The latest US mortgage delinquency data
Tuesday, June 30, 2009 at 02:23PM Greetings fellow inmates:
Our friends at the Office of the Comptroller of the Currency (OCC) released a report today detailing the performance of mortgage servicing activities of large and medium banks. The report covers about 64% of all mortgages, including subprime, or more than 34mm loans with a principal balance of $6tr, through Q1 09. Naturally, this is a very broad survey that gives a very thorough picture of the mortgage market in the US. The report identifies two main trends, a worsening in mortgage performance and a rising number of mortgage modifications. Ostensibly, a rising number of modifications could be a positive sign, as the OCC seems to imply, since the lower monthly payments will allow more people to stay in their homes and avoid the foreclosure process. Thus far, loan modification programs have been unsuccessful as more than 50% of modifications for the past 12 months or so have re-entered delinquency. In other words, modifications seem to only forestall the eventual debt default on a substantial number of loans. More on this below.
Delinquencies are classified as early stage (30-59 days late) or serious (60 days or more), the latter being close to foreclosure. In total, about 10% of all mortgages were delinquent in Q1 09, about the same as the previous quarter. This apparently steady performance belies the fact that there was a significant increase of 9% in serious delinquencies to almost 5% of all mortgages. We’ve said this before, but these numbers are huge, 1 out of 20 homes is close to initiating the foreclosure process. This increase in serious delinquencies was partly offset by a decline in early-stage delinquencies. The report ascribes this reduction to seasonal factors and says it does not mean a sustainable trend is forming. In addition, foreclosures in process rose to 844,389, or 2.5% of all loans, a 22% jump from the previous quarter. Notice that there is a trend for delinquencies to worsen towards the “serious” end of the scale, implying that there is a wall of mortgages that have reached a point-of-no-return, and this could still be a prevalent factor in early-stage delinquencies that we cannot yet see.
Prime loans, which represent two thirds of the entire survey, showed the most dramatic rise in serious delinquencies, rising more than 20% from the previous quarter, to a total of 2.9% of all prime mortgages, more than double from a year-earlier levels. This slow-moving train wreck has been in our collective consciousness for more than a year now. A variety of observers, ourselves included, have worried from the start that the malaise in subprime would eventually spill into prime mortgages. Well for some time now, it has, and prime mortgage performance is likely to continue worsening. The report ascribes this worsening to the usual rising levels of unemployment, declining home prices and high debt levels. We advise all our readers to seriously consider this fact, especially when tempted to coddle notions that a sustainable recovery is underway. Unemployment, home prices and debt levels will not recover any time soon, thus continuing to exert pressure on mortgage performance.
The table above details loan modification actions taken by banks from Q1 08 to Q1 09. Notice the very strong increase in loan modifications in the latest quarter. These modifications do not include Obama’s “Making Home Affordable”, which will drive these numbers up. Modifications involve a variety of different changes to the terms of the loan, like interest rate or principal reductions, extension of maturities and lower monthly payments. It seems like the modification bonanza of late is due to the banks’ increasing concern about credit losses. After all, the foreclosure process is expensive and much higher losses must be reported on their loan portfolio than if loans are modified to the benefit of the debtor. As we shall see below however, loan modifications in a large fraction of the cases only serves to prolong the inevitable. The table below presents the data.
This data clearly speaks for itself in terms of the effectiveness of loan modification programs. A scant three months after modification, nearly a third of all loans are seriously delinquent. Remember that seriously delinquent mortgages are one the verge of default. The biggest jump in re-defaults however happens between 3 and 6 months, when nearly half of all mortgages re-enter default. Loan modifications are supposed to make the mortgage affordable. Of course, the problem is that many of these loans were never affordable from the very beginning, so no amount of modification will make them so. There is no reason to believe that modifications will be any more effective in the future, even under Obama’s plan. Another interesting point is the amount of re-defaults in GSE debt, a large part of which was sold as mortgage-backed securities (MBS). Remember Uncle Benny is purchasing $1.25tr of this debt, and has not written any of it down. The high and accelerating delinquency rates will surely create losses for the securities and for the Fed.
Ultimately, what the data is telling us unequivocally is that mortgage performance continues to worsen and there is no end in sight. The factors described above - unemployment, negative equity, debt levels – will continue to pressure home-owners, who will continue to walk away from their homes. In addition, there is a great fraction of adjustable-rate mortgages that will reset in the coming two years, and many of those will be under-water already. The impairment and losses stemming from the more than $10tr of mortgage debt is far from over. Any observer can conclude that the massive surge in loan modifications in the US is largely politically motivated. It also however, allows the banks to forestall taking losses and buy more time. Loan modifications are very ineffective and far from a cure to the massive household debt burden. Loans that were meant to go sour, will go sour – and there is plenty of those.
May your capital be safe and your investments prosperous,
MAAA
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Reader Comments (6)
But that means that the derivative of mortgages going into delinquency has turned positive. The sun shines anew. What is all this nonsense about seasonality. That doesn't make any sense to me.
Seriously though I find the bit about the MBS securities the most fascinating. Actually what I would like to know is exactly how the implicit government guarantee works. Does it relate only to creditors of the GSEs or also to holders of GSE MBS? Obviously for the MBS still held by the GSEs it is important. Is this part of the reason that Uncle Benny is so intent on buying these up? What happens if a MBS full of GSE debt falls in value by half because of defaults in the portfolio? Nothing? Something? Anybody know?
Saw your blog on Alphaville. My take (in case you didn't know, and may be interested) is that the solution to the mortgage problem lies in a debt/equity swap on a grand scale.
But not equity as we know it.
In other words, I advocate the replacement of secured debt with a new generation of what are essentially REITs within a partnership (LLC in the US) framework, rather than conventional trust or company law frameworks.
The key innovation is that the Units in these REITs are redeemable for the right to occupy land/location. The outcome is that such Units are essentially a form of domestically fungible currency. An Internationally fungible currency would be Units redeemable in energy use.
This lecture in Ireland may be of interest (a diagnosis of the Credit Crunch, plus Unitisation as the solution)
Credit Crunch Solution- the movie
and the slides are here
Credit Crunch Solution - slides
The second half - outlining Unitisation - is also on YouTube here
Unitisation
Discipulus, I disagree that this data implies that the derivative has turned positive. I normally like to see more than one data point to begin thinking about a turnaround. The fact that fewer mortages entered early stage delinquency in the first quarter does not mean that Q2 will be the same. As for the seasonality issue, you´re right that it makes little sense. The report made it seem as though the first quarter is historically a period in which fewer homeowners fall behind on their mortgages. I don't know if this is true, nor if it applies to our present case.
As for the MBS, Im also very interested in the questions you pose. The implicit government guarantee is one that works mostly to support the GSE creditors, although through the guarantee mechanism of the GSEs themselves, it also extends to MBS. How I understand it works is if an underlying loan that has been packaged into an MBS defaults, then the holder of the MBS gets paid in full immediately, aka prepayment. The GSE is then on the hook for the loss incurred from that bad loan after foreclosure. So in other words, the implicit government guarantee also applies to the MBS holders since it basically states that the gov will pump money to prop them up and keep them functioning.
Therefore, it seems like a GSE MBS cannot fall in value by half because of underlying defaults, but instead gets prepaid and wound down, with the loss incurred by the GSE. Of course, price is another issue and can fall significantly below their cash flow; this is what happened last fall. So the real danger seems to be around the massive wave of defaults that could cause major losses for the GSE, requiring a lot of government money (which would now be monetized by Uncle Benny) to prop them up. I believe this is one of the big reasons behind this push for loan modificiations and spreading the losses around in order to buy time, both for the GSEs and for the banks.
The bit about the seasonality and the first derivative was meant sarcastically. I should have included a ;).
Thanks for explaing the GSE MBS default. What are the implications of inflation on these loans? Of the top of my head you should see a decrease in defaults assuming across the board inflation as it becomes easier to make a mortgage payment (on fixed interest rate loans). So theoretically Uncle Benny's purchase of these securities should make these securities more stable. Of course their value vis-a-vis other things will decrease because they will be paid back in devalued dollars. However many of the statistics will look good and they will not need to be written down even though they will be worth less because their nominal value will remain the same. Only their real value will decrease.
How dense of me to have failed to spot the sarcarsm!
I tend to agree with you on the general premises of how inflation will affect the mortagage loans and securities. There will be a period however where wages will not keep up with the currency-driven inflation, and this will mute and potentially counteract the effect of inflation. In other words, people will have a harder time coming up with the dollars to meet debt payments since they are using more of them on other things as their purchasing power dwindles. Basically what I´m trying to say is that this inflation will not be wage-driven, so there wont be a "smooth" path to "debt easing".
On a macro aggregate level, a big percentage of all debt, not just mortgages, will in fact avoid default due to the inflation. You are correct that the statistics will seem fine simply because little or no losses will actually be incurred, so a lot of the debt WILL in fact seem fine, it will just be devalued in real terms. Due to the size of the debt overhang, I do believe however that the magnitude of the inflation has to be quite significant to avoid the hemmorhage of defaults.
Indeed and the exact nature of the relationship between goods inflation and wage inflation will prove very important in terms of how this plays out. A little difference in scale and time has the potential to make a big difference in the fate of debt.