Will banks can-kick bad loans for as long as it takes?
All delinquent borrowers living in properties worth less than the outstanding balance of the loan will be offered a loan modification in lieu of a foreclosure because the banks can’t absorb the losses.
Prior to the housing bust, lenders always foreclosed on delinquent borrowers — always. They had no incentive to kick the can with a loan modification because they could reclaim their capital and loan it to a borrower who would pay the full rate. Lenders only kicked the can when house prices fell and they could not recover the full amount through a foreclosure.
Can-kicking is a policy of necessity. If lenders had foreclosed on all the delinquent mortgage squatters and liquidated the inventory, house prices would have retreated to Great Depression levels, and our entire banking industry would have gone bankrupt.
For the next several years, the housing market will endure low MLS inventory as lenders wait for higher prices to finally resolve their legacy loan problems. MLS inventory is low because lenders deny short sales, approve loan modifications, and allow delinquent mortgage squatters to live payment free. The lack of MLS inventory forces the depleted buyer pool to compete for available properties and bid up prices. As prices rise, collateral value returns, and lenders could foreclose and recover their original capital, which is why lenders are so motivated to see house prices go up.
The lender’s options
Lenders have two main options when a borrower stops making payments on a loan: (1) foreclosure, or (2) can-kicking. The option lenders exercise depends almost entirely on the collateral backing of the loan. If the value of the property backing is insufficient to recover the outstanding balance of the loan in foreclosure, lenders will opt to kick the can instead. It’s really that simple.
When lenders collectively realized they would all go bust if they kept foreclosing and flooding the MLS with supply, they all changed their loss mitigation procedures. Since Manipulating for-sale home supply succeeded wildly for bankers, I believe they will continue on this path for as long as it takes. In fact, I don’t believe they have a choice in the matter. No matter what happens to house prices or the economy, no matter how long it takes to recover their bad loan capital, lenders will kick the can.
Does this seem unrealistic to you? It’s been going on for eight years now here in the US, and lenders show no signs of changing course. Despite cries about the lack of inventory, no political pressure mounts to compel lenders to change their behavior. Consider also that this practice has been going on in Japan for 27 years since the collapse of their stock market and real estate market in 1989 prompted the longest and slowest deflation the world has ever known.
When banks don’t have any good options, they do what they must to survive, and right now and for the foreseeable future, that means can-kicking any underwater loan.
February 22, 2016, by Keith Jurow
After disregarding the looming home equity line of credit (HELOC) disaster for several years, Wall Street and media pundits have finally taken notice. Homeowners with HELOCs will soon see them convert to fully amortizing loans and will face a huge increase in their monthly payment. Banks have not set aside adequate reserves to cover a HELOC-driven crisis, which would impact even those investors in broadly diversified index funds.
Here is the problem in a nutshell: Over the next three years, roughly three million homeowners who either could not pay off their bubble-era HELOCs or were unable to refinance into a more affordable one will face soaring payments on these second liens. …
Millions of homeowners were not content with taking out a single HELOC. Many refinanced their HELOCs – some more than once – to take advantage of rising home values and pry still more cash out of the house. California was the center of this HELOC madness. Between 2004 and 2006, roughly six million HELOCs were refinanced around the country.
All true. And this is no small problem. I reported last year that 250,000 HELOCs due to recast in Orange and LA Counties. However, I made the case back in 2014 that Upcoming mortgage resets and recasts will prompt more loan modification can-kicking. I stand by that assessment.
In its latest FDIC call report for the third quarter of 2015, Wells Fargo showed $67.3 billion in HELOCs on its balance sheet. That is down substantially from the $108 billion in its portfolio at the end of 2009. Clearly, the vast majority of HELOCs reported in 2009 were from the bubble era. …
What is the bubble-era HELOC portfolio of Wells Fargo worth? Their call report for the third quarter of 2013 reveals a great deal. For the first nine months of 2013, Wells Fargo charged off slightly more than $1 billion of HELOCs and had recoveries of $147 million. That equates to roughly 15% of the outstanding balance. …
Nevertheless, these figures clearly show that the market value of the HELOCs on underwater properties is substantially less than the outstanding balance. The banking regulators have never forced Wells or any other “too big to fail” bank to mark down their HELOC portfolio to its market value. …
Because these are second liens, the HELOC on an underwater home becomes essentially worthless if the borrower defaults. The bank will eventually take a total loss on the loan.
This is where Keith and I fundamentally disagree. He believes the banks can’t can kick forever. I do. In my opinion, those loans will be modified again… and again… and again until resale prices exceed the outstanding balance, and HAMP loan modifications will become permanent housing subsidies. If they don’t fully reflate the housing bubble, lenders will have to modify these HELOCs as these loans won’t have collateral backing if they need to foreclose.
I can’t see a scenario where the banks aren’t permitted to can-kick bad loans to avoid insolvency or bankruptcy, particularly the too-big-too-fail banks that own our government. Perhaps the populist presidential candidates Bernie Sanders or Donald Trump might put pressure on the banks — Bernie Sanders probably would — but when faced with the potential for economic calamity if our banking system implodes, I doubt even they will do much about the endless can-kicking.
If any of you have a scenario that leads to HELOC recast Armageddon, please share in the astute observations. I just don’t see it as a realistic possibility.