Souring Prime Loans Compound Mortgage Woes

WSJ 8/21/2009

By NICK TIMIRAOS

A survey found that one in eight U.S. households with mortgages was in foreclosure or behind on its mortgage payments during the second quarter, putting added pressure on programs aimed at preventing foreclosures.

While foreclosure starts have slowed on the subprime loans that ignited the mortgage and banking crisis, loans extended to borrowers with good credit are deteriorating at a faster clip as falling home prices and mounting job losses weigh on more households.

The Mortgage Bankers Association said its latest survey, released Thursday, showed that 13.2% of mortgages on homes with one to four units were at least a month overdue or in the foreclosure process in the April-to-June period, up from 12.1% in the first quarter and 9% a year earlier.
As home sales have picked up in recent months, some were expecting foreclosures and delinquencies to ease. But Jay Brinkmann, chief economist at the MBA, said foreclosures weren't expected to peak until later in 2010 when the economy improves.

"Just because we see prices level off doesn't necessarily mean we'll see a big reduction in foreclosures," said Mr. Brinkmann, in part because many homeowners would still owe more than their homes were worth.

Deteriorating prime loans are increasingly behind the steady rise in delinquencies and foreclosures. Among prime loans, 9% were past due or in foreclosure at the end of June, up from 5.35% one year ago. For subprime loans, those for borrowers with weak credit records or high debts relative to income, the rate was 39.5%, compared with 30% last year.

Prime loans, however, accounted for 58% of foreclosure starts, up from 44% last year. Meanwhile, subprime mortgages accounted for 33% of foreclosure starts, down from 49%. Prime fixed-rate mortgages, usually considered among the safest of all loan types, accounted for one in three foreclosure starts, up from one in five.

More than 235,000 borrowers have begun trial mortgage modifications under an Obama administration effort launched in March that focuses on reducing monthly mortgage payments for borrowers who have fallen behind on their payments. An additional 60,000 borrowers with little or no home equity have refinanced to lower rates through a parallel program launched by the administration.

But modification programs may not be able to help the growing number of borrowers who are falling behind on their payments because they are losing their jobs. Most loan-modification programs have been designed to help borrowers with loans that reset to higher payments or with high debt-to-income ratios.

The first wave of foreclosures that began two years ago, when the economy was still relatively healthy, was triggered by a downturn in housing prices that made it harder for subprime borrowers to refinance mortgages that were resetting to higher payments. Now, foreclosures are increasingly being driven by traditional economic problems, including falling home prices, falling incomes and rising joblessness.

Four states -- Florida, Nevada, Arizona and California -- continue to account for a large part of foreclosures in the U.S., but their share of new foreclosures fell to 44% in the second quarter, from 46% in the first quarter. In Florida, nearly 23% of mortgages were past due, including 12% that were in some stage of foreclosure and 5% that were 90 days or more past due at the end of June. Nevada trailed closely behind, with 21% of mortgages that were late or in foreclosure.
More borrowers in areas that have seen a big plunge in home prices now have mortgages that exceed the value of their homes. Two-thirds of borrowers in Nevada and nearly half of borrowers in Arizona and Florida had negative equity at the end of June, according to First American CoreLogic, a real-estate-data firm. Nationally, a third of mortgaged properties were underwater.

Foreclosures also continued to rise on loans backed by the Federal Housing Administration, to 3% from 2.8% in the first quarter and 2.2% one year ago. The collapse of the subprime-mortgage market in 2007 has swelled the volume of loans headed to the FHA, which insures lenders against the risk of defaults on loans. FHA-insured loans are available to borrowers who make down payments as low as 3.5%.

Originations of FHA loans increased by 30% in the second quarter from the previous quarter, according to Inside Mortgage Finance, a trade publication.

Why the ‘Wave’ of Foreclosure Listings Might Never Happen

By Nick Timiraos

For weeks, even months, real-estate professionals have been asking the same question: when will the so-called shadow inventory of homes in the process of foreclosure finally hit the market?
Most mortgage servicers ended a foreclosure moratorium in March, and pre-foreclosure filings have accelerated since then, even as the supply of bank-owned properties in some markets has dwindled.

But what if that wave of foreclosures never hits the market? “For those of you still waiting for a surge of foreclosure sales, the truth is you’ll likely be waiting a long time,” writes Sean O’Toole, the founder of ForeclosureRadar.com, which tracks foreclosure filings in California. He breaks down his argument at his blog in this pithy post here.

For one, the time between a mortgage default and a foreclosure listing has grown longer as more homeowners try to complete loan modifications or short sales. Banks aren’t likely to cancel foreclosures even if they put a borrower into a trial modification. Instead, they’ll simply keep the opportunity to foreclose in case the loan modification fails.

One clue that modifications will work: cancellations of foreclosure auctions. So far, cancellations are up slightly, Mr. O’Toole says, but not enough to explain the yawning gap between mortgage defaults and bank-owned listings.

One possibility: foreclosures will simply stay at an elevated level for the next couple years, he says, but there won’t be a huge wave of inventory added all at once. For now, California is seeing a housing inventory shortage, in part because short sales are still hard to execute. Many homeowners are underwater and can’t sell, and those who can don’t want to put their homes on the market if they’re looking at a big loss.

Mr. O’Toole has done some interesting analysis that shows just how profound government policies may have been in encouraging banks to slow down foreclosures. His argument: When the U.S. last September began purchasing direct obligations of government-sponsored mortgage companies, and later began buying mortgage-backed securities that sent a message to banks that they didn’t need to refill empty cash cushions by foreclosing. Policymakers also changed accounting rules so that banks wouldn’t have to take as severe writedowns. (Scroll down this page to see the accompanying chart).

While the raw data suggests that foreclosures should be increasing, it’s harder to predict because “there’s so much government middling into this process,” Mr. O’Toole told the Developments blog. “When you have this much government intervention going on, things don’t necessarily proceed as they should.” (See our earlier post this week on the topic.)

As for the idea that banks are deliberately holding onto foreclosed homes? Mr. O’Toole shoots that idea down too, with a quick back-of-the-envelope sketch that shows that while the gap between bank repossessions and foreclosure sales stands at around 90,000 in California, the actual shadow inventory is probably closer to 22,500.

Readers, what do you think: is the shadow inventory just a Realtor pipe dream?