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Bigger Wave of Loan Defaults ComingUser Forum Topic
Submitted by HarryBosch on August 5, 2008 - 2:51pm
The first wave of Americans to default on their home mortgages appears to be cresting, but a second, far larger one is quickly building. (This article showed up in the NY Times on August 4, but I found a working link here: Mortgage Troubles Spread In the last few months, delinquencies and foreclosures in subprime mortgages have started to slow. But defaults on alternative-A and prime loans, which make up a larger part of the market, are still rising. Homeowners with good credit are falling behind on their payments in growing numbers, even as the problems with mortgages made to people with weak, or subprime, credit are showing their first, tentative signs of leveling off after two years of spiraling defaults. The percentage of mortgages in arrears in the category of loans one rung above subprime, so-called alternative-A mortgages, quadrupled to 12 percent in April from a year earlier. Delinquencies among prime loans, which account for most of the $12 trillion market, doubled to 2.7 percent in that time. The mortgage troubles have been exacerbated by an economy that is still struggling. Reports last week showed another drop in home prices, slower-than-expected economic growth and a huge loss at General Motors. On Friday, the Labor Department reported that the unemployment rate in July climbed to a four-year high. While it is difficult to draw precise parallels among various segments of the mortgage market, the arc of the crisis in subprime loans suggests that the problems in the broader market may not peak for another year or two, analysts said. Defaults are likely to accelerate because many homeowners’ monthly payments are rising rapidly. The higher bills come as home prices continue to decline and banks tighten their lending standards, making it harder for people to refinance loans or sell their homes. Of particular concern are “alt-A” loans, many of which were made to people with good credit scores without proof of their income or assets. “Subprime was the tip of the iceberg,” said Thomas H. Atteberry, president of First Pacific Advisors, a investment firm in Los Angeles that trades mortgage securities. “Prime will be far bigger in its impact.” In a conference call with analysts last month, James Dimon, the chairman and chief executive of JPMorgan Chase, said he expected losses on prime loans at his bank to triple in the coming months and described the outlook for them as “terrible.” Delinquencies on mortgages tend to peak three to five years after loans are made, said Mark Fleming, the chief economist at First American CoreLogic, a research firm. Not surprisingly, subprime loans from 2005 appear closer to the end of defaults than those made in 2007, for which default rates continue to rise steeply. “We will hit those points in a few years, and that will help in many ways,” Mr. Fleming said, referring to the loans made later in the housing boom. “We just have to survive through this part of the cycle.” Data on securities backed by subprime mortgages show that 8.41 percent of loans from 2005 were delinquent by 90 days or more or in foreclosure in June, up from 8.35 percent in May, according to CreditSights, a research firm with offices in New York and London. By contrast, 16.6 percent of 2007 loans were troubled in June, up from 15.8 percent. Some of that reflects basic math. Over the years, some loans will be paid off as homeowners sell or refinance, and some homes will be foreclosed upon and sold. That reduces the number of loans from those earlier years that could default. Also, since the credit market seized up last year, lenders have become much more conservative and have stopped making most subprime loans and cut back on many other popular mortgages. The resetting of rates on adjustable mortgages, which was a big fear of many analysts in 2006 and 2007, has become less problematic because the short-term interest rates to which many of those loans are tied have fallen significantly as the Federal Reserve has lowered rates. The recent federal tax rebates and efforts to modify more loans have also helped somewhat, analysts say. What will sting borrowers more than rising interest rates, analysts say, is having to pay interest and principal every month after spending several years paying only interest or sometimes even less than that. Such loan terms were popular during the boom with alt-A and prime borrowers and appeared appealing while home prices were rising and interest rates were low. But now, some borrowers could see their payments jump 50 percent or more, and they may not be able to sell their properties for as much as they owe. Prime and alt-A borrowers typically had a five- or seven-year grace period before payments toward principal were required. By contrast, subprime loans had a two-to-three-year introductory period. That difference partly explains the lag in delinquencies between the two types of loans, said David Watts, an analyst with CreditSights. “More delinquencies look like they are on the horizon because so few of them have reset,” Mr. Watts said about alt-A mortgages. The wave of foreclosures is still rising in states like California, where many homeowners turned to creative mortgages during the boom. From April to June, mortgage companies filed 121,000 notices of default in California, up nearly 7 percent from the first quarter and more than twice as many as in the second quarter of 2007, according to DataQuick, a real estate data firm based in La Jolla, Calif. The firm said the median age of the loans increased to 26 months from 16 months a year earlier. The mortgage giants Freddie Mac and Fannie Mae, which own or guarantee nearly half of all mortgages, are trying to stem that tide. Last week, they said they would pay more to the mortgage servicing companies that they hire to modify delinquent loans and avoid foreclosures. Delinquencies in prime and alt-A loans are particularly challenging for banks because they hold more such loans on their books than they do subprime mortgages. Downey Financial, which owns a savings bank that operates in California and Arizona, recently reported that 11.2 percent of its loans were delinquent at the end of June, a big increase from the 6.1 percent that were past due at the end of last year. The bank’s troubles stem from its $6.2 billion portfolio of so-called option adjustable-rate mortgages, which allow borrowers to pay less than the interest owed on their mortgage in the early years. The unpaid interest is added to the principal due on the loan, so over time borrowers can owe more than the initial loan amount. Eventually, when loans grow by 10 percent or 15 percent, the borrowers are required to start paying both the interest and principal due. Many borrowers who got these loans during the boom had good credit scores, but many of them owe more than their homes are worth. Analysts believe that many will not be able to or want to make higher payments. “The wave on the prime side has lagged the wave on the subprime side,” said Rod Dubitsky, head of asset-backed research at Credit Suisse. “The reset of option ARM loans is a big event that will drive the timing of delinquencies.”
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Thank you for sharing.
It's amazing that we have some many threads titled "is it time to buy yet?" We obviously have at least 2-3 years of falling prices ahead of us!
Keep renting and don't think about throwing money away in mortgage payments or lost equity.
Depending on short-term interest rates, these future loan resets may or may not be as much of a problem as advertised. Personally, I think it is being overblown. The Option ARMS are certainly toast, but the other varieties ... remains to be seen.
Consider a 5/1 IO ARM loan originating in 2005 at an initial rate of 5.625%.
Typical terms:
Margin : 2.25%
Index: 12-month LIBOR
At today's LIBOR, this resets to 5.5 %. So, the difference in payment is not 50% as the article states, but more like 20-25%.
It all depends on where the Index rates (these are short-term rates, either 1-year or 6-month treasuries or LIBOR) are upon reset.
I dont understand why people keep accepting these interest rates. At some point inflation has to force rates up. It wouldnt take much, going up to a 4% LIBOR.
SHort term rates are low because people are willing to accept 3% on short-term treasuries instead of putting the money in stocks, real estate, commodities, corporate bonds, junk bonds, mortgage backed securities, and long-term treasuries, etc.
Which asset classes do you think people should be putting their money into ? It seems to me that in scary economic times there is plenty of demand for short-term bonds.
" Personally, I think it is being overblown. The Option ARMS are certainly toast, but the other varieties ... remains to be seen. The Option ARMS are certainly toast, but the other varieties ... remains to be seen."
I agree the other varieties won't have the same degree of problems, but I think size of the Option ARMS alone are big enough to wreak havoc on the market and this looks like it has its barrel pointed at California. Here is a post from Dr Housing Bubble in June explaining the data
http://tinyurl.com/6ocooq
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"-$500 Billion in total Pay Option ARMs outstanding in the U.S.
-60 Percent of these issued to folks in California"
"“(Businessweek 2006)Now the signs of excess are crystal clear. Up to 80% of all option ARM borrowers make only the minimum payment each month, according to Fitch Ratings. The rest of the money gets added to the balance of the mortgage, a situation known as negative amortization. And once balances grow to a certain amount, the loans automatically reset at far higher payments. Most of these borrowers aren’t paying down their loans; they’re underpaying them up."
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I don't think this is overblown, I think this is the nail in the coffin for the higher end markets. All the preliminary data is pointing in that direction.
Perhaps I may miss understand, but isn't alot freddie/fanny debt being bought by foreigners? Lower risk of loss of nominal dollars, but in foreign currencies, it seems alot riskier. But I dont speculate or follow currienies, so I can totally be wrong.
I guess the reality of just too much money seeking too few good investments is still reality.
Conveniently omitted is that it now can take up to 300 days to foreclose, that the GSEs are also rewarding every step any lender takes to rewrite loans or sell short rather then foreclose, and oh yeah let's see who the new president is next year.
Does anyone think that guys like Schumer and Dodd are through trying to socialize our housing and rescue the lenders?
I am not trying to downplay the significance of the second wave because I have pretty much shot all my bullets and used every excuse for putting off my own purchase. However again, the more I look at things, the more I see a very prolonged stagnant market rather then a market that depreciates fast and loses significant value in a relatively short timeframe.
"However again, the more I look at things, the more I see a very prolonged stagnant market rather then a market that depreciates fast and loses significant value in a relatively short timeframe."
If we are to see steep declines in the desirable areas that would be starting right about now IMO. I don't think they can totally bail this thing out, also as pointed out these Option Arms are heavily weighted to the high cost coastal areas especially CA. A huge bailout of these loans may not be very popular with the rest of the country. Who knows. I think the economy is worse than being reported. I only say that from anecdotal evidence from my work. I am in a sales management capacity with a very large mult-billion dollar corp. Our division gets an editorial every month on our percentage to plan. Nationwide July was the worst performance as a percentage of plan since they have been keeping records. This is business to business sales of a commodity like must have product being sold into basically every sector of the economy. The downturn became more acute in the last 6 weeks. Needless to say it is not exactly pleasant right now. My gut tells me we haven't seen the full extent of the carnage here. I think the next 6 to 12 months will give the verdict. Just my two cents.
This is shaping up to be the worst economic melt down since the 1930's. Deflation is just cranking up to speed. Throw in increasing unemployment and we've got a long way yet to fall. I've never seen anything near to this in my life time and the bad news just keeps rolling in. This article does not address how many people may walk away from their mortgage simply because they are way underwater. Regardless of their ability to pay.
All I can say to someone who's chomping at the bit to buy a house right now is,"I hope you really want the house and dont care that it will drop in value for at least another 2 years." How will you feel when the place you bought for $650K in 2008 is worth $450K in 2010?
SD R, I totally agree. These bailouts after bailouts are going to drag this thing out much much longer than I would like. However, I think it's very much a possibility if we get even more bailouts and more socializing of the housing and banking industry. It's very unfortunate, but we might see a repeat of Japanese housing market from the 90s.
AN, I thought the same thing but doctorhousingbubble.com made a good case for how ineffective the bailout will be for CA.
I don't think the high end has seen the worst yet. Just because someone had a good credit score and made 200K+/yr doesn't mean they didn't fall for the same bubble euphoric high that subprime borrowers did. And for them, borrowing eas even easier.
The lenders are not going to voluntarily take hair cuts because that will immediately impact their profitability which inturn could cause a run on their stock and that means the company is in much bigger problems. Therefore the bailout bill is not as going to do much!
I think that the reference to a "second wave" of defaults is a bit misleading to the extent that there are numerous and distinct waves heading our way. The option-ARM wave is its own animal, and absent mass modifications it is going to hit and it will hurt.
The Alt-A/Prime loans will generate numerous waves, categorized by the loan terms. There are loans that upon reset will immediately become unaffordable and will go into default - that's one wave. As FSD addresses above, we have already seen '04/'05 vintage 3/1 ARMS reset with negligible impact on payments and thus minimal defaults. It should be noted that many 3/1 and 5/1 loans in SoCal do not go to P&I on the reset but have a longer (often 10 yr) IO period, which keeps payments lower.
However, it seems likely that the loan indices (LIBOR et al.) will eventually rise and thus cause payments to rise. This will likely take several years to play out. Due a rise in the indices (and possibly coupled with income reduction due to a weak economy) will we see another, later wave of defaults due again to inability to service the loan. So there will be successive waves generated by inability.
There is also an entirely separate category of potential defaults where ability is not an issue. These are the "business decision" waves that will be generated by borrowers with ability who decide to ruthlessly default because they are hundreds of thousands of dollars upside down and they can rent or buy a similar home for 1/2 of their present monthly outlay. The bigger the spread between servicing the current property and servicing a rental/new property, the more likely the ruthless default.
As to "bailouts", I will restate the obvious which is that the recent housing bill is only the beginning.
Alt-As and ARMS are pointed at coastal areas. Subprime has taken care of the outlying areas and the cancer is spreading inward. Many of these loans recast quicker than 5 or 7 years if the LTV reaches 110-125% In a declining market, that can cause a world of hurt quicker than one might think. Santa Monica, Brentwood, Beverly Hiils, Malibu and many of the affluent areas on the Westside of LA are now in the crosshairs.
I'm sure La Jolla, Coronado, Del Mar and others in San Diego are as well.
www.westsideremeltdown.blogspot.com
Counselor well authored post. I agree entirely with your thoughts. Especially the last sentence.