March 5, 2007
Market Leader in Subprime, Alt A, and Option ARM Loans
I was looking through the year-end 2006 slides for the Home Loans segment (PDF) from Washington Mutual. The best graph is on page two that shows “Industry Originations.” In both 2004 and 2005, ARM loans accounted for half of all originations, about $3 trillion worth. That’s a very different picture from the previous three years when ARM loans accounted for only 16%-26% of originations.
I read that 80% of subprime ARM loans are 2/28s (30-year loans where the “teaser” rate (of say 7.55%) adjusts after two years (to say 11.25%), but that may not be accurate — does someone have a link to accurate numbers?
WM looks cheap on paper (I own it), but it makes me a little leery that one of their stated “Strategic Objectives” is to become the market leader in Subprime, Alt A, and Option ARM products.
Aside: A mortgage is a pledge of collateral against which a lender makes a loan. I don’t like it when people refer to their “mortgage” when they mean their debt, but maybe I’m a nitpicker. “Home loan” is a nice, simple term I like.
March 5th, 2007 at 10:31 pm
Can you not find your sell button? Bring up WM and press it!
March 5th, 2007 at 10:34 pm
Chris: I want to buy more actually; it’s cheap. ;-)
March 6th, 2007 at 8:09 am
You are correct on the 2/28 ARM. Rate is fixed for first 2yrs them it goes into it’s adj period. However, it is unlikely it could go from 7.7%-11%. Most ARM’s are pegged to LIBOR and have caps. Each one is different, but the usual is to have a 1-2% annual cap, and most have a lifetime cap too. The worse a borrower’s credit, the worse the terms are.
A big problem is the market price and the home appraisals. I’ve seen people get jammed b/c when they want to refi before the adjustment period kicks in they go to get another appraisal done and now recent home sales cannot support what they owe. And then they can’t refi and get forced into the adjustable part of the ARM.
TO make matters even worse, municipalities love to re-asess homes during housing boom, then raise your taxes too. But do you think they’ll lower taxes when the mkt prices drop? LOL. “Ish don’t think so”.
March 6th, 2007 at 8:12 am
I was in the mortgage business for a few years. If anyone has any questions feel free to post or send me a PM on Elitetrader.
There are a lot of people to blame for what happened with the sub-prime biz. The mortgage companies/brokers, the appraisers, and even the borrowers and home buyers themselves.
March 6th, 2007 at 8:22 am
uptik: I meant is it true that 80% of subprime ARM loans are 2/28s, but thanks for sharing your knowledge of the business. You could argue that the borrowers are to blame since they don’t understand the terms of the loan and get themselves in over their heads.
March 6th, 2007 at 12:39 pm
i used to bank with Wamu, both business and personal. Absolutely loved their service. Three months ago they closed all their branches in our county and the county next door… out of the blue. While Chase and others are expanding like crazy. I am in the Midwest in a very rapidly growing area, i.e. plenty of business for bankers. I do not know for sure, but my guess is that they know they will get hit with the sub-prime loans issues and are downsizing ahead of the news.
also, FWIW, i have to use a branch that’s an hour away to unwind my business with wamu and they have the worst customer service ever. I do not know if it just bad luck, or that they are changing their policies across the board. They also bad-mouth the manager of my now-defunct branch… very weird.
March 6th, 2007 at 1:57 pm
Born2: Thanks for the insight. It’s always good to get this qualitative input since I’m just looking at financial statements to make an estimation of value and judge what’s a fair (bargain) price to pay for the stock.
March 6th, 2007 at 10:37 pm
What I do not understand is why the lenders should be in so much trouble. Homeowners, yes, but lenders? Even the most subprime loans are secured by a mortgage, and even in a total default the bank should usually be able to recover all of the principal, and always at least some of it. What am I missing?
Andreas
March 7th, 2007 at 6:26 am
Washington Mutual (WM) is big in Alt-a adjustables with loan loss reserves of just .6%, about 40% below the average bank. Across the WM options chain, put options volume is running 39k to 9k against the calls.
March 7th, 2007 at 7:39 am
jill: I would argue that the options activity in WM you describe is actually bullish, not bearish.
March 7th, 2007 at 11:48 am
WM (short)… WM is setting up an intermediate term short set up.
Just heard on CNBC that the sub prime melt down will have an effect, market wise, on all of the lenders.
Last week saw selling volume double the weekly average. This amount of selling in a week very rarely sees an immediate reversal. I would expect price to decline further, and at worst, a consolidation with a slight decline for the next week or two.
Professional traders are taught to pick up their short positions on stocks falling below their 40 week (200 day)moving average.
Price not only closed below the 200 day moving average, price gapped down at the open on the first day following the first weekly close below said moving average. This is where one could reasonably expect to see selling pick up.
Entry target $41.50. Profit targets $1.50 - $3.50. Initial stop loss $42.50.
http://stockcharts.com/c-sc/sc?s=WM&p=W&st=2005-09-05&en=2007-03-05&i=p25909936499&a=100064260&r=7873
March 7th, 2007 at 11:55 am
jill: By the time CNBC starts yacking about something, the market long ago discounted it. Understand that I’m not talking about trading WM for a couple bucks of short-term profit; I’m talking about investing in WM for the next decade.
March 18th, 2007 at 1:17 pm
Andreas: The trouble is that the lender will not be able to raise funds to make new loans (no one will extend them credit) and it will also get stuck with a crummy loan portfolio which it may have to sell at a loss just to raise short term funds. A “liquidity crisis” is a scary thing.
If the lender declares bankruptcy then its creditors will have first dibs on its assets (mortgage inventory) and the common shareholders will likely end up with nothing.
August 16th, 2007 at 11:12 am
[…] Related: 80% of sub-prime ARM loans are 2/28s Cat: […]
March 5th, 2008 at 4:00 am
Hows that Wamu Stock doing? ;)
March 5th, 2008 at 4:38 am
Observer: Poorly, and I should have been more than “a little leery,” eh?
March 5th, 2008 at 12:13 pm
if WM does not get bought out they most likely will go under.
Recall the first time you brought it up i wrote a detailed comment (my nature :) ) of my experience with them as my bank. They were still in the mid 40’s at the time, way before any sub-prime news.
I do not think you got a decade to play this one out… you will either cash out if somebody buys them or you will see it go to zero… much sooner than a decade.
March 5th, 2008 at 2:09 pm
Born@: You’re too pessimistic and I’m too optimistic, that’s the nature of things. :)
March 5th, 2008 at 11:06 pm
Creative destruction is all about optimism :)
mediocre enterprises in limbo are just that: mediocre.