Do loan mods reduce delinquency rates?

If you get into trouble on a mortgage, and you are American, and you are offered a loan modification, it is unlikely to help much. The following data is from the Big Picture. Barry explains:

On the left we see the re-default rates of homeowners who were current on their loans when they first defaulted (sounds odd, I know, but these tend to be people who can afford their homes but who subsequently ran into economic problems). The data tells us how many of them have defaulted again 10 months after their loans were modified.

The adjacent table (at right) shows the same thing, only this time with homeowers who were seriously delinquent prior to loan mods. As you would imagine, their re-default rates 10 months after their loans were modified are considerably higher. These are often the people who could barely afford their home (or not at all).

Skin in the game

The most important factor in determining whether a residential mortgage will default is whether the home owner has skin in the game, according to the WSJ:

The evidence from a huge national database containing millions of individual loans strongly suggests that the single most important factor is whether the homeowner has negative equity in a house -- that is, the balance of the mortgage is greater than the value of the house. This means that most government policies being discussed to remedy woes in the housing market are misdirected...

51% of all foreclosed homes had prime loans, not subprime, and the foreclosure rate for prime loans grew by 488% compared to a growth rate of 200% for subprime foreclosures.

This isn't exactly news, but it is further confirmation of a fact that has been clear since 2007 - alignment of interests is key in the credit markets.

Sunday foreclosure datapoint

Courtesy of Realtytrac:

The pain in Spain...

...as the FT says, will be felt mostly by the banksWhat is interesting about this is how vintage insensitive it is. In the US, there is a world of difference between the 2005s and the 2007s: in Spain, not so much.

Update. Downgrades loom for the Spanish banks as an interest diversion test is tripped on a Caja Madrid RMBS.

80% off

No, not the closing down sale at one of Britain's many bankrupt retailers, although it could be. Rather it is the fall in property prices from the peak in one of the exurbs of Fort Myers, Florida. The NYT story is here. But mull on that number for a second. 80%. Then consider putting -0.8 in the HPI vector, and think what that will do for the price of even prime RMBS.

Valuation uncertainty

A great data point from S&P via the New York Times:

The wild variations on the value of many bad bank assets can be seen by looking at one mortgage-backed bond recently analyzed by a division of Standard & Poor’s, the credit rating agency.

The financial institution that owns the bond calculates the value at 97 cents on the dollar, or a mere 3 percent loss. But S.& P. estimates it is worth 87 cents, based on the current loan-default rate, and could be worth 53 cents under a bleaker situation that contemplates a doubling of defaults. But even that might be optimistic, because the bond traded recently for just 38 cents on the dollar, reflecting the even gloomier outlook of investors.

Or as a friend of mine put it, `if you wanna throw the dart at the board and give me an HPI vector, I can tell you what the bond is worth. But who the hell knows what's the right HPI?' Given that future house price inflation cannot be known today, he has a point.

Your real estate data point of the day

One of the points I have repeatedly mentioned is that it did not take a very large fall in house prices to create the credit crunch. Contagion and widespread bank stress had begun by early 2007 despite falls at that point of only 10% or so nationwide. But of course the falls in the worst affected areas - including Florida, Nevada, and California - were rather worse. And since 2007, as Bloomberg points out, things have got quite a lot worse. In particular rising volumes of foreclosures are driving steep price falls:

A total of 19,926 new and existing houses and condos sold last month in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties, up from 13,240 a year earlier... The median home price in the region fell 35 percent to $278,000...

Foreclosed homes accounted for 56 percent of Southern California’s December sales, more than double the amount a year earlier, MDA DataQuick said.

Such transactions made up almost 70 percent of sales in Riverside County, where the median price plummeted 41 percent to $209,000. Sales jumped 77 percent to 4,435, MDA DataQuick said.

The conforming limit

With rather little fanfare the exceptional high limit for conforming mortgages of $729,750 expired yesterday. The limit is now $625,500 in high cost areas: it remains $417,000 elsewhere. The details are here.

I am surprised this was allowed to happen: I thought that the exception would be extended indefinitely given the state of the US housing market. This cannot be good for California, for instance.

MOAB Revisited

A good friend pointed out that the real problem is the mortgages. Those are the things behind the dodgy assets, or most of them anyway. (The reasoning being that if you sort out the RMBS problem the CMBS will come mostly good.) So, if you are the US government and you want to spend a trillion dollars, give or take, here's what you do.

• You own a lot of the problem anyway via Freddie and Fannie. Immediately refi all current or less than 90 day delinquent ARM, hybrid ARM, and option ARM loans on the F&F books into 30 year fixed. That ensures a lot of them stay current.
  
• Modify the non-current ones into 30 year fixed on a reduced notional, and take equity in the homes as compensation for the writedown. Yes, you'll lose money on this, but not as much as you will lose if you don't do it.
  
• Offer Federal subsidies to any banks that will participate in doing the same in exchange for capital. You take the hit now, they give you ideally warrants but I can live with preference shares. Change the law so any problems which stop securitised loans being mod'ed in this way go away.
  

California Foreclosures

Prompted by an article in the WSJ on foreclosures, I did a little research. The basic issue is to what extent banks are delaying selling foreclosed inventory, or delaying the foreclosure process, either because they do not want to realise the loss, they do not want to increase their volume of REO (real estate owned) or they do not physically have the capacity to process all the foreclosures they have. So, how long can a bank delay an auction once the property has been foreclosed? In CA at least, the answer is a year. The relevant portions of the CA state code are here, if you have tolerance for US law, and the key paragraph reads:

There may be a postponement or postponements of the sale proceedings, including a postponement upon instruction by the beneficiary to the trustee that the sale proceedings be postponed, at any time prior to the completion of the sale for any period of time not to exceed a total of 365 days from the date set forth in the notice of sale. The trustee shall postpone the sale in accordance with any of the following:

1. Upon the order of any court of competent jurisdiction.
   
2. If stayed by operation of law.
   
3. By mutual agreement, whether oral or in writing, of any
   trustor and any beneficiary or any mortgagor and any mortgagee.
   
4. At the discretion of the trustee.

So we are in a situation where property is dripping out of the bottom of the bucket through foreclosure sales, property is entering the bucket through delinquencies turning into foreclosures, and property cannot stay in the bucket for more than a year, ordinarily. This is clearly going to lengthen the duration of the real estate downturn, at least until the bucket starts to empty. Clearly it is in banks' economic interest to get this done, but I wonder whether they have the capacity to sell at a much faster rate than they are doing now, or whether the market in parts of California, Nevada, Florida and Illinois will support that volume of sales.

Update. Foreclosure volumes are rising fast in CA: 1,300 a day are now being executed according to the LA Times, or more than three times the rate of a year ago. I'd really like to see a detailed industry wide analysis of the levels and trends in delinquencies of various ages, foreclosures, and REO to get a sense of how full the bucket is. My sense is that the banks are effectively long rather more property than they would have us believe but pinning this down is difficult.

Another update. Further background is here (an LA Times update) and here (a discussion by Sacramento Real Estate Statistics of a Deutsche research report on Shadow Inventory).

Ball of steel or brains of lead?

In what is either a strong buy signal for the market or a strong sell signal on the stock, MBIA has announcing that it was not changing its projection of losses on its mortgage-related exposures. The FT story is here. Yes, they had some bizarre FAS 159 gains (CNN is here and my take on the rules is here): yes, they resumed a share buy-back programme. But ignoring all that, if their actuarial loss estimates for RMBS have not changed, either that is a very useful datapoint on where realised default losses actually will be, or their actuaries are fools and it is time to short the stock again. It will be interesting to see which.

Update. John Dizard has pointed out the possible value in the monolines as a vulture play on the eventual losses on RMBS. I can see the idea, but I'd like to know more about the implied residual value of the monolines given the current equity price. Are they really cheap yet?

Salt n' pepper with that?

No, not a US rap act. But I do think that Fitch is not really pushing it in their new ratings model. According to Housing Wire:

Fitch Ratings said Thursday that it had enhanced its U.S. residential mortgage loss model, called ResiLogic, a key component of the agency’s overall approach to assessing U.S. RMBS new-issue ratings...Fitch said in its report that it is expecting home prices to decline by an average of 25 percent in real terms at the national level over the next five years, starting from the second quarter of 2008.

And that’s the base case scenario.

What is interesting about this, as Housing Wire points out, is that it will put the focus back on seasoned deals. In that kind of environment you cannot just blow out 3 month old loans into an RMBS deal - investors will want some history as well as a lot of credit enhancement. It should also be a powerful stimulus for the covered bond market - something which although strong in Europe, is still nascient in the US. (See here for the FDIC's recent press release on their policy concerning covered bonds. Or, to summarise, Shoop, Baby, Sexy.)

Should the government take mortgage price risk?

Felix Rohatyn and Everett Ehrlich had some suggestions in the FT yesterday for how the bailout of the agencies (and the rest) might proceed.

One option would be to design terms on which the Treasury would create “certificates” that would be swapped for conforming mortgage assets up to a predetermined percentage of banks’ capitalisation, together with a schedule for swapping these certificates back to the Treasury over the next three to five years. This would give banks breathing space to meet capital standards while the housing market stabilised. The prospect for government participation in any upside could parallel the Chrysler bailout that worked quite successfully almost 30 years ago.

Presumably these certificates would carry the faith and credit of the U.S. government and hence would trade like T bonds. But how would the upside participation work? If the government sells the mortgages back at their then current market price - however that is determined - it is taking mortgage price risk. Possibly hundred of billions of dollars of it. For the authorities to fund illiquid assets for three to five year is reasonable: for them to take market risk over that period surely introduces massive moral hazard. Central banks are de facto funders of first resort: asking even more of them is probably a mistake.

The pain in Spain stays mainly away from the plain

From Reuters via a decidedly dubious post on FT alphaville (which signally fails the ask if the large European retail banks are hiding all the pain in accrual accounted books): the largest Spanish corporate default ever happened yesterday.

Spanish property company Martinsa Fadesa said it would file for administration after it failed to raise funds and meet debt payments, marking one of the biggest corporate failures in the country's history...

The company added in a statement that it would focus on selling assets to repay creditors, which include Caja Madrid, La Caixa, Ahorro Corporacion and Morgan Stanley.

Spain is a classical bursting bubble market with a way further to fall. Speculative building has been rampant, particularly on the coasts, and development controls were lax. Now prices are falling and controls are tightening the construction companies and their financiers are feeling a lot of pain. If Caja wasn't the Spanish version of a GSE, it might well be in trouble. In fact the parallels between the Spanish Caja and Freddie & Fannie are a little too obvious for comfort...

The real estate bust in pictures

Some Friday illustrations. First the Markit ABX AAA 0702s, down again this week.And a heat map of foreclosures. Note the California and Nevada clusters are joining up, and Arizona is also a problem area - get not so much your kicks, but certainly your bargain properties on Route 66. Michigan isn't going down as fast as it was, but Florida continues to be problematic, and Northern Colorado is a new hot spot.

Mortgage eye candy data from the NYT

Florida and Nevada I can understand but that Michigan/Ohio/Indiana cluster is interesting. My shorthand - if it's a CSI location it has a mortgage problem - clearly needs to be revised unless CSI New York is renamed to CSI Lansing.

The GSEs ate my mortgage

If you are a U.S. residential mortgage consumer and you don't want a jumbo (and I don't mean these wonderfully horrible elephants) then the overwhelming likelihood at the moment is that your loan will be funded by a government agency. Freddie and Fannie currently have more than 80% of the mortgage funding market according to AP (link via MSN here). That is double what it was a year ago. And for debt consolidation and refi, amongst other things, there is the FHA. Add in their contribution, which amounts to providing insurance on roughly 10% of new loans, and the GSEs one way or another are supporting over 90% of the market. And that is without counting the FHLBs. We have a problem Houston.

Consider prime jumbos

Yields are attractive. From the FT:

US mortgage rates soared last week amid a sharp rise in Treasury market yields, as investors started to bet that inflation pressures could prompt the Federal Reserve to raise interest rates later this year.

The sell-off pushed rates on 30-year fixed-rate mortgages to an 11-week high of 6.02 per cent, up from 5.81 per cent a week earlier, according to Bankrate.com. Meanwhile, the so-called “jumbo” mortgages – or those for loans above $417,000 – rose to 7.21 per cent from 7.05 per cent.

A rough duration hedge is 7 year swaps at 4.4%. I'll take more than two and half percent running for prime jumbos vs. swaps.

Deal of the week

On Wednesday HBOS closed the first UK RMBS deal since August 2007 (that we know about, anyway). Libor + 85 for AAA bonds with a 160% OC. Yep, the deal is £500M and there is £800M of collateral. 800. Just pause a moment and think about that OC. The deal can suffer 35% delinquencies with zero recovery and still be money good. That is truly an astonishing level of safety for the market to demand in return for something as rich as 85bps. Remember AAA prime UK RMBS used to trade at low teens of bps: 85 was BBB territory. Verily the Crunch is a harsh mistress.

For the curious, there are more details here and here.

The US housing market in pictures

Continuing our occasional series, more pictures of retail housing gloom. First from Big Picture, house pricesAnd unsold inventoryCalculated Risk likes to look at Sales vs. Inventory normalised by the number of owner occupied units. This gives a sense of the percentage of unsold inventory and the percentage turnover:They argue that since turnover is still above the historic average, the volume of home sales could have further to fall.