i think you have three separate questions here (correct me if i’m wrong):
1. what percentage of these thrifts’ of total interest income is represented by deferred interest income?
obviously it differs from institution to institution, but i’d say meaningful but not enormous (yet). to give it some perspective, golden west generated $2 billion of interest income in 1Q06. consequently, $60 million (or twice that number if you like) hurts, but is not a back breaker if it disappears. nevertheless, these option ARMs are a big concern. having said that…
the biggest problem with these articles is that they are written by non-bankers and they confuse the terminology. to use golden west as a specific example, the company has almost $121 billion in loans on its balance sheet. 90% of that $121 billion is NOT comprised of option ARMs, however perhaps 90% of their origination volume in any particular recent quarter is comprised of option ARMs and/or perhaps 90% of the company’s deferred interest income comes from option ARMs.
These option ARMs could cause huge problems for thrifts, but their composition of thrift balance sheets is not stated properly in the recent articles on the subject.
2. what happens to the deferred interest income if the homeowner prepays the loan (whether through refinancing or a sale of the house)?
assuming the homeowner receives enough to pay off the entire outstanding loan balance, the thrift gets paid off in full (including the deferred interest balance) and the loan disappears. no problem for the institution.
3. what happens to the deferred interest income if the home goes into foreclosure?
assuming the home gets sold for some number below its original mortgage balance, then both that portion of the original mortgage balance as well as the deferred interest balance gets charged off – a direct hit to the thrift’s equity.
this accounting, like the gain-on-sale securitization accounting that many lenders were using several years back, will get changed after these institutions run into serious problems, which they likely will. accrual accounting is wonderful in concept (and in practice most of the time), but sometimes it gets taken a bit too far.
