At First Fed, Pushing the Pain Below

A recent 8-K filed with the Securities and Exchange Commission by Los Angeles, Calif.-based FirstFed Financial Corp. (FED) provides a unique look at just how the option ARM crisis is likely to play out for many of the banks that tended to lend in the space during the recent housing boom. First, the good news: non-accural and loans 30-60 days delinquent both decreased between August and September, as the bank worked to aggressively modify what loans it could for a large number of its option ARM borrowers. But that may prove to be a temporary trend, unfortunately. The SEC filing shows that 22.3 percent of borrowers in First Fed’s $4.52 billion single family mortgage portfolio were already underwater on their mortgages at the end of June, using OFHEO’s price index data to adjust original loan-to-value ratios. Were updated OFHEO numbers to be used, or another less conservative index — i.e., the Case-Shiller — that estimate would absolutely be far higher than the percentage reported. More than half of the mortgage portfolio is of the stated income variety, as well, and all of it is in California; just less than half of the portfolio is in option ARMs. Underwater borrowers are, not surprisingly, proving to represent a significant risk of default; in fact, 41.4 percent of $653.7 million in borrower defaults on the books at the end of September emanated from borrowers (conservatively) estimated by the bank to be upside down on their mortgage. So 22.3 percent of the portfolio was driving 41.4 percent of defaults. A dig deeper into the numbers is even more telling: 24.1 percent of borrowers estimated to be at between 100 and 110 percent of current LTV had defaulted on their mortgages by the end of Sept.; for borrowers over 110 percent current LTV, that number reached an astonishing 32.8 percent, or roughly 1 in three. With price declines expected to continue throughout much of California — and, according to at least one study, the vast majority of borrowers in bubble markets unlikely to see any meaningful equity accumulation through 2012 — the question of managing credit and collateral becomes critical in assuming just what will become of a mortgage portfolio so heavily focused in California, and one where more than 40 percent of borrowers in the portfolio were estimated to be at 90 percent or greater in current LTV at the end of Sept. Part of the problem is also in option ARMs that are waiting to hit their recasts, and borrowers that are largely trapped in the loans, thanks to a growing negative equity problem. And that’s a problem that won’t begin to roost until next year, based on First Fed’s estimates: after an expected $79.5 million in recasts during Q4, 2009 is forecast to see 1,304 loans totaling more than $575 million reach their maximum negative amortization. 2010 is even worse, with an estimated $804 million expected to recast. All told between 2009-2011, First Fed is expecting $1.88 billion in recasts on its option ARM holdings. Which means that the pain of existing borrower defaults — NPAs were at 7.87 percent of total assets by the end of Sept. — seems only likely to intensify as we roll into 2009, with a weak economy along for the ride. Of course, First Fed isn’t alone here — but the bank’s relatively open SEC disclosures illustrate the sort of pain that lies just below the surface for many lenders managing substantial option ARM portfolios. Write to Paul Jackson at [email protected]. Disclosure: The author held no positions in any of the stocks mentioned when this story was published. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.