Wachovia Ditches Pick-A-Pay, Will Waive Prepayment Fees on Option ARMs

In a nod to increasing investor and credit rating agency concern over mushrooming exposure to its now-infamous Pick-A-Pay mortgages, Wachovia Corp. (WB: 15.99 0.00%) said on Monday afternoon that it would no longer offer negatively amortizing mortgages to customers. So-called option ARMs were originated in force during the recent housing boom, and have recently led to large losses for the banks involved in making them.

The move is a stark change of direction for the Charlotte, North Carolina-based bank, and a tacit admission that option ARMs are a big problem for the bank, which paid $25 billion to purchase Golden West Financial in 2006. Golden West owned World Savings Bank, one of the nation’s largest originators of option ARM mortgages, and was at the time the nation’s second largest thrift; that ill-fated deal ended up costing CEO Ken Thompson his job roughly one month ago, and the bank has yet to find a successor.

Wachovia also said it will waive all prepayment fees for borrowers looking to refinance out of an option ARM, a clear indication of the stress borrowers in such loans are now facing; the bank recently hired Goldman Sachs Group Inc. (GS: 161.83 0.00%) in an effort to help it figure out what it should do with the Option ARM loans on its books.

“Wachovia is committed to serving our customers and ensuring they not only have the right product to meet their needs, but also the resources available to help them during these challenging times,” said David Pope, president of Wachovia Mortgage.

“Proactively waiving prepayment fees for our Pick-A-Payment mortgage products gives our customers the freedom to manage their current financial situation more effectively.”

It also helps Wachovia avoid spiraling losses, too, although such a sentiment is likely less palatable to investors.

Option ARMs were nearly universally put into portfolios by banks, due to the innovation of deferred interest that allowed them to book current-period income when borrowers chose to make only the minimum payment on the loans. Wachovia, for example, has already booked $3.5 billion in deferred interest as income tied to the loans.

The bank holds a substantial $170 billion residential mortgage portfolio; a whopping $121 billion of that total was in the form of option ARMs at the end of Q1.

Wachovia’s option ARM portfolio saw non-performing assets jump by $1.6 billion in just one quarter to $4.6 billion at the end of Q1, almost 4 percent of loans; analysts expect that number could be as high as $7.5 billion when the company reports its Q2 results on July 22.

For more information, visit http://www.wachovia.com.

Disclosure: The author held no positions in WB or GS when this story was originally published. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.