Unpaid Interest, What’s That?
The LA Times looks at a firm writing exotic loans. “For much of its 77 years in Santa Monica, First Federal Bank of California led an unremarkable existence. Nowadays First Federal is stirring up more excitement, on account of its emphasis on making relatively risky home loans. In fact, to listen to some Wall Street skeptics you might conclude that this sleepy savings and loan has taken a figurative dive off the end of the Santa Monica Pier.”
“Critics accuse First Federal and other West Coast thrifts of overindulging borrowers’ lust for artificially low initial payments. By generating so-called exotic or nontraditional mortgages, they warn, these S&Ls have allowed speculators to buy homes they can ill afford, and will be unable to resell when the mortgage payments rise and home prices take a tumble.”
“‘”I think this spring you will see housing prices crack,’ said Richard Bove, a banking analyst. That, he added, ‘is going to be terrible’ for people with mortgages that let them pay less, sometimes a lot less, than the full monthly payment during the early years of the loans. After those payments are reset to their full amounts, ‘I think you’re going to see a wave of defaults,’ Bove said.”
“Regulators, consumer advocates and skeptical investors have raised questions about the deferred-interest loans, formally known as payment-option adjustable-rate mortgages, or option ARMs for short. Many lenders larger than First Federal offer option ARMs, but First Federal has taken to them like few others. Of all the home loans that Washington Mutual held at the end of 2005, 52% were option ARMs. Golden West and Downey said more than 90% of their loans were option ARMs. At First Federal, 100% of residential mortgages were option ARMs.”
“Nationally, 26.4% of mortgages allowed for interest-only payments last year, up from 1.1% in 2000. First Federal has benefited from this trend, doubling in size from $4.8 billion in assets at the end of 2003 to $10.5 billion at the end of 2005. ‘Low doc’ and ‘no doc’ loans also fueled its boom, by the end of last year, 4 of 5 First Federal borrowers got credit without having to document their earnings, their assets or either.”
“Nontraditional mortgages have drawn attention from federal bank regulators, and the new rules have not been finalized. But federal examiners from agencies including the Office of Thrift Supervision, the Treasury Department division that regulates S&Ls, aren’t waiting for them to take effect, said banking lawyer Stuart Stein.”
“‘The OTS is already walking into shops that have these loans and is essentially demanding that these institutions take action,’ Stein said. ‘What I’m seeing from all the agencies is that they’re incredibly concerned about risk on the balance sheet, especially these low-doc and no-doc loans.’”
And a reader posted this related advice column. “Question: About a year ago, we bought our home with the help of an adjustable rate mortgage at 1.95 percent interest. We knew it would adjust after six months to 4.95 percent interest. However, when we received the lender’s Internal Revenue Service 1098 year-end report, we learned our mortgage balance has grown by about $7,800. When I called the lender, I was told the increase was ‘unpaid interest.’ What’s that?”
‘federal examiners from agencies including the Office of Thrift Supervision, the Treasury Department division that regulates S&Ls, aren’t waiting for them to take effect’
I have mixed feeling about this. Obviously, the regulators need to do something, but this looks like more of a CYA move. The letter writer shows that at least one lender doesn’t have the sophisticated borrower they claim to have.
Right — there was all that boilerplate BS about how these loans were only marketed to sophisticated buyers (wealthy business owners, etc.) who needed the financial flexibility of an Option ARM to match their irregular cash flow.
It’s the new economy man. Inflate the price of real estate and live off of the future. Make the youngin’s pay for it all. Restrict the supply of homes via the environmental laws. Charge an arm and a leg for building permits. Isn’t the american dream just great.
If a borrower astute enough to purchase a home then by definition he or she must be “sophisticated”. Only renters are unsophisticated and renters don’t require mortgages. So all mortgages are written for “sophisticated” borrowers. So where’s the problem?
Just give a dam loan. The lenders just want to profit from doing a loan. I think a monkee can even get a loan these days.Once the lender makes the loan and sells it what the hell do they care? Home ownership is at all time highs and all is well according to bush.
As a sophistcated borrower, I would like to know what “ARM’ stands for, what interest is, and what exactly is bankruptcy?
if you read “wall street” research on this product, it all says “over the past 5 years, loss experience has been minimal with this product”. no sh*t, sherlock! that’s because property values were going up due to loose lending standards. gonna be ugly now that the music is stopping.
“First Federal has benefited from this trend, doubling in size from $4.8 billion in assets at the end of 2003 to $10.5 billion at the end of 2005. ‘Low doc’ and ‘no doc’ loans also fueled its boom, by the end of last year, 4 of 5 First Federal borrowers got credit without having to document their earnings, their assets or either.” ….
“For much of its 77 years in Santa Monica, First Federal Bank of California led an unremarkable existence. Nowadays First Federal is stirring up more excitement, on account of its emphasis on making relatively risky home loans.”
This company may not make it to it 80th year. Like many of its borrowers it to may have to declare bankruptcy.
David
Bubble Meter Blog
I first heard about this craziness at First Fed right here on Ben’s blog a few weeks back…so I added it to my ’stocks to watch’ screen. Could be a good time to short this one and ride the escalator down.
‘What is unpaid interest’, you ask? You took taken a partial forebearance on interest payments in the first year. This means you’re paying interest on interest, you numbskull.
Ah, but don’t worry. Appreciation will surely save you.
That’s the thing; where will the appreciation come from now that a crackdown is coming? And there are already serious profit problems due to the yield curve. How many of those no-docs were really lying?
TRY 90% AND YOU’LL BE CLOSE
PLENTY….Particularly in the construction related field…
yeah, but that was the only way they could be the winner in the bidding war for the house they absolutely had to have before they were priced out of the market forever.
YUP…
Future generations will look back on this bubble with absolute amazement.
Millions of borrowers were given hundreds of thousands of dollars each to buy speculative real estate. They didn’t have to provide documentation of income, they didn’t have to put any money down and the first few years of payments didn’t even cover the interest on the loan.
It really is a case of mass financial hysteria. Borrowers will do anything to get in on the speculation and lenders have thrown the entire concept of risk management out the window just so they can get loans on the books.
The biggest crooks of all in this may be the bank officers who HAVE to know that these loans will not perform over the long run. But in the short term the loan volume will drive up stock prices and provide them with huge bonuses.
“The biggest crooks of all in this may be the bank officers…”
Nah. Alan Greenspan is the biggest crook in this story. He had the duty and the power to prevent loony loans and he didn’t do a damn thing. He stood by knowing full well that suicide loans would crater the housing industry and did nothing. NOTHING! He left in the nick of time or his world would have come crashing down on his head. Bernanke will now be the guy when it all falls in.
And Greenspan can sit on the beach knowing that he will never be held accountable. Strange world we live in….
Nothing to berate, but there is always a scapegoat. It is bible mandated! Bernake is the sacrificial lamb, and Greenspan is left to run covered in the ARM blood through the night!!!
“When I called the lender, I was told the increase was ‘unpaid interest.’ What’s that?””
That is your bell tolling, buddy
LOL! Hells Bells.
OT - just returned from a trip and couldn’t believe the cover of the current Business Week -> “Buyer (and seller) Beware”. Has this article already been discussed here? Wow, what a difference a few months can make!
No problem, dude! RE doubles every 5 years…get on board or be left at the station.
Not discussed yet , what did Business Week say ?
Business week
I wish we had preview. Here is the link:
http://yahoo.businessweek.com/magazine/content/06_09/b3973108.htm
I think this is the article…
Buyer (and Seller) Beware
Do you mean this article:
http://www.businessweek.com/magazine/content/06_15/b3979601.htm
Or this one?:
http://www.businessweek.com/magazine/content/06_15/b3979609.htm
Or this page?:
http://www.businessweek.com/magazine/toc/06_15/B39790615housing.htm
From the table in the article, it looks like short interest in FED stock has almost quintupled since July 2005, and the stock has been bouncing around below the July top. The stock took a haircut during the last housing downturn (1990-1995), and they almost went BK during the 80’s recession.
From the interviews, it sounds like management is denial that they have a problem, even though Bill Gross is recommending a sell on the stock. The bank’s COO says: “We think these folks [the critics] don’t understand the operations of a bank.”
At the end of 2005, First Federal’s borrowers had deferred $62.5 million in interest payments (up from $5.6 million in one year). Due to accounting rules, they can claim this as income, but that’s more than 65% of their reported net income of $91.7 million.
And 100% or their loans are option ARMs.
I think I’d better drop by my branch tomorrow and clean out my account.
Tomorrow may be too late.
operations of a bank=
1. loan $ to complete idiots
2. inflate bank profits
3. exercise options
4. sell all insider shares
5. leave car at airport
You forgot
2.5 Use whatever real profits there are to buy the bank’s shares back
Screw the little guy over
Sounds a little bit like Fastows & Skillings “mark-to-market” accounting at Enron. Well, we all know that strategy worked out well for Enron shareholders so I’m sure First Fed is doing the right thing. Yep, I swear.
Santa Monica is a really rich area, full of “creative types” like actors, directors, musicians, etc. People who get multi-million dollar paychecks but don’t get them every week. If they are really screening their customers like they say they are, and if the customers are putting down 20%, I don’t think this bank is in that much risk. The cheapest home in the area is a dump valued at $1 million. Regular homes would cost $3+ million. Check it out on Realtor.com.
“At First Federal, 100% of residential mortgages were option ARMs. ”
and…
“4 of 5 First Federal borrowers got credit without having to document their earnings, their assets or either”
I thought that there was little left to shock me with regards to this mania. That a 77 year old thrift would lend in such an obviously and completely reckless manner does shock me.
Wonder what the average down payment was on these loans?
According to the article, the bank claims that their mortage portfolio averages 73% of the appraised value of the home at the time that they are written.
So I guess that means that 50% of First Federal’s mortgage portfolio will not be under water until home prices fall about 27%. Assuming that the appraisals were honest, of course. Given the way averages work, that means that the percentage of underwater loans at First Federal should increase at twice the rate that home prices drop.
Yikes!
The loans first fed has may have been 73% LTV, but I would bet most of those borrowers took out a piggyback loan at the time of purchase resulting in MUCH less equity in the property than the 73% would lead us to believe.
As long as the second is junior to the first if the property drops less than 27% First Fed would be covered. The bank’s profits care little about who ends up owning the home as long as it can be sold for more than their note is worth.
Uh, no. Your math assumes that their LTV average is 73% of CURRENT value, whereas the article states that they claimed 73% average LTV at the time they were written. Thus, a loan on a home that was written at 73% LTV would have to decline about 34% from current value if the home has appreciated just 10% since the loan was written. If the home has appreciated 30%, value would have to decline 44% for their loan to be underwater.
“What’s that,” the sophisticated borrower asked as he leaned over the commode to inspect a large, brown, round deposit he’d made.
“That rush could flood the market with a niche product. ‘They all jump in at once and sink the boat,’ Walter Hahn, a longtime county real estate economist said.”
They just pulled their market strategy from Micky D’s. Everyplace they built one, Burger King, Taco Bell and others came on in. Gotta love the creative thinking here.LOL
Hey kids,
In reading this item I have mixed emotions:
1)First I am upset that this irresponsible behavior by lenders allowed this bubble to grow so big.
2)But then I also feel that every time I read something like this I rejoice that things like this will make RE crash even worse. I can only immagine how bad the bust will be when this thing ends. And have no doubt it will end, just a matter of time.
3)But then I am also scared at what this lunacy will do to the overall economy down the road.
Also, I was driving from the south bay to Marina Del Rey just now and I was astounded to see an Open House sign on every corner in Redondo, Hermosa and Manhattan Beach. But when I got to Marina Del Rey it was actually worse. On the intersection of PCH and Maxella there were 3 sign twirlers on opposite sides of PCH(1 on the west side and 2 on the east side)advertising condo’s for sale. Yes, sign twirlers, like they used to have just for apartments, fast food joints and cell phone places, must be getting desperate
My buddy and his wife just bought a house in S. Torrance a couple of months ago so I dropped by last night to check it out. Nice place, views of the city and about 3000 sq. ft. so they must’ve plunked down nearly a mil for the place. After a couple glasses of wine I asked how he financed it…10 year fixed I/O…I couldn’t believe it…they make decent $$$ so I know they could afford a 30 yr fixed…he claims they send in more $$ each month to pay for principal…i don’t know…they are either really smart or really stupid…
They are still locked into the an extremely high mortgage compared with what they could have paid later, plus they have to pay the property tax on that amount for as long as they own it. Really stupid…
Sign twirler workmen’s comp has skyrocketed. There were 3 reports of eye injuries due to “close proximity twirls”, 7 reports of moderate hearing loss due to “excessive iPod volume”, and 12 reports of carpal tunnel.
I also saw yesterday sign twirles in downtown Pasadena, advertising Hovnanian condos. It was pretty funny
It would be one thing if he didn’t understand the structure of his option mortgage (like making a minimum payment on your credit card, the balance can go up). But he didn’t retort anything about his mortgage, he didn’t know what “unpaid interest” meant. That’s pretty bad financial ignorance… guess he missed that question on the financial SAT.
Funny you mention the credit cards; they are required to make the minimum payment cover all finance charges, so it is not possible for the balance to grow anymore.
If you guys could see the prices in the Santa Monica area, you’d see why this local bank, First Fed, has stooped to making these loans. Who could buy anything around there without exotice financing?!
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Comment: “Houston……..we have a problem”