If you thought subprime was bad, you might want to close your eyes for the option-ARM nightmare:

An analysis prepared for The Wall Street Journal by UBS AG shows that 3.55% of option ARMs originated by Countrywide in 2006 and packaged into securities sold to investors are at least 60 days past due. That compares with an average option-ARM delinquency rate of 2.56% for the industry as a whole and is the highest of six companies analyzed by UBS.


Among option ARMs held in its own portfolio, 5.7% were at least 30 days past due as of June 30, the measure Countrywide uses. That's up from 1.6% a year earlier. Countrywide held $27.8 billion of option ARMs as of June 30, accounting for about 41% of the loans held as investments by its savings bank. An additional $122 billion have been packaged into securities sold to investors, according to UBS.


The deteriorating performance of option ARMs is evidence that lax underwriting that led to problems in subprime loans is showing up in the prime market, where defaults typically are minimal. Challenges could grow, as from 2009 to 2011, monthly payments on some $229 billion of option ARMs will be adjusted to include market-rate interest and principal, according to Moody's Economy.com.


By 2005, option ARMs accounted for $238 billion of loan volume, or about 8% of loans originated that year, according to Inside Mortgage Finance, a trade publication. At Countrywide, these loans accounted for $93 billion, or 19%, of the company's loan volume by 2005, making it the top option ARM lender that year.

These mortgages can be highly profitable. Once the short teaser-rate period ends, the interest rate typically is higher than on other types of loans for a similar borrower. Investors were willing to pay more for securities backed by option ARMs than for those backed by traditional mortgages and guaranteed by Fannie Mae and Freddie Mac.


It now appears that many borrowers who moved into option ARMs were attracted by the low payments and may have been staving off other financial problems. More than 80% of borrowers who are current on these loans make only the minimum payment, according to UBS.


Of the option ARMs it issued last year, 91% were "low-doc" mortgages in which the borrower didn't fully document income or assets, according to UBS, compared with an industry average of 88% that year. In 2004, 78% of Countrywide's option ARMs carried less than full documentation.

This is even worse than I thought.

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