The Next Crisis in Residential Mortgages – New Data Emerges
Back in the fall of last year, we commented to many that the so-called “foreclosure-gate,” or “document-gate” (remember, the Schwarzeneggerian term “robo-signers”) was going to prove to be a double edged sword for the large banks.
On the one hand, lying to judges and facing the possible voiding of mortgage collateral documents and the ability to foreclose is decidedly bad for business. On the other hand, we pointed out that there would likely be sighs of relief (we were once, injudiciously, quoted as referring to the popping of champagne corks) at the notion that the recognition of losses connected with the bubble of pending home repossessions, that was then coming towards the end of the foreclosure snake, could again be delayed.
Over the past week, two intrepid investigative business reporters, at The Financial Times and The New York Times, respectively, have published stories that shed new light on this issue, in a manner that furthers our concerns about the banking sector. More about the articles below (don’t miss this, keep reading).
In our view, the magnitude of pending foreclosures, together with housing prices that continued to decline through March, could potentially result in losses to banks that materially exceed existing provisions for such losses. Moreover, if the backlog of foreclosures were to move through repossession and liquidation, the impact on the housing market would unquestionably be to accelerate the pace of falling prices (at least in many regions of the country).
Not surprisingly, in this environment, lender recoveries of loan principal through the liquidation of foreclosed mortgage collateral has been dismal – averaging between 35% and 40% of loan face amount (taking into consideration both selling price and all costs related to the foreclosure and liquidation) for years now and showing no signs of improving.
With home prices, per the S&P Case Shiller 20-City Index, having fallen 6.2% from the end of Q3 2010 through the end of Q1 2011, and now more than 33% below peak levels in July of 2006, the largest banks in the U.S. are therefore loath to repossess and liquidate defaulted home loan collateral.
Yet, apparently driven by a now-questionable view (possible, but by no means a certainty) that the American economy is positioned for a sustainable recovery, banks have been releasing provisions for losses on loans held in portfolio. This has had a positive effect on bank earnings for several quarters. Although, with many banks trading below book value, the market seems not to believe either the sustainability of recent earnings or the recoverability of bank loan assets.
So the banks owning large residential loan portfolios have slowed the foreclosure process to a trickle and, at the same time, have been unwilling to restructure home mortgage loans in a manner that would lead to large scale principal reductions. According to various studies, the best path to the maximization of defaulted mortgage recoveries runs through actions that keep people in their homes and paying instead of walking away.
And with regard to underwater borrowers (nearly a third of all mortgagors now) the best way to keep people paying is to renegotiate the original principal. Recoveries on that basis promise numbers closer to 70% of face, than to liquidations yielding half that ratio.
The banks do have one further concern that is not entirely illegitimate. The see moral hazard in the notion that aggressive principal modifications would trigger more widespread default, as borrowers who might otherwise pay will, literally in some cases, covet their neighbors principal reduction and default themselves in order to obtain the same treatment. But we do not see the advantages of a stand-off over liquidations or modifications in a stable or declining price environment, in the absence of sustainable macroeconomic improvement. We also note that it is somewhat painful to listen to moral hazard arguments from lenders who have recently been the beneficiaries of assistance themselves.
So that’s why we feel it important to highlight two pieces of journalism that have shed more light on these issues and promise further data to come.
Last Monday, Suzanne Kapner of The Financial Times wrote a small but interesting piece entitled Concern Rises over U.S. Mortgage Defaults which discloses that she has received some hitherto unpublished numbers from the Office of the Controller of the Currency (the principal regulator of large banks) that potentially suggest that delinquencies on bank residential mortge loans in portfolio may be higher than have been previously understood (and higher than what banks have disclosed for securities act purposes). Some 20% of bank-held mortgage loans, according to Kapner, are 30-days or more past due, which we read as meaning loans that are about to miss two or more payments. We are very interested in seeing more work from Ms. Kapner on this subject as banks hold nearly $3 trillion of mortgage loans in non-securities form on their books. 20% could be an alarmingly large number relative to existing loan loss provisions if such loans are eventually liquidated at anything near today’s prevailing recovery rates.
Yesterday, in a piece entitled Backlog of Cases Gives a Reprieve on Foreclosures, David Streitfeld of The New York Times writes extensively on the fact that the pace of foreclosure repossessions has slowed to a crawl throughout the country. He quotes one Florida chief judge as noting, “We’re here to do what we’re asked to do. But you’ve got to ask. And the banks aren’t asking.” He further notes that, at the current pace, it would take years to liquidate even the homes that are presently repossessable – and that’s just in the so-called non-judicial states. In states in which courts control the foreclosure process, it would take decades.
Yes, it is possible that these matters are coincidental and that the unfortunate situation merely looks as though large banks are kicking the can in order to avoid recognizing substantial losses for as long as possible. Or, perhaps, the situation is exactly as is appears – only bank regulators know for sure. And, like the rest of us, the regulatory establishment fears having the banking system fall back into disarray in a political environment in which renewed taxpayer assistance to the industry is by no means a certain alternative.
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