OTS issues warning on 'risky' ARM loans.

With an increasing number of thrifts, especially on the West Coast, offering adjustable-rate mortgages that are highly susceptible to error, the Office of Thrift Supervision Western Regional Director John F. Robinson on June 30 issued a supervisory bulletin to chief executive officers cautioning them about this and other potential problems with ARMs. While Robinsons warning letter technically only affects thrifts in the Western OTS Region, Washington OTS sources said examiners nationwide have been put on alert to paying particular attention to thrifts ARM loan portfolios. The potentially risky terms of ARMs to which Robinson directed thrifts attention are: The qualification of borrowers at an introductory,teaser, rate that is well below the fully-indexed rate; The combination of a periodic rate adjustment cap, high loan-to-value ratio at origination, and deeply discounted introductory rate. The deeper the introductory rate discount and the faster and higher the increase in COFI, the more negative amortization will add to the effective LTV, perhaps even eliminating borrower equity altogether; Abnormally low lifetime caps. An ARM transfers interest- rate risk from the lender to the borrower. Lifetime caps transfer some of this risk back to the lender. In general, the lower the cap, the greater the likelihood the ceiling will be hit and the ARM will revert, in effect, to a fixed-rate mortgage and lose its ability to protect the lender against further increases in rates.