Libor Rise to Boost Subprime ARM Defaults 10%, Citigroup Says

By Jody Shenn

Oct. 7 (Bloomberg) -- Increases in benchmark London interbank offered rates may boost homeowner defaults on resetting adjustable-rate mortgages, contributing to a ``vicious cycle''
in the credit crunch, according to Citigroup Inc.

Among subprime loans, defaults may climb by 10 percent, analysts Rahul Parulekar, Udairam Bishnoi, Sumeet Kapur and Tanuj Garg wrote in a report yesterday. About $23.7 billion, or 87 percent, of the ARMs underlying bonds whose interest rates begin adjusting next month track Libor rates. Six-month dollar Libor has climbed to 4.02 percent, from 3 percent on Sept. 15.

The deepening of the credit crisis that started last year amid record defaults on subprime mortgages, contributing to $593 billion in writedowns and losses at banks worldwide, may end up causing more borrowers to fail to make their monthly payments. Libor rates, which track how much banks charge each other for loans, help set the cost of everything from credit cards to corporate loans.

``America's homeowners are going to get uncomfortably familiar with 'LIBOR' starting next month,'' the New York-based Citigroup analysts wrote.

Libor rates have soared since the bankruptcy of Lehman Brothers Holdings Inc. last month as financial companies hoard cash.

The average subprime borrower facing an adjustable payment for the first time next month would face a monthly payment increase of about 18 percent based on Libor rates as of Sept. 30, rather than the 10 percent that would have occurred based on the rates on Sept. 15, the analysts wrote. The payment would be $1,951, instead of $1,807, they said. Fannie Mae and Freddie Mac loans would be boosted to $1,021 on average, instead of $904.

`Payment Shock'

Their report didn't quantify the effect of higher Libor rates on any of the $361 billion of mortgages underlying bonds whose rates have already begun tracking benchmarks, changing monthly, semi-annually or annually. The report also didn't address whether higher potential ``payment shock'' may lead to increased efforts to rework mortgages by loan servicers, even though mortgage modifications are rising amid record foreclosures.

The seizure in global credit markets, sparked by the U.S. housing downturn, has been deepening on speculation central bank attempts to revive lending between financial institutions won't work, resulting in more failures. The Libor rate for overnight loans in dollars between banks rose 1.57 percentage point today to 3.94 percent, the British Bankers' Association said.

Mortgages Reset

About 121,000 mortgages will reset for the first time next month, according to the Citigroup report, which looked at only securitized mortgages. About 1.8 million loans have already begun adjusting based on benchmark rates, the report said, while 3.7 million face resets scheduled for after next month.

``Almost all'' subprime and Alt-A ARMs with a few years of fixed rates, about 60 percent of those prime-jumbo mortgages and about 75 percent of such loans in Fannie Mae, Freddie Mac and Ginnie Mae bonds are linked to Libor, the report said. The loans most often are pegged to six-month Libor.

Subprime loans are given to borrowers with poor credit or high debt. Alt-A loans were made to borrowers who wanted atypical terms such as proof-of-income waivers, delayed principal repayment or investment-property collateral, without sufficient compensating attributes.

Prime-jumbo loans are made to the best borrowers seeking loans larger than Fannie and Freddie can finance. Fannie and Freddie are government-chartered mortgage-finance companies; Ginnie Mae is a federal agency.

doug reich

Some guy
A vicious cycle: borrowers default, lowering worthiness of financial institutions, which boosts LIBOR, which causes more borrowers to default.

I believe the bailout gives the government the power to rewrite the loan terms on those that it buys (to minimize the chance of defaults). They better start buying so we can break that cycle. The upshot will still be lower mortgage values, as the payments themselves will be lower. Those prices will still be higher than the default value, of course.