Saturday, March 27, 2010

More on that Hamp-lified moral hazard

The below is a very timely — and thought-provoking — data set, given that things are once again heating up in the realm of US mortgage modification post-Bank of America’s principal reduction plan.

Behold, courtesy of Amherst Securities, the charted moral hazard in US housing:

In words, those are the default transition rates for various types of mortgages divided into owner-occupied and non-owner occupied — things like investment properties, second homes, and the like.

The default transition rate is that at which previously always performing loans (i.e. never more than a single payment behind) go to two payments behind for the first time.

The idea is to show how an environment that’s increasingly geared towards borrowers, viz all those anti-foreclosure programmes, is affecting their behaviour.

It’s something that’s long been suspected (borrowers are rational economic agents who’d be foolish not to take advantage of some of these programmes, right?) but hasn’t really been proven.

By dividing default transition rates into owner-occupied and non-owner occupied you can sort of isolate the effects of all the modification schemes, since most of them don’t apply to investment properties and second homes. For instance Hamp, the centrepiece of the US Treasury’s housing plans and aimed at reducing interest payments for underwater borrowers, is just for owner-occupied houses.

So, here’s what the Amherst analysts, led by Laurie Goodman, says:

There is no question that the current environment is much more “borrower-friendly” than it was a year ago, by which we mean that delinquent borrowers have more options available to delay or avoid foreclosure. For starters, there have been offand- on foreclosure moratoriums at both the state and federal level. Servicers are also now “strongly encouraged” not to move a borrower along in the delinquency/foreclosure pipeline before testing to see if they qualify for a HAMP loan [modification] . . .

Moreover, borrowers could be going delinquent in order to get a modification. For borrowers already 2 payments behind, modification had been semi-automatic. The borrower must qualify for the program on the basis of stated income and must pass the NPV (net present value) test. If a borrower is current, he must do all of the preceding, plus the servicer must be convinced that default is imminent (requires additional documentation, albeit with no clear guidance on what constitutes “imminent”).

Have borrowers been taking advantage of the more borrower-friendly environment? Has the more borrower-friendly system, which allows borrowers to prolong the rent free period they can live in their home, encouraged further delinquencies?

Using that contrast between owner- and non-owner occupied then, Amherst suggests that borrowers are taking advantage of current circumstances; they’re going into default for the first time.

In fact judging from the above chart, the difference between the two transition rates actually appears to be widening. First-time defaults — strategic or otherwise — are on the rise.

Incidentally, the contrast between the two transition rates is even more stark if you throw the timing of the Hamp programme — which began about a year ago — into the mix:

And here’s Amherst’s conclusion:

. . . Borrowers can stay in their home rent free for a much longer period than was previously the case. However, few of these benefits apply to investor properties. Thus, when we look at the difference pre- and post-HAMP in the behavior of owner-occupied borrowers versus that of non-owner occupants—we find a dramatic difference in performance. Owner-occupied borrowers behave far worse than their non-owneroccupied counterparts.

One wonders what the default transition rate would be for a principal reduction scheme.

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