Jan212013

Delinquent jumbo loans in Coastal California pollute bank balance sheets

The good news in the mainstream media is that delinquency rates are down year-over-year. Of course, they ignore the fact that delinquencies have flatlined since the settlement agreement in February 2012 because that fact doesn’t fit with their optimism bias. The delinquency rate is a national average, so it doesn’t reflect where the delinquencies have declined and what segments of the loan market are recovering. The assumption most casual observers make is that delinquencies are concentrated in poorer subprime areas and the more affluent prime areas like Coastal California are relatively free from mortgage delinquency problems. Nothing could be further from the truth.

Subprime loans became delinquent early in the housing crash because these borrowers were often given the extremely toxic 2/28 loan and only qualified based on the teaser rate, and the teaser rates on these loans were scheduled to recast and reset earlier than prime loans. Further, subprime borrowers have fewer resources than prime borrowers, so when they got in trouble, they immediately imploded. As a result, subprime borrowers were foreclosed on in large numbers in 2007 and 2008 while alt-a and prime borrowers waited their turn at the gallows. The situation got so bad that the government changed the accounting rules to allow lenders to keep delinquent loans on their books at fantasy value, and since Bernanke lowered interest rates to zero thus reducing the bank’s carrying costs, lenders allowed their more affluent delinquent borrowers to squat. The situation hasn’t changed much over the last three years.

The GSEs and the FHA don’t allow squatting in their properties. During the bubble, the GSEs lost market share to private lenders, but since the bubble burst, the GSEs and the FHA have insured 95% or more of the loans in the market. In addition, they have been the dumping grounds for banks as they picked up liability for many of their bad loans through the numerous failed loan modification programs run by the government. As a result, many bad mortgages under the conforming loan limit came under the control of the GSEs, and they have not allowed delinquent borrowers to squat. The delinquency rate at the FHA is very high, but then again, they have been issuing 3.5% down loans in a declining market. The GSEs and FHA try to modify loans, but when the modifications fail, they push the properties through foreclosure.

So where does that leave the bad loans? On bank balance sheets concentrated in affluent areas dominated by jumbo loans — think Coastal California.

Mortgage Crisis Lingers On at Citigroup and Bank of America

By BEN PROTESS and JESSICA SILVER-GREENBERG — January 17, 2013

More than four years after the financial crisis, many big banks have regained their footing. But Bank of America and Citigroup remain dogged by the past.

On Thursday, the two banks disclosed that substantial legal costs undercut their fourth-quarter earnings. The expenses, the banks said, stemmed from huge settlements involving their mortgage businesses. …

“The 2008 collapse was not the flu — it was a major debilitating disease,” said Lawrence Remmel, a partner at the law firm Pryor Cashman. “It takes time rebuilding your strength,” he said, and it is “unpredictable when some of the institutions will fully recover.” …

The too-big-to-fail institutions should have been put out of our misery in 2008.

“Litigation expenses have taken a huge toll,” said James Sinegal, an analyst with the research firm Morningstar. …

For Bank of America and Citigroup, the recent mortgage settlements are a reminder of past mistakes. During the housing boom, Citigroup, like other Wall Street firms, sold to investors billions of dollars of securities backed by subprime mortgages that later hurt its balance sheet. Bank of America largely inherited its mortgage woes through Countrywide Financial, the subprime lending giant it bought in the depths of the financial crisis.

Now, the banks are hoping to close a dark chapter in their histories. This month, Bank of America and Citigroup, along with eight other banks, signed a sweeping $8.5 billion settlement with the Federal Reserve and the Office of the Comptroller of the Currency over foreclosure abuses like erroneous fees and flawed paperwork.

The settlement allowed them to a halt an expensive review of millions of loans in foreclosure. The pact follows a $26 billion deal in February involving the five largest mortgage servicers and 49 state attorneys general, an agreement to resolve accusations that bank employees were blowing through mountains of documents used in foreclosures without checking for accuracy.

Banks may have finally stopped the bleeding from the consumer lawsuits hanging over them. They must still deal with put-back suits from the GSEs and lawsuits from buyers of their bad ABS pools, but with the consumer lawsuits out of the way, they can focus on other issues — like what to do with all the people not paying their mortgages.

It’s obvious to everyone that loan modification programs are not the answer. The first of these programs failed more than 75% of the time. The recent mortality rate in loan modifications runs at about 50% per year. 14% don’t even survive the initial three-month trial period. Loan modifications are a portrait in failure.

As a result of failed loan modifications and a slow foreclosure rate, delinquency rates have remained about 10% at the major banks since 2009. They are making almost no progress toward solving their delinquency problems.

Another way to look at the delinquency rate is to look at its inverse, the percentage of current loans. Currently, the rate of current loans in the United States is 83.7% with the bulk of performing loans being in flyover country. By definition, that means 16.3% of all loans are not current. That’s nearly one in five.

We’ve known since 2010 that jumbo loans are defaulting at higher rates than conforming loans. Perhaps it isn’t the subprime borrowers who are the deadbeats after all.

Nationally, 6.3% of jumbo loans are delinquent. These delinquent loans are largely concentrated on the coasts. The jumbo loan delinquency rate in California is 8.4%.

Orange County California has a jumbo loan delinquency rate higher than the national average, and since our market is historically so inflated, we have a lot more jumbo loans than other markets across the country.

It should be clear from the charts above that the much of the problem with shadow inventory and long-term delinquent mortgage squatting is concentrated in coastal California housing markets, particularly in the jumbo loan sector. These markets have been performing well lately causing many to tout their strength. This strength is an illusion created by allowing large numbers of jumbo loan owners to squat for years on end. Right now, the banks who hold most of this toxic paper are content to let them squat hoping they can liquidate at higher prices. Perhaps they will be successful, but the segment of the housing market most in danger of future declines is the coastal California jumbo loan market.