Loans Could Be Next Nightmare For Banking Sector

FirstFed Grapples With Payment-Option Mortgages

The bank posted a loss of nearly $70 million in the first quarter -- reversing years of profit. Forty percent of its borrowers became at least 30 days delinquent after the payments on their adjustable-rate mortgages were recast. The number of foreclosed homes held by the bank doubled in the second quarter from the first quarter.

FirstFed was ranked last year as one of the top five banks in the nation by a trade publication, partly because it appeared to have pared back on risky mortgage loans. Yet this year, the Los Angeles bank is on the front lines of what could be the next big mortgage debacle: payment option mortgages. These loans went mainly to people with good credit, but they are likely to experience defaults that are nearly as high as -- in some cases higher than -- those for subprime.

Barclays Capital estimates that as many as 45% of option ARMs, as they are often called, originated in 2006 and 2007 could wind up in default. Another analysis, by UBS AG, suggests that defaults on option ARMs originated in 2006 could be as high as 48%, slightly higher than its estimate for defaults on subprime loans