Thrifts that last year did a booming business in discounted adjustable- rate mortgages continue to be in good shape even though prepayments have accelerated.

"I haven't seen anybody get into big trouble," John Robinson, director of the West region of the Office of Thrift Supervision, told American Banker.

But, he added, "what will really tell the tale is if interest rates continue to decline and ... to what extent people prepay those loans."

Thrifts aggressively marketed ARMs with low start rates last year, as they tried to refill their portfolios after several years of a fixed-rate lending boom.

In June 1994, Mr. Robinson wrote to many of the nation's largest thrifts warning that adjustable loans with heavily discounted start rates were "unsafe and unsound." The concern then was that borrowers would be unable to keep pace with payments as rates rose.

Last week, Mr. Robinson focused more on whether an increasing stream of prepayments would make the discounted adjustables unprofitable.

He said he had been advising thrifts to impose prepayment penalties on such loans, so that they could hang on to the loans long enough to at least recoup origination costs.

"You better be thinking of ways to encourage people to stay with those ARM loans at least long enough to get your money back," Mr. Robinson said. "Some sort of prepayment penalty. And a number of institutions are, in fact, doing that."

The big California thrifts have been offering a slightly reduced interest rate to encourage borrowers to accept prepayment penalties. The offers have increased the percentage of loans with prepayment penalties in their portfolios.

Meanwhile, the Federal Housing Finance Board reported that adjustables fell as a share of the market to 23% in July. It was the sixth straight month in which the share of adjustables declined.

In June, adjustables made up 25% of the market. Just seven months ago, in January, adjustables were 59% of the market. Since then, falling long- term rates have led consumers to choose fixed-rate loans over those with adjustable rates.

In some cases, the fully indexed rate on adjustables is about the same as on a 30-year fixed loan.

Sixty percent of adjustable mortgages closed in July were linked to the yield on one-year Treasury securities, and 13% to the 11th district cost- of-funds index.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.