Toomre Capital Markets LLC ("TCM") has written previously about the perils of pay option ARMs in the post Option ARMs Spur New Worries. One of the largest holders of this type of mortgage product is Wachovia, which on Monday April 14^th 2008 announced a substantial capital raise simultaneously with the release of its first quarter financial results. The loss of $393 million was significant less than the small profit Wall Street was expecting.. One of the main culprits in the loss was those pesky Pay Option ARMs, many of which came with the 2005 acquisition of Golden West (also known as World Savings) based in Oakland, California.

According to the HousingWire website, "The so-called "pick a payment" loans [Option ARMs] represented $119.6 billion of Wachovia's mortgage portfolio at year's end, by far the largest segment of the bank's mortgage loan holdings. Among these loans, $2.76 billion — or 2.31 percent — were classified as non-performing during Q4; Wachovia has seen NPAs in this loan category increase by $1 billion within one quarter."

Now, according to the just released earnings report, credit provisions for non-performing option ARMs increased by another $1.6 billion as the NPA percentage rose to 3.55%. Plus new credit modeling for this large asset pool leads Wachovia to suggest that credit reserves for Option ARMS in 2008 will be $3.2 - $3.8 billion and $2.4 - 2.8 billion for 2009. Ouch!! As the saying goes, a billion here, a billion there and pretty soon one is talking about some real serious money.

The Charlotte Observer ran a story on Sunday April 13^th entitled 'Moment of Truth' for Wachovia that explains in greater detail just how Wachovia bought World Savings and consequently increased its exposure to the California real estate market at the very top of the market. The key question will be just how bad will this portfolio of option ARM loans become?