributor, and one of the nation’s top forensic loan auditors, Patrick Pulatie, what he thought of all this.  He responded with the following email, and just for good measure, a new post at IamFacingForeclosure.com entitled  What’s Really Up With Wells’ Option ARMs?.

Below is the content of his email to us (emphasis ours):

Most of the World Option ARMS had higher start rates than the Countrywide and other Option ARMS. This tended to hold down the speed of Negative Amortization. However, they tended to have Margins in the 3.5% range, which was yielding about a 3 point rebate, which was the upper range for most Option ARMS.

World did use their own indexes, Cost of Savings and Cost of Deposit. These indexes were less volatile, and lower than the MTA, so that is how they got away with the higher margins.

I have seen a couple of hundred of World TILDs. They show recast periods from 5-10 years, depending upon when they were written, so this has no real basis for drawing a conclusion.

What the [iStockAnalyst] article does not mention is that the World Savings underwriting conditions were a joke. They did “make sense” loans. This meant that they were doing Stated Income most of the time. Credit scores could be in the upper 500’s, with any attempt at explanations.

World loaned on the foreclosure value of the property. They would accept outside appraisals, but then the World appraiser would “review” the appraisal. The appraisal would then be cut by 10% minimum to show a lower value. This was their “protection” factor. Brokers knew that if the loan was pushing the Loan to Value limits, then they would not send it to World because it would be declined.

Currently, the World client tends to be going into default at the same level as the CW client, based upon what I am seeing. That is because the borrowers were all stated income, and after 4-5 adjustments, they can’t make the payment. Many are now doing strategic defaults.

Wells is blowing smoke like always. To give you an idea, Wells has said that they never did a Sub-Prime loan. That is “funny” because I have one of their Sub-Prime rate sheets.

After reviewing all of the above, our  take-away executive-summary is:

  • There is no such thing as a “recast date at X years”.  Recasts occur whenever the negative-amortization limits are hit.  That in turn is based on how often the borrower made the minimum payment (usually always), and what the underlying financing index is doing (low now, but likely high later).   While current interest rates stretch this time out to the max, that certainly won’t be the same if the Fed has to start raising rates for whatever reason (economic recovery or inflation problem/dollar collapse.  At any rate, those predicting a recovery should take heed.)
  • Someone who has examined hundreds of World Savings loans says they are a mix of “5 and 10 year” recast schedules.   So we aren’t sure where this blanket “10 year” number is even coming from or how representative it really is.
  • Golden West/World Savings’ underwriting became a joke, like everyone else.  While they attempted some underwriting adjustments to be “conservative”, most of the time, they were doing stated “NINJA” loans, just like most of the toxic waste out there.  So World Savings was clearly gamed and gameable (see Pat’s full article for more details).
  • Golden West/World Savings loans are subject to the same awful negative equity problem as all the other bubble-zone Option ARM loans out there.  This implies “strategic defaults” (walk-aways).
  • Many borrowers have been defaulting after a mere 4-5 adjustments, well before the recasts, on these loans.
  • Golden West/World Savings loans are “defaulting at CountryWide rates”.  ‘Nuff said.

In conclusion, we still expect Wells to be in some serious hot water due to the World Savings legacy portfolio, within the next few years.  We simply don’t see substantial grounds to categorize Golden West loans significantly better than most Pay Option ARMs out there.

So, the stagecoach can run, but it can’t hide.   We hope Warren Buffett saved some pennies to put into this particular piggy bank.

Disclosure: Some of our staff is short WFC.

After reviewing all of the above, our executive-summary take-away from all this is:

There Are 2 Responses So Far. »

  1. Error in “take-away executive summary” – there is in fact such a thing as a “recast date at x-years” in most if not all pay option ARMs. The closing documents include language that provides for a recast at the earlier of x-years (typically 5 or 10) or the outstanding loan balance reaching the maximum negative amortization limit of 110% or 125% (of the original balance). That means they all blow up at some point in time – some sooner than others.

  2. Technically right Steve, but since 90%+ of people are paying only the minimum rate, virtually no one will hit the years limit before the neg-am limit. So the original concept of doing the modelling based on actual pay-down rates is correct.

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