March, 8 2011
The Multi-Agency Mortgage Servicer Settlement, Principal Balance Reductions, Effective Negative Equity, Foreclosures
1) The $20 Billion Multi-Agency Mortgage Servicer Settlement – A Pee-Hole in a Snow Bank. Even Less if Used for Principal Reductions
The multi-agency mortgage servicing settlement draft, or term sheet, was leaked to the press this week. There was a lot of commotion over it — mostly that the banks are getting only a slap on the hand yet again – including over the missing monetary penalty and its intended use.
The monetary piece of the settlement has been rumored to be between $20 and $25 billion. Its primary use has been stated as being for counseling, legal-aid, hotlines, web portals, education, outreach, post-Foreclosure relo assistance etc. However, it is also stated that ‘a substantial amount’ of the monetary settlement was to be used to ‘support an enhanced program’ for loan modification including principal reductions.
For the purposes of this analysis let’s pretend the entire $20 billion goes to distressed borrowers for principal reductions. Of note, I am still convicted to the idea that a wide scale principal balance mod program for distressed borrower’s will never happen.
The BAC/Countrywide $8.6 billion settlement of late 2008 — referred to many times during the current multi-agency mortgage servicing investigations — included ~400k borrowers, or $21,500 per loan. Therefore, the $20bb monetary fine being floated to potentially be used for principal reductions for four to seven million borrowers in the delinquency, default or Foreclosure process – $2.6k to $5k per borrower – is a proverbial ‘pee hole in a snow bank’. It’s only a few percent of what is really needed for an effective principal program, if there is such a thing. I would rather see the money used to buy and rehab condo complexes around the nation and give keys to condos, instead of general assistance checks, to the less fortunate to cover rent.
An apples-to-apples Robo-Settlement based on the BAC settlement would be $86 to $161 BILLION depending on how many were allowed to benefit. And still, reducing principal on every underwater borrower in the country by $21,500 would not do much. Add an Order of Magnitude to that and we are talking – but not even the Fed has a couple of trillion dollars lying around.
A $20bb settlement makes no difference to anything in mortgage and housing that is occurring, or set to occur. As an example of how small of a number $20bb is, new Notice-of-Defaults — the first stage of Foreclosure — in the state of CA totaled $9bb in January alone.
If this settlement draft – which not incidentally does include a laundry list of servicer guidelines, codes of conduct, and consumer protections (albeit much of it is ambiguous and should have already been in place based on existing law) – is accepted then I counter intuitively expect Foreclosure, short sale, and deed-in-lieu liquidations to increase substantially…far beyond what is considered ‘normalized’.
This is because as the uncertainty that has been hanging over the servicer’s heads since Robo first broke in September 2010, which has resulted in a decrease of total legal default filings and Foreclosure completions by over 40% as of the end of February, is removed and servicer’s check their ‘conduct boxes’ off on each loan unit, there will be no uncertainty over liquidating when the hand book says it’s okay to do so. Further, there are hard and fast rules on modification timelines within the term sheet. In short, quicker modification decisioning allows loans to proceed to either the permanent modification or liquidation stage much quicker than is happening at present when loan mod can be in process for months on end with no final resolution.
2) Principal Balance Reduction Benefits are Overstated
As a career mortgage banker until 2006 — when it became blatantly obvious mortgage and housing was going to fall off a proverbial cliff and I left the industry to pursue other ventures – I am confident that the primary default driver has more to do with the back-end (total) debt-to-income ratios on the average legacy loan and loan modification being in the stratosphere than negative equity. In fact, on the average HAMP loan modification the median back-end DTI is ~65% of gross income. A household paying 65% of their GROSS monthly income to debt service each month — that can’t save, spend or vacation — is a massive credit risk, plain and simple.
Obviously, if a borrower has 20% equity and 65% debt ratios they can always sell making them less of a risk. But when you combine a high DTI and low to no home equity, it’s toxic. Even legacy Subprime loans only had a maximum total Debt-to-Income ratio allowance of ~55% when they were originated during the bubble years. To that end, legacy Subprime loans had an average LTV of ~93% and credit score of ~600. To that end, loan mods — with a ~65 DTI, 150% LTV, and 550 score on average — are much worse in structure than Subprime loans ever were and should perform accordingly. Even if loan mods had an average LTV of 100% due to principal reductions they still would be worse in structure than legacy Subprime originations.
Loan mods, restructurings, workouts and payment plans are simply new-vintage, higher leverage, worse-than-Subprime loans. And by design millions were originated from Q209 through Q310, when the low hanging fruit had been plucked and new mod volume began to fall sharply. All of these new-vintage toxic loans — many now called something else by banks and servicers including ‘performing and re-performing’ — are a real risk to housing and finance that few consider as such.
Bottom line: A borrower at a 65% total debt-to-gross income ratio is a debt slave whether he is 50% underwater OR has 5% equity in the house. There is no difference between the two. Neither can sell their house — pay their mortgage, pay the Realtor 6%, and put a 10% to 20% down payment on a new house — and re-buy. Both are stuck.
Therefore, unless total debt-to-income ratios are taken considerably lower through long-term household de-leveraging – or complete household balance sheet modifications that target the back-end DTI (the only known way now is through Chapter-13) — no modifications will ever stick in mass.
3) What is to be gained through reducing principal balances on mortgages?
Nobody is asking the primary question in my mind with respect to principal reduction mortgage mods…What is to be gained?
The central planners making the rules will say ‘fewer people will default and go into Foreclosure’. We already discussed that negative equity alone is not a determining factor. Further, if a principal reduction plan was rolled out to the mainstream, then I suspect many would strategically default to take advantage of it. So, principal reduction mods to prevent loan defaults and Foreclosures are hogwash.
However, principal and ‘other debt’ forgiveness to ’unburden the organic homeowner allowing them to participate in the housing market again’ would be highly beneficial. But, of course, this isn’t a quick fix, as homeowners who received mortgage principal and other debt forgiveness could not turn right around and buy houses for various reasons. Further, there just isn’t enough capital at all of the top banks in the nation to bring balances down enough to make it effective. Lastly, demographics are not in the favor of the repeat buyer — especially at the mid-to-higher end of the market — as baby boomers that were such a vital part of the bubble from 2001 through 2007 are not moving up anytime soon. In fact, they are looking to downsize. I suspect that the next time repeat buyers have an outsized benefit on the housing market is when today’s first time buyers can move-up.
Remember, housing has a demand AND supply problem, which most don’t understand. In a normal housing market, the repeat buyer drives volume, followed far behind by first timers and then investors. In this market, the repeat buyer is by and large absent relative to historic averages leaving all the heavy lifting up to first timers and investors who want low priced properties, preferably Foreclosures, REO and short sales. Thus, anything that disrupts the flow of distressed real estate prevents a housing bottom and subsequent recovery.
There is just no way to easily or quickly unleash the organic repeat buyer or unburden them from their extraordinary leverage positions. Actually, the latter could be achieved by offering foreigners immediate US citizenship for the capital investment into residential real estate of at least $500k, but I suspect things would have to get really bad before an idea such as this was floated.
4) Real (Effective) Negative Equity is a much larger problem, as it pertains to housing, than mainstream reports suggest
CoreLogic came out today with their latest monthly negative equity figure of 11.1mm borrower’s with mortgages, or 23.1%. But this number doesn’t mean much to me.
What most don’t consider is real, or effective negative equity, as it pertains to repeat buying I touched upon in the item #2. They generally only focus on the default and Foreclosure probability with being ‘underwater’. Effective negative equity begins at the point at which the homeowner can’t sell the house and rebuy another, which requires paying a Realtor 6% on the sale and putting 10% to 20% down depending on the type of loan needed.
For example, on a Jumbo purchase in CA effective negative equity begins at 75% CLTV (6% Realtor fee and 20% down payment), which is the reason the Jumbo housing market continues to languish and will get worse. In fact, when you lower the CA Jumbo negative equity threshold to 75% CLTV, then 64% of all mortgaged homeowners are effectively underwater. This is also why I believe that Jumbo loans, a clear focus of banks and servicers with respect to modifications, payment plans and workouts for the past year and a half, have not even begun the pain stage that will ultimately come.
In lower house price states such as AZ and NV where it takes 6% to pay a Realtor and 10% down to move-up, down, or across, when you lower the negative equity threshold to 85%, even a greater percentage are effectively ’underwater’.
When national house prices fall another 10% to 20%, entire states will be consumed by effective negative equity putting even more pressure on real estate supply and demand fundamentals.
Bottom Line: Whether the borrower is at a 95% LTV or a 140% LTV, they are in an effective negative equity position. Then it all comes down to debt-to-income ratios. If I was a whole loan long-term investor, I would much rather own a 140% LTV loan on a borrower with a 40% DTI than a 95% LTV loan on a borrower with a 65% DTI. To the 40% DTI borrower, the LTV is an inconvenience. But, the 65% DTI legacy or modified borrower — even at 95% LTV – is trapped and not saving, shopping or vacationing, with few options available. After months or years of being in debtor’s prison, walking away and stripping down the house in order to sell the parts for security deposit and first months rent, moves way up the most likely list. Further, with respect to sales demand, the US real estate market has lost its most significant segment of buyers – repeat buyers — due to effective negative equity and tighter lending guidelines.
5) Where do we stand now?
In final, I am always asked about my predictions for total Foreclosures stemming from the bubble years. And I have said the same thing for years.
In short, there have been 3.5 million foreclosures and short sales to date stemming from legacy loans. There are presently ~7.5 million borrowers delinquent, defaulted, or in Foreclosure at present — grows by 100k to 125k per month — of which 75% to 80% will ultimately be liquidated. If another 7.5 million defaults — and modification redefaults — occur over the next three to five years then a total of 12 million to 15 million Foreclosure, short sale, and deed-in-lieu liquidations will occur, meaning we are now ~25% complete in cleansing the infamous 2003-2007 Bubble-Year’s toxic lending cesspool.
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