Wednesday, December 10, 2008

Jumbo Prime: ‘Walk Away’ Loans - More Downgrades Coming

From Mr. Mortgage:

This story was originally released a couple of weeks ago but somehow did not make it to the blog. It goes hand in hand with the Moody’s downgrade of many Bank of America Jumbo Prime deals citing a 13% delinquency rate. This represents a total meltdown in the sector happening right now that nobody is reporting.

Through my proprietary default and foreclosure data and research we have been watching this happen in real-time for months…I have warned you many times about this coming. It is amazing it took this long for somebody to say something. Now that the raters are reporting such massive default rates, I am going to officially say that the ‘Jumbo Implosion’ is upon us. The sad part is (ex-Countrywide) BofA was one of the better lenders during the bubble years. In my opinion, much more conservative than Wells Fargo, Citi, Chase, Wachovia or WaMu.

Jumbo Rates At Multi-Year Highs

AAA Prime, full doc, bank portfolio Jumbo 30-year fixed rate loan rates over the Fannie/Freddie $625k limit for higher value areas have recently surged again. Actually, they never really came back but rates are between 7.75% and 9% for perfect borrowers. And you have to put down 25 to 40% in many cases. Agency Jumbo from $417 to $625k and FHA Jumbos to $730k in some areas are both about 7.5%. Either way, Jumbo rates are at multi-year highs no doubt.

In my opinion, bank portfolio mortgage loan rates show the true appetite by a bank to take on real estate and consumer exposure. These loans are submitted directly to the bank, underwritten by the bank, come with large down payments or significant equity in the case of a refi and are only available to perfect borrowers. In addition, they are totally secured by real estate! Jumbo mortgage rates being 500 to 600 bps above 10-year money and 700 to 800 above the funds rate show a mortgage credit market that would evaporate if the government was not in charge of 99% of its action through Fannie, Freddie and FHA.

The home made chart below of actual no-point mortgage rates shows what has happened to mortgage rates vs. the 10-year for the past 5-years. Notice how back during the bubble years, actual rates tracked the 10-year very closely. Now, look at what has happened recently - the right side of the chart is nasty. Fannie/Freddie loans are not even participating after the initial knee-jerk lower a couple of weeks ago.

Analysts are not taking into consideration how much trouble the American economy will be in across the nation when those middle to upper class home owners all over the nation see their prices fall as much as the lower end has. This will happen - it has to. Unless folks start paying cash and see extra value in million dollar homes, home prices will gravitate to the most readily available financing, which is still $417k.

We are already seeing this price compression in CA. As a matter of fact, even when the lower priced homes stop falling the upper end could fall for quite some time continuing to weigh on overall prices. As prices drop and more go into a severe negative equity position defaults and foreclosures in Jumboland, which includes Jumbo Prime and Alt-A, will follow the path of Subprime.

More Downgrades to Come

I am hearing that more ratings agency downgrades are on the way in the Jumbo Prime arena - rightfully so. Believe it or not, as with Pay Option ARMs, much of Jumbo Prime are also ‘walk away’ loans.

These programs offered by most of our nations largest banks allowed a considerable amount of leverage when purchasing or refinancing. These are the ultimate ‘walk away’ loan, as a household income of $85k per year could legitimately buy a $650k home with 5% down during the bubble years. With stated, no ratio and no doc available at a slightly higher rate, many didn’t even need $85k. Now that home is worth 25-70% less and borrowers are making the wise decision to walk away given most their after-tax income is going towards this massively depreciating asset.

The greatest volume of Jumbo Prime was on the 5/1, 7/1 and 10/1 interest only product line with 5/1 being the most popular. Wells Fargo was the leader for this program on the West Coast. Chase, Citi, WaMu, Wachovia and Countrywide were also significant players. The 5/1 interest only is fixed for 5-years at a low introductory rate, typically 1.5% or so below a 30-year fixed then after 5-years adjusts higher or lower depending upon the underlying index such as the 1-year T-Bill or LIBOR plus a margin of 2.25 to 3.25%. Although Pay Options were considered Prime for years, they are not included in this analysis, as they are now in a category of their own.

Jumbo Prime are high-leverage programs that allowed borrowers to buy much more home than they should have. Because Jumbo Prime borrowers had better credit overall, banks were very easy on the qualifying. For example, with full-documentation a 620 credit score could get an 80% $750k first mortgage that allowed a 15% second on top of that for a 95% loan. These loans typically qualified at interest only payments. For stated income, the fee was very small, typically .125% in rate, with allowable credit scores around the 660 level. A 50% debt-to-income ratio was typical. THESE ARE NOT PRIME LOANS. This goes to show how distorted risk-management became.

This entire mortgage and housing blow up is very linear…Subprime to Alt-A to Jumbo Prime then Prime conventional. Helocs blow the entire way up the chain. The defaults in Jumbo Prime have to do with a) the way they were structured with longer teasers such as 5, 7, 10-years b) the high leverage allowing up to 50% debt-to-income ratios on full-doc and unlimited on stated, no ratio and no doc c) the massive negative equity due to median home prices falling in the biggest Jumbo regions by 25 to 70%.

BUYING A $650K HOME WITH $85K PER YEAR INCOME - MOST POPULAR IN CA

A 5/1 interest only at 5%, qualifying at interest only payments, means that a $520k loan carried a payment of only $2166 per month. Add in $650 per month for taxes and insurance, and the total is roughly $2825. With a 15% second of $97,500 at Prime carrying payments of $325 per month and reasonable ‘other debt’ at the time of $400 per month, the total payment out the door would be $3541 approx. This means a household income of $7082 per month could buy a $650k home with 5% down. This is not out of the realm of hourly workers or moderate income single worker families .

Now the same home is worth $450k, the borrowers added debt after the loan was funded and all of their after tax income is going out to debt each month. They can’t save a penny and are going broke just to live in this underwater house. They can rent the same house for $2500 per month. The best decision is to walk.

$650k Purchase in 2006 - 95% first/second combo

$2166 per month on a $520k 5/1 interest only Jumbo Prime
$650 taxes and insurance
$325 per month on a $112,500 heloc
$400 other debt
——————————————————–
$3500 per month total payments
$7000 per month ($84k per year) needed to qualify

(numbers above are approximate)

Now days, the same income buys a $275k to $300k mortgage with 10% down. This shows why housing prices keep falling.

The average note discount at Trustee Sale in CA last month among the big banks was 45%. If these loans were mostly 80% loans at the beginning, this means the homes are being discounted over 55% and still less than 5% sell at auction. They rest go back to the bank as REO.

Home values going parabolic in Jumbo regions like CA had much to do with the nation’s past six year’s wealth effect. When a home goes from $300k to $1 million, that equity is extracted and spent. The home in Nebraska going from $100k to $200k was insignificant. This is why when it comes down to housings impact on the broader economy, ‘as goes CA so goes the rest of the nation’.

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