Thursday, June 24, 2010

Fed: The Depth of Negative Equity and Mortgage Default Decisions

Abstract: A central question in the literature on mortgage default is at what point underwater homeowners walk away from their homes even if they can afford to pay. We study borrowers from Arizona, California, Florida, and Nevada who purchased homes in 2006 using non-prime mortgages with 100 percent financing. Almost 80 percent of these borrowers default by the end of the observation period in September 2009. After distinguishing between defaults induced by job losses and other income shocks from those induced purely by negative equity, we find that the median borrower does not strategically default until equity falls to -62 percent of their home's value. This result suggests that borrowers face high default and transaction costs. Our estimates show that about 80 percent of defaults in our sample are the result of income shocks combined with negative equity. However, when equity falls below -50 percent, half of the defaults are driven purely by negative equity. Therefore, our findings lend support to both the "double-trigger" theory of default and the view that mortgage borrowers exercise the implicit put option when it is in their interest.

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Wednesday, June 23, 2010

Fannie Mae Increases Penalties for Borrowers Who Walk Away

WASHINGTON, DC — Fannie Mae (FNM/NYSE) announced today policy changes designed to encourage borrowers to work with their servicers and pursue alternatives to foreclosure. Defaulting borrowers who walk-away and had the capacity to pay or did not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure. Borrowers who have extenuating circumstances may be eligible for new loan in a shorter timeframe.

"We're taking these steps to highlight the importance of working with your servicer," said Terence Edwards, executive vice president for credit portfolio management. "Walking away from a mortgage is bad for borrowers and bad for communities and our approach is meant to deter the disturbing trend toward strategic defaulting. On the flip side, borrowers facing hardship who make a good faith effort to resolve their situation with their servicer will preserve the option to be considered for a future Fannie Mae loan in a shorter period of time."

Fannie Mae will also take legal action to recoup the outstanding mortgage debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments. In an announcement next month, the company will be instructing its servicers to monitor delinquent loans facing foreclosure and put forth recommendations for cases that warrant the pursuit of deficiency judgments.

Troubled borrowers who work with their servicers, and provide information to help the servicer assess their situation, can be considered for foreclosure alternatives, such as a loan modification, a short sale, or a deed-in-lieu of foreclosure. A borrower with extenuating circumstances who works out one of these options with their servicer could be eligible for a new mortgage loan in three years and in as little as two years depending on the circumstances. These policy changes were announced in April, in Fannie Mae's Selling Guide Announcement SEL-2010-05.

However, Rortybomb asks:

1) Why don’t they cramdown these mortgages? Why don’t they do a Right-To-Rent process? “Loan modification” has turned out historically to increase the balance of the loan by capitalizing fees and then just spinning out the length of the loan.

We know from HAMP analysis, specifically carried out by Analysis of Mortgage Servicing Performance, that 70% of modified mortgages have a principal increase (data discussed here):

And that a surprising amount of them redefault a year out:

There is no working definition of predatory lending, but a loan that has a negative amort (increases the balance) and a person is unlikely to be able to pay seems like a good working definition of predatory lending. If the GSEs are going to pressure people into modifications, I wonder what their expectations are of how much principal will be reduced and how likely it is people will immediately redefault. We didn’t do this with HAMP, even though we should have, and HAMP is a disaster nobody will stand by.

Reducing principal, especially cramming it down to the market rate, is a plan to save a mortgage and get homeowners back on track. Modifications have a history of kicking a serious problem 10 yards down the road. And don’t be mad Fannie, but the “we’ll just kick the can for now” solution seems right up your alley.

2) Annie Lowrey has a good catch in When Underwater Homeowners Walk Away, with this Federal Reserve paper The Depth of Negative Equity and Mortgage Default Decisions:

After distinguishing between defaults induced by job losses and other income shocks from those induced purely by negative equity, we find that the median borrower does not strategically default until equity falls to -62 percent of their home’s value. This result suggests that borrowers face high default and transaction costs. Our estimates show that about 80 percent of defaults in our sample are the result of income shocks combined with negative equity. However, when equity falls below -50 percent, half of the defaults are driven purely by negative equity. Therefore, our findings lend support to both the “double-trigger” theory of default and the view that mortgage borrowers exercise the implicit put option when it is in their interest.

The median 2006 borrower from the four housing disaster states doesn’t strategically default until LTV is at 162, and even then it is mostly from income shocks (unemployment, health care, etc.). For what it is worth, we ran some numbers here:

And if you are an LTV of 160, it will be, under generic estimates, a range of around 8 to 12 years until you are above water. You “own” (and have to upkeep) a place you are a decade out from owning. So a 7 year penalty has to be taken in context.

That paper has issues that could be extrapolated (we don’t need the median borrower to walk away before we have major problems), but it’s important to us to have a clear sense that there is an actual problem here, as opposed to the income shocks of near 20% underemployment.

3) Fannie is saying homeowners should be working with the servicers here. And they should. But it is worth noting that even when we bribe servicers to “nudge” them, as we have done in HAMP, we still don’t actually get principal cuts. Shahien Nasiripour has just found, “As few as 0.1 percent of mortgage modifications initiated under the Obama administration’s signature foreclosure prevention program involve reductions in principal, according to a federal report released Wednesday…A January report by the State Foreclosure Prevention Working Group noted that principal reduction is the best way to stem the foreclosure crisis.” Usually these involve payment increases, unless they lengthen the period of the loan, which means more time underwater.

HAMP, the Obama adminstration’s foreclosure prevention program, has gone from “look busy” to “not working” to utter, complete disaster. A complete waste of time, resources and energy. And Fannie now wants to replicate it. Let’s see how this goes.

Friday, June 18, 2010

Are foreclosures racist?

Felix Salmon reports that "if you’re a high-income Latino with a mortgage, you’re almost twice as likely to be facing foreclosure than a high-income non-Hispanic white person. "

And in general, the foreclosure crisis is hitting blacks and Latinos much harder than it is whites, according to a startling new report from the Center for Responsible Lending.

Overall, there have been 790 foreclosures per 10,000 loans to blacks, and 769 for Hispanics — compared to just 452 to non-Hispanic whites. And within every income group, the disparities are startling: here’s the chart.


Wednesday, June 16, 2010

Lenders go after money lost in foreclosures

The Washington Post reports that "over the past year, lenders have become much more aggressive in trying to recoup money lost in foreclosures and other distressed sales, creating more grief for people who thought their real estate headaches were far behind."

In many localities -- including Virginia, Maryland and the District -- lenders have the right to pursue borrowers whose homes have sold at a loss to collect the difference between what the property sold for and what the borrower owed on it, also called a deficiency.

Before the housing bust, when the volume of foreclosures was relatively low, lenders seldom bothered to chase after deficiencies because borrowers had few remaining assets to claim and doing so involved hassles and costs. But with foreclosures soaring, lenders are more determined to get their money back, especially if they suspect borrowers are skipping out on loan they could afford, an increasingly common practice in areas where home values have tanked...

Those who had a second mortgage, such as a home-equity line of credit, in addition to their primary mortgage may find themselves particularly vulnerable, especially if they tapped into the equity line for cash.

Second lenders are last in line to get paid when a distressed property is sold. There's usually little or no money left over for them, making it more likely that they will pursue large deficiencies, several attorneys said...

A handful of states do not allow lenders to pursue deficiencies, nor does a federal program that took effect April 10. Lenders participating in that initiative are paid for approving short sales and as a condition, they cannot go after outstanding debt.

In many states, lenders can go after deficiencies, though laws vary widely, said John Rao, an attorney at the National Consumer Law Center. Some states limit how long the banks have to file a claim or collect the debt. Others may calculate deficiencies based on the fair-market value of the house, Rao said. For instance, if a home sells for $200,000 yet its fair market value is $250,000, "the borrower who owes $240,000 on the mortgage would not have a deficiency," he said.

Borrowers should get a waiver in writing from their lenders to protect themselves, said Diane Cipollone, an attorney at the nonprofit Civil Justice. "Nobody should assume the deficiency is forgiven," she said.

Wednesday, June 9, 2010

Ax may fall on tax break for mortgages

The Hill reports that "the popular tax break for mortgage interest, once considered untouchable, is falling under the scrutiny of policymakers and economic experts seeking ways to close huge deficits."

Although Congress last year rejected the White House’s proposed cut to the amount wealthier taxpayers can deduct for home mortgage interest payments, the administration included it again in its 2010 budget — saying it could save $208 billion over the next decade.

And now that sentiment has turned against all the federal red ink — and cost-cutting is in vogue — Democrats on President Barack Obama’s financial commission are considering the wisdom of permanent tax breaks such as the mortgage deduction and corporate deferral. Calling them “tax entitlements,” senior Democratic lawmakers have argued they should be on the table for reform just like traditional entitlement programs Medicare, Social Security and Medicaid.

The new spotlight on the mortgage deduction and other tax expenditures comes as the Obama administration and Congress consider ways to reduce deficits the Congressional Budget Office (CBO) expects will average nearly $1 trillion over the next decade.

Policymakers seeking savings have tried to cap the mortgage interest deduction before — and failed. Five years ago, a bipartisan tax reform commission created by President George W. Bush proposed ending the mortgage tax break. But the commission’s plan stalled in Congress, partly because of popular support for the mortgage deduction.

Obama’s proposal, which would cut the deduction rate for itemized expenses for those making more than $250,000 to the rate paid by the middle class, was panned last year by members of both parties. They worried about its effect, during a recession, on charitable deductions and the housing market.

The White House says it was included in the president’s budget proposal again this year because it remains a good idea.

“The proposal will correct inequities in our tax code that allow millionaires to benefit from higher itemized tax deductions than middle-class families enjoy,” said Meg Reilly, spokeswoman for the Office of Management and Budget (OMB).

Although the backers of the mortgage interest tax break defend it as a key incentive for people to own rather than rent their homes, some say that’s not so. A Brookings-Urban Tax Policy Center study found that the mortgage interest tax break costs more than $100 billion annually but does little to encourage the middle class and less wealthy to buy homes.

“I’m not sure that we need to subsidize homeownership at all through the tax system,” said Eric Toder, the study’s lead author.

A bipartisan tax reform proposal this year by Sens. Judd Gregg (R-N.H.) and Ron Wyden (D-Ore.) would lower base tax rates and eliminate a host of tax expenditures, but not the mortgage deduction. Gregg and Wyden said they left it out because they wanted a “politically viable vehicle,” conceding that ending the mortgage break would mean less support for their plan from other lawmakers.

Tuesday, June 8, 2010

More Consumers Making Payments on Their Credit Cards Before Their Mortgages

Posted on the TransUnion website:
A new study developed by TransUnion confirms that the "new" payment hierarchy -- where consumers pay their credit cards prior to their mortgages -- is continuing, with the trend occurring more readily than ever before.

"Conventional wisdom has always been that, when faced with a financial crisis, consumers will pay their secured obligations first, specifically their mortgages," said Sean Reardon, the author of the study and a consultant in TransUnion's analytics and decisioning services business unit. "However, a recent TransUnion analysis has found that increasingly more consumers are paying their credit cards before making mortgage payments. This analysis reaffirms the results of a previous TransUnion study that examined data between the third quarter of 2006 and the first quarter of 2008."

The percentage of consumers current on credit cards and delinquent on mortgages first surpassed the percentage of consumers current on their mortgages and delinquent on credit cards in the first quarter of 2008. This "flip" is representative of the change in the conventional wisdom around the payment hierarchy, or which debt obligations consumers would choose to pay first.

The latest study, conducted on consumers that had at least one credit card and one mortgage, examined 30-day credit card and mortgage delinquency data between the second quarter of 2008 (Q2/2008) and the third quarter of 2009 (Q3/2009). Although many industry analysts believed that a reversion to the conventional payment hierarchy would ensue once we had passed through the worst of the recession -- that has not, in fact, been the case. To the contrary, this study found that the hierarchy reversal has become even more widespread, with the percentage of consumers who are delinquent on their mortgages and current on their credit cards rising to 6.6 percent in Q3/2009 (from 4.3 percent in Q1/2008). Conversely, the percentage of consumers who are delinquent on their credit cards and current on their mortgages has decreased to 3.6 percent in Q3/2009 (from 4.1 percent in Q1/2008).

"This same trend is evident within the lowest scoring risk segment," added Reardon. "Moreover, it should be noted that the 'flip' in payment hierarchy in the lowest scoring segment was evident earlier during Q4/2007, compared to Q1/2008 for the total market."

The study found that the magnitude of delinquency in the lowest scoring segment is significantly higher than that of the total market. The delinquency rate for consumers in this segment who were delinquent on their mortgages but current on their credit cards during Q4/2007 was 19.1 percent, and rose to 29 percent in Q3/2009. In a trend similar to that of the total market, the percentage of consumers delinquent on their credit cards but current on their mortgages decreased from 18.1 percent in Q1/2008 to 14.5 percent in Q3/2009.

The payment hierarchy shifts are even more pronounced in states such as California and Florida that experienced a more severe housing bubble effect. Within California, the percentage of consumers delinquent on their mortgages but current on their credit cards increased from 3.5 percent in Q3/2007 to 10.2 percent in Q3/2009 (a 191 percent increase). In Florida, this same variable increased from 5.1 percent in Q3/2007 to 12.4 percent in Q3/2009 (a 143 percent increase). In this same timeframe, the United States experienced a 68 percent increase (from 4.0 percent in Q3/2007 to 6.6 percent in Q3/2009).

In contrast, the number of California consumers delinquent on their credit cards but current on their mortgages declined from 3.3 percent in Q3/2007 to 2.7 percent in Q3/2009. In Florida, this variable declined from 5.0 percent in Q3/2007 to 3.9 percent in Q3/2009.

"The implosion of the mortgage industry over the last 24 months, the resetting of adjustable-rate mortgages and the weak job market have all come together to redefine how consumers are managing their finances and meeting (or not meeting) their credit obligations," said Ezra Becker, director of consulting and strategy in TransUnion's financial services business unit. "The insight gained through this analysis reveals a lot about changing consumer preferences. The financial services industry must recognize and adjust to the payment hierarchy shift with judicious modifications to business models, new assessments of specific areas of risk, and by strategic revisions to acquisition and account management strategies."

The source of the underlying data used for this analysis was TransUnion's Trend Data, a proprietary historical database consisting of 27 million anonymous consumer records randomly sampled every quarter from TransUnion's national consumer credit database. Using TransUnion's standard definitions of credit card and mortgage trades, TransUnion was able to create and evaluate the custom attributes that are the basis of this study.

And from FICO:

FICO (NYSE:FICO), the leading provider of analytics and decision management technology, today announced new and troubling findings uncovered in the latest analysis offered by its subscription service for businesses, FICO® Score Trends. Reversing a long historic trend, mortgage default risk for consumers with high FICO® scores now exceeds their credit card default risk, even though most credit cards are unsecured credit and mortgages are secured by real estate. The company observed a parallel rise in mortgage delinquencies for higher-scoring U.S. consumers.

According to the analysis in FICO Score Trends, recent repayment behavior across the financial services industry has shifted significantly from historical trends. In 2008-2009, bankcard accounts were just 1.6 times more likely to become 90 days delinquent than were mortgage loans. By comparison, in 2005 bankcard accounts were more than three times more likely to become 90 days delinquent. And for borrowers scoring high on the FICO® score’s 300-850 score range, the level of repayment risk actually has become greater for real estate loans than for bankcards. In 2009, 0.3 percent of consumers with FICO scores between 760-789 defaulted on real estate loans, compared to 0.1 percent who defaulted on bankcards.

“We’re identifying lending industry situations in FICO Score Trends that to our knowledge have never been seen before,” said Dr. Mark Greene, CEO of FICO. “Economic instability is creating unknown risk in lenders’ credit portfolios as well as counter-intuitive trends in consumer behavior. While the FICO 8 score continues to prove its unprecedented power in rank-ordering consumers for risk, even low-risk consumers are changing the value they give different credit lines. As the CARD Act goes into effect next week, it likely will create additional, unhelpful pressures on the banking business.”

In FICO Score Trends, company experts found new evidence that lenders tightened their criteria for new loans in 2008-2009 and began “cherry picking” the kinds of borrowers to whom they would extend credit. Mortgage loans opened last year between April and October reflected significantly tighter standards than in prior years. In 2005, nearly 46 percent of consumers who opened a new mortgage had a FICO score less than 700. In 2008 this percentage had dropped to just 25 percent of the newly booked mortgage population. Other industry sectors experienced similar shifts. In the bankcard sector in 2005, 51 percent of consumers with a new credit card had FICO scores less than 700. That percentage dropped to just 38 percent in 2008. As lenders tightened their credit standards, it became correspondingly more difficult for consumers with delinquencies in their credit histories and lower FICO scores to qualify for additional credit.

Regional shifts in risk
FICO also examined FICO Score Trends to learn how credit risk of real estate loans and bankcards varied across U.S. regions. The company found the most dramatic shift in the Pacific region. In 2005, bankcards were 6.4 times more likely to default than were mortgage loans. That percentage dropped to only 1.3 times riskier in 2009.

Consumers in the Midwest region demonstrated the smallest relative change. Bankcards were 2.5 times more risky of default than were mortgages in 2005, but bankcards were just 1.5 times more risky of default by 2009. Borrowers in the Northeast continue to present the least amount of default risk nationally for real estate loans.

These observations were taken from FICO® Score Trends, the subscription service that provides lenders with unique access to industry FICO® score trends indexed by a range of criteria such as industry, geography and time period. Lenders regularly use FICO Score Trends to benchmark their own portfolios and trends in order to improve their risk management and forecasting.

Thursday, June 3, 2010

Subprime Mortgage Default

By James B. Kau, Donald C. Keenan, Constantine Lyubimov and V. Carlos Slawson Jr.

Abstract: Using data on privately-securitized subprime ARMs (adjustable rate mortgages) originated between 1997 and 2008 and observed between 2000 and 2008, and so covering the start of the subprime crisis, this paper constructs a reduced-form credit risk model of default, and then uses contractual properties of the loans to infer the market’s price of default risk at various times of origination.

Treating the hazard of default as a process rather than a single realization for each period of origination permits the probability of default to be calculated without knowledge of the still unfolding hazard realization, allowing one to adopt the same position as lenders, who also cannot foretell the future. It is empirically determined that a change in the inherent nature of borrowers caused some deterioration in their default behavior, a change which we can first detect by late 2004, but of which, evidence indicates, the secondary mortgage market became aware at about the same time. The large rise in defaults in 2007 cannot, therefore, be attributed to any surprise other than the unexpectedly large fall in housing prices.

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Wednesday, June 2, 2010

BofA Begins Principal Reduction on Delinquent, Underwater Mortgages

CNBC's Diana Olick:
This morning executives at Bank of America rolled out their new "Principal Reduction Enhancement" program, which is an earned principal forgiveness plan for borrowers behind on their mortgages and whose loans are at least 20 percent underwater in value.

The plan is in conjunction with the government's Home Affordable Modification Program, but the government's principal reduction plan isn't in place yet.

What makes BofA's plan so proactive is that it employs, "a principal reduction as the first step toward reaching HAMP’s affordable payment target of 31 percent of household income when modifying certain NHRP-eligible mortgages — ahead of lowering the interest rate and extending the term."

On the conference call to announce the program this morning, BofA's credit loss mitigation executive, Jack Schakett, said the amount of strategic defaulters (those who can pay their loans but opt not to) are "more than we have ever experienced before." He went on to say, "there is a huge incentive for customers to walk away because getting free rent and waiting out foreclosure can be very appealing to customers."

Schakett says the foreclosure process is still taking 13 to 14 months (and by my estimates that's an optimistic assessment), and so there's over a year of free rent. While the banks are trying to improve the time, they're just not there yet.

31 percent of foreclosures in March were deemed to be "strategic default" by researchers at University of Chicago and Northwestern University.

That's up from 22 percent in March of 2009.

We already know that mortgage walkaways are more prevalent among borrowers whose neighbors or friends have done the same thing.

We also learn from those same researchers that the likelihood of walking away increases by 23 percent when homeowners learn that a neighbor got some principal forgiveness...
And some details on the program from the Housing Wire:

The bank will attempt a principal reduction as the first step in the servicer waterfall to reach the 31% debt-to-income ratio target – the amount of the borrower monthly income that goes toward the mortgage. Loans eligible for the NHRP include subprime, pay-option adjustable rate mortgages (ARM) and prime-quality two-year hybrid ARMs originated by Countrywide before Jan. 1, 2009. The amount of principal owed must exceed the property value by 20%, and the loan must be delinquent by 60 or more days.

Through the five-year NHRP, BofA sets up an interest-free forbearance account for the amount of principal owed above the current value of the home. For instance, if the borrower owes $250,000 on a home worth $200,000 and qualifies for the program, BofA will set up a separate account of $50,000 that will sit alone without collecting interest while the borrower makes payments on the $200,000 at the current market interest rate. There are no required payments on the $50,000 non-interest bearing mortgage account.

For the first three years of the NHRP, BofA reduces the separate account – the $50,000 in the example above – by 20% each year if the borrower remains current. Meaning after three years, $30,000 would be forgiven in the example. If, by then, house prices have gone up and the borrower is once again at a 100% loan-to-value ratio, BofA will no longer reduce the principal. If the borrower remains above 100% LTV, BofA will continue reducing payments for an additional two years.

BofA will not reduce the principal on the non-interest bearing mortgage account if the sum of both mortgages achieves 100% LTV....

Schakett added that of the BofA borrowers currently moving through the HAMP process, 45% had an LTV of more than 120%.

“Our tests have shown that many homeowners who are severely underwater on their mortgages will respond positively to a modification offer that includes reduction of their principal balance, increasing the rates of acceptance of HAMP trial modification offers, conversion to permanent modifications and long-term success of the homeowner,” Schakett said.