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Wednesday, June 18, 2008 2:13 AM

Wachovia Still Does Not Understand Pay Option ARM Risk

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In an interesting twist of irony, Wachovia is Taking New Steps to Assure Borrower Understand Loans.

Wachovia Corp., which ousted its top executive after estimating it may lose more than $4.5 billion on adjustable-rate home loans, will start calling would-be borrowers to explain the risks of such mortgages.

Wachovia is contacting applicants through independent mortgage brokers to ensure "the customer understands the key features of the Pick-A-Payment loan product," according to a June 11 memo from Tim Wilson, head of loan origination at the Charlotte, North Carolina-based company. The loans let borrowers defer part of their monthly bills.

Wachovia and lenders including Countrywide Financial Corp. and Washington Mutual Inc. have been burned by delinquent option adjustable-rate mortgages, often called option-ARMs. Wachovia is led by interim Chief Executive Officer Lanty Smith who replaced Kennedy Thompson on June 2, two years after the bank's $24 billion purchase of Golden West Financial Corp. at the peak of the housing boom.

"Stepping so much into the underwriting process is very unusual and almost unprecedented," said consultant David Lykken of Mortgage Banking Solutions in Austin, Texas. Wachovia spokesman Don Vecchiarello confirmed the new policy, which took effect this week.

Golden West was the market leader in option-ARM mortgages, with about $120 billion of the loans when it was acquired by Wachovia. The loans, termed Pick-a-Payment by Wachovia, allow borrowers to make lower initial payments that don't even cover the accrued interest. Almost 70 percent of Wachovia's borrowers choose to pay as little as possible.

Wachovia on April 14 said losses on its option-ARMS may reach $1.7 billion this year and $2.8 billion in 2009. That estimate may be optimistic with the bank potentially setting aside almost $17 billion to cover losses, CreditSights Inc. analyst David Hendler wrote in a June 2 report.

Wachovia's new policy "is far too little and far too late and indicative of how bad it is," said William Purdy, a Soquel, California, lawyer who concentrates on home refinancing. "These loans are ticking time bombs and probably the worst thing the bank can say it has ever done to its customers."

"We feel comfortable making these loans even in this market environment," [said Vecchiarello, the Wachovia spokesman.] About 60 percent of Wachovia's home loans are in California, among the states hardest hit as housing prices slide.

Wachovia set aside $2.8 billion for credit losses in the three months ended March 31, mostly because of deteriorating housing markets in California and Florida. The bank wasn't collecting payments on $8.4 billion of loans, or 1.7 percent of its total loans, quadruple the level a year earlier.

Through February about 14 percent of the bank's option-ARM portfolio had loan-to-value rates of 100 percent or more, with 85 percent of those loans in California and Florida. When loan amounts exceed the value of a home, borrowers may stop paying, said Keith Gumbinger, vice president of HSH Associates, a Pompton Plains, New Jersey-based publisher of mortgage data.
This is really quite interesting. Wachovia is "comfortable making these loans even in this market environment" but has to individually call customers to make sure they understand the loans. This is coming from a bank that paid $24 billion for Golden West the leader in Option ARM insanity.

The negative amortization time bomb is ticking. Almost 70 percent of Wachovia's borrowers choose to pay as little as possible. All those customers will owe more on their loan next month than they do this month. And to top it off, Wachovia expects (as do I) home prices to continue falling.

Pay Option ARM blowups, one of the Things That Have Not Yet Happened is now the initial stages of happening. The bottom is still years away.

Wachovia may set aside as much as $17 billion to cover losses according to CreditSights Inc. But what about commercial real estate losses, credit card losses, home equity losses, etc? A quick check of Yahoo Finance shows Wachovia's market cap is $34 billion.

Yet in rapidly deteriorating economic conditions accompanied by rising unemployment, and falling home prices, Wachovia continues to make these loans. Is it customers who do not understand the risk of this product or Wachovia? How about both?

Here is one possible answer.

click on chart for sharper image

The market clearly does not think Wachovia knows what it's doing, and neither do I.

Mike "Mish" Shedlock
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