Apr262012
Forcing second mortgage loss recognition brings reality back to bank reporting
For the last four years the health of the American banking system has been an illusion. In 2008 our insolvent banks were deemed too-big-to-fail, and regulators began allowing banks to market their assets to a fantasy valuation rather than fair-market value. Once insulated from loss recognition, lenders embarked on a policy of amend-extend-pretend with delinquent borrowers. Never before have so many been allowed to squat in luxury for so long.
The policy of mark-to-fantasy bank accounting was necessary to make our banks look solvent. The hope was that banks would earn their way back to health as the federal reserve took the interest it used to pay retirees and instead diverted it to its member banks. The ongoing bailout of the banking system has largely been paid by retirees on fixed incomes. With zero percent interest from the federal reserve, lenders bought government treasuries to earn a riskless return. If given enough time and enough money to buy treasuries, lenders would eventually make up the losses they incurred from their unconscionably stupid lending practices of the housing bubble era.
So far this policy has largely worked. Seniors have been screwed, and although lenders drove the yields on treasuries down to near 2%, our big banks have earned considerable income from this riskless trade. Each quarter, they write down a certain amount of their bad debts, report a small profit, and everyone pretends everything is copacetic in the world of high finance.
Eventually banking regulators will bring reality back to reporting on bank balance sheets — I hope. Recently, the first steps were taken as regulators forced lenders to acknowledge the obvious: second mortgages behind delinquent first mortgages have no value. Believe it or not, lenders have been allowed to carry these assets on their books at 100% value even though they are a total loss in a foreclosure or short sale. This is one of those complex issues few really understand — and lenders and regulators are happy to keep it that way. If the general public realized banks are holding billions of worthless assets on their balance sheets at full value, their confidence in the banking system would be shaken because they would realize our banks are still insolvent today.
Large Banks Begin to Recognize Reality of Second Liens
e21 Staff Editorial | 04/18/2012
Concern that banks were not properly accounting for potential losses on second liens in foreclosure proceedings led regulators to issue a January 31 guidance that effectively requires banks to treat a second lien as nonperforming if it is subordinate to a first lien that is nonperforming. The result was that J.P. Morgan, Wells Fargo, and Citi combined to classify over $4.1 billion of second liens as nonperforming during the quarter. The largest holder of second liens is Bank of America, which is likely to report a large increase in nonperforming second lien loans when its data are released next week.
In total, more than $10 billion of second liens may be classified as nonperforming during the quarter.
Those numbers sound bad, and they basically wiped out the quarterly earnings of the banks when they were forced to take this write down, but the problem is far, far worse than that.
This is just 1.4% of the $723 billion of second liens held by insured depository institutions at the end of 2011, according to the FDIC.
$723 billion! OMG! There is no way our banks can absorb the losses that are coming. This is the primary reason the federal reserve, the Treasury Department, and the entire US government is throwing all its resources into papering over these losses and making house prices go back up. Our banking system simply cannot afford for house prices to remain low indefinitely, yet they have been unable to move the market higher. With so many on the wrong side of the trade, it’s unlikely prices will go up. Distressed sales will continue to dominate the market and squelch every recovery as it begins.
It is also not clear what loss severity is used for loan loss reserves. In many cases, the loss severity is likely to be 100% when the homeowner is underwater on the first mortgage. Yet, in the recent stress test the Fed estimated only $56 billion in potential losses on second liens, which suggests a maximum default rate of about 8% or recovery rates that are far above what is implied by house prices.
This is clear evidence the stress tests for banks were bogus. Only $56 billion in losses on $723 billion in worthless second mortgages? If everyone stays in their houses and pays these mortgage until values return to the peak, then maybe, but realistically, it will take a long time for values to rise enough to give borrowers equity again. In the meantime, people will want to move, and they will either default or short-sell their house. When they do, the second mortgage is a total loss. It doesn’t seem likely this will only effect 8% of these mortgages.
The graph below compares the nonperforming rate on first lien and second line closed-end mortgages (mortgages with a fixed principal balance). These data (from the FDIC), show that borrowers are 2.75-times more likely to go delinquent on their first mortgage than on their home equity loan, as delinquencies on the first liens are 9.61% relative to 3.49% for second liens. The share of HELOCs that are nonperforming is even lower, at 1.83% of all loans, according to the FDIC. This is anomalous because the second liens are subordinate to the first mortgage and should therefore be riskier and have a higher default rate. Instead, many households continue paying their home equity loans even as they stop making payments on their mortgage.
There are many hypotheses for why a homeowner would continue to pay his second lien even after going delinquent on his mortgage. The payment is lower, the loan is fully recourse to the borrower in 39 states, and revolving home equity lines provide the household with access to credit. However, it is also important to note that the servicer of the first loan is often the owner of the second lien. Given that the servicer has much greater exposure to the second lien, it makes sense to think the servicer would work harder to ensure the second lien is current. Part of the anomaly could therefore be explained by servicers exerting greater pressure on borrowers to pay their second liens. The new regulatory guidance seems to recognize this conflict of interest.
It’s only a matter of time
… Also, home-equity payments are smaller, meaning homeowners are likely to keep paying after a default on their primary mortgage — at least for awhile.“When we analyzed it, it was pretty obvious it was just a timing difference,” JPMorgan CEO Jamie Dimon said. “In almost all cases when the first went delinquent, the second eventually went delinquent. And in all cases where the first went into foreclosure, the second was a loss, basically a total loss.”
I first reported on this strange phenomenon back in 2010: Borrowers default on first mortgage and keep second mortgage current. There are few good explanations for why people would remain current on the second while not paying on the first. What Jamie Dimon noted makes more sense. It’s only a matter of time.
While this new rule requiring banks to recognize these losses is a step in the right direction, we are still far from having a transparent banking systems with accurately reported book values. Only the implied promise of solvency through the too-bid-to-fail policy of the government keeps investors buying bank stocks and bonds. The write offs on second mortgage liens will continue for years, and unless house prices go back up strongly — a very unlikely scenario given the level of distressed debt — then these second loans losses will mount as people leave their underwater homes through strategic default and short sale.
Beach properties also benefit from amend-extend-pretend
Property near the beach is intrinsically more desirable than inland properties. The narrow strip of land within a few miles of the ocean gets the ocean air which is clean and cool. It’s the perfect climate all year. Because this area is so desirable, it always has higher house prices. High wage earners porting equity from previous sales bid up prices on homes beyond rental parity. These are a classic move-up destination market. During the housing bubble, these areas were even more desirable because prices went up so much. The Ponzis particularly coveted these properties because they provided so much free spending money. Further, since prices have crashed elsewhere, lenders elected to let these people squat in luxury rather than foreclose on them and endure massive losses. These losses are coming, perhaps when lenders can finally afford them.
Today’s featured property shows just how bad these losses will be. This condo a few miles from the ocean sold for $985,000 in 2004. Today, eight years later, it is selling for 27.5% off its 2004 purchase price. The beach communities are not immune to the crash, and when lenders finally get around to foreclosing here, we will see many more properties selling for 30% to 40% off their bubble-era prices. Corona Del Mar is still grossly inflated. This market always trades at a premium to rental parity, but the current premium is nearly 60% over its historic norm. I remain very bearish about Orange County’s high end. Today’s featured property is still considered an anomaly. If not for amend-extend-pretend, it would be the norm.
IR: Frontline’s “Money, Power and Wall St.” series has started. The first 2 episodes have been pretty good.
The saddest part is prolly when Senator Barnes from Georgia passed a pre-meltdown law regulating mortgages and CDS, which outraged banksters and was almost immediately repealed. (Speculators felt that investors would ignore Georgia in favor of other states.)
I want to add something to the above post.
Not only do the banks get to mark these loans at phantom values, but they also get to accrue phantom interest/income from non performing loans on their quarterly earnings. They don’t have to erase this phantom income until they sell the loan at auction or buy it back (REO).
More smoke and mirrors. This phantom income is pretty large as well. I see homes where the final loan was $600,000, but the bank foreclosed with an outstanding balance over $800,000. The $200,000+ was phantom income. One more reason why banks haven’t been foreclosing on high wage earning squatters in Orange County.
This is another reason why the banks actually have an incentive to delay foreclosure.
It’s interesting and amusing how the Fed tries to walk the thin line between the economy is improving, but not enough to raise interest rates, and certainly not enough to take more QE off the table.
This is way I have been buying real estate. To me it is a hold your nose investment. I don’t trust the fed with my cash. If I buy a house, I get cheap money from the fed, collect rent, and if helicopter Ben keeps throwing money around, I have some protection against inflation. Of course they are many in these parts that would call me a fool. But I have a gut feeling now is the time to load up on rentals.
Just wondering when IR will have some more houses for us to buy from the flipping fund?
“Just wondering when IR will have some more houses for us to buy from the flipping fund?”
It’s been a real struggle to get property in Las Vegas this year. The declining inventory has made bidding much more competitive. I have one more I will be rolling out in a week or so. I am waiting on Jacki to finish the renovation. Tenants are already in place.
I believe that once a loan is delinquent for more than 90 days it becomes a non-earning asset and stops accruing interest. If that’s the case, then the accrued income is not a big driver of the amend-extend-pretend policy. It’s all about the underlying value of the asset.
The banks still pile on late fees, collection fees, and every other kind of fee they can think of. Plus, part of the reason they do offer the loan modifications knowing full well the borrower will redefault is because they can roll all the fees, missed payments and uncollected interest into a new loan balance and start the “earning” process all over again.
I wonder if previously non-recourse loans become recourse after the workout also.
An asset class is targeted. Set objectives. Make it profitable which attract/encourage people to buy-in. Provide concessions to bring more people in. Once objectives are met, gradually make it unprofitable. Implement price controls which make it even more unprofitable. Remove concessions, then steal it.
5,591,000 mortgages are delinquent
Mortgage delinquencies fell back on both a monthly and annual basis in March, according to preliminary market data released by Lender Processing Services (LPS) for the month.
The company’s estimation puts the national delinquency rate – measured as 30 or more days past due but not in foreclosure – at 7.09 percent.
That’s down 6.3 percent from the previous month, an 8.8 percent drop from March 2011, and is the first time since
2006 that the delinquency rate has come in lower by both measurements, according to LPS.
The nationwide foreclosure rate stands at 4.14 percent by LPS’ assessment – up just barely one-tenths of a percentage point from February and down 1.6 percent from a year earlier.
LPS reports that there are 2,060,000 properties that comprise the nation’s foreclosure inventory.
Another 3,531,000 have missed at least one mortgage payment but haven’t made it as far as foreclosure yet. Of those, 1,643,000 are behind by three or more payments and will likely join the foreclosure inventory soon.
Altogether, the numbers equate to 5,591,000 mortgaged properties that are in arrears.
According to LPS’ report, the states with the highest percentage of non-current loans in March – including 30-plus days delinquent and in foreclosure – were Florida, Mississippi, Nevada, New Jersey, and Illinois.
States with the lowest percentage of non-current loans for the month included Montana, Alaska, South Dakota, Wyoming, and North Dakota.
This uncomfortable fact is why housing markets probably have not bottomed.
From Zerohedge:
“Meaningless NAR data is out. Will be revised much lower in a few years.”
NAr has been a joke for years. “Pending” sales are up.
Pendings are essentially USELESS data, except… can be used to determine an approx ‘cancellations’ rate. ie.,
Steve Thomas was reporting Feb ’12 OC pendings in the 3600 range. Actual closed sales for the month were 1903. Thus, OC had an approx 47% cancellation rate. OUCH!
The pendings get reported with much fanfare, but the actual closings disappoint, and nobody cares to report on that.
Fresh reports show little evidence of housing rebound
Hopes may be fading for a long-awaited spring rebound in the U.S. housing market.
Two widely watched benchmarks Tuesday signaled that the pace of sales softened and prices fell last month. And a prominent housing economist warned that the market may not stage a major turnaround “in our lifetimes.”
Falling home price were recorded in 20 cities tracked by the Standard & Poor’s/Case-Shiller home price index. Prices in the 20 cities fell 3.5 percent year over year, moderating from the previous month’s decline of 3.8 percent.
The composite index of 20 cities gained 0.2 percent in February on a seasonally adjusted basis, matching economists’ forecasts. But overall, the trend of falling prices has yet to reverse course, according to Maureen Maitland, a Standard & Poor’s vice president.
“Some of the annual rates of change are improving,” she told CNBC. “But they’re still largely negative. There are very few markets that are seeing positive annual rates of change, and very few rose on a month-over-month basis. So I wouldn’t say there were very many bright spots.”
Banks are running out of homeowners to refinance
Mortgage applications filed by U.S. borrowers declined 3.8% last week as refinancing activity cooled, an industry trade group said Wednesday.
The Mortgage Bankers Association’s loan application volume fell as the refinancing index slipped 5.6% from the previous week. Despite the slowdown in refinancing, the purchase index saw a 3.6% uptick in activity.
Refinancing activity represented 73.4% of total application volume, compared to 75.2% a week earlier.
“Within refinance applications taken in March 2012, 58.8 percent were for fixed-rate 30-year loans, 23.1 percent for 15-year fixed loans and 5.2 percent for ARMs,” the MBA said. “The share of refinance applications for other fixed-rate mortgages with amortization schedules other than 15 and 30-year terms was 12.8 percent of all refinance applications.”
The average interest rate for a 30-year, fixed-rate mortgage with conforming loan limits declined from 4.05% to 4.04%, the lowest in the history of the survey.
Meanwhile, the average interest rate on a 30-year, FRM with nonconforming loan limits declined from 4.36% to 4.27%.
The interest rate for the 30-year, FRM backed by FHA declined to 3.81%, while the 15-year, FRM declined from 3.33% to 3.32%.
The average rate for 5/1 ARMs fell from 2.83% to 2.81%.
This is something I don’t understand about the mortgage industry. There is a pool of borrowers you could tap for refinance, who aren’t currently being targeted.
If you’re creditworthy (high credit scores, low DTIs, solid incomes) yet underwater, the only refi available is a 98% FHA that comes with steep mortgage insurance. HARP targets GSE borrowers, but what about non-GSE borrowers in this situation?
e.g. As a lender/investor making a loan, which would you rather make?
1) 98% LTV, credit scores in the low-700s, DTIs nearing 33%/40%, no reserves; or
2) 110% LTV, credit scores in the low-800s, DTIs nearing 20%/30%, large reserves.
Assuming they’d both earn you the same, which is at a greater risk of default?
The investor’s worry about underwater loans is the loss severity. The likelihood of an 800 FICO score borrower defaulting is low, but the severity of the loss would be very high. That’s why they won’t do it.
It’s the opposite of what when on with subprime lending. Back when house prices were going up, subprime lending flourished despite very high default rates. With rising house prices, the loss severities were very low because even a foreclosed home could be sold for enough to recover the original loan amount. Once prices stopped going up, the high default rates coupled with high loan loss severities revealed subprime lending to be a Ponzi scheme only sustainable when prices were rising.
Lenders worry very much about people in your circumstances. Although the FICO score suggests you wouldn’t default, many people who do strategically default have very high FICO scores. Lenders fear you could change you mind in an instant and leave them with a very large loan loss. Many of your cohorts are doing just that.
True. The proof that I am currently a default risk, is that I haven’t refinanced. I’m preserving the purchase-money character of the mortgages in the event home values drop another 25% and/or my household income drops significantly.
My mortgagees have turned-down some very attractive proposals, especially the second considering its position. My second is a purchase loan and in the event of a default, would receive $0.
I’ve asked them to refi (making their position recourse) the first and second into a 115% LTV loan. The rate could be 3% + another 100 bps for the risk to total 4% for TEN years. That would increase our mortgage $1K monthly, but still be well below DTI thresholds. At that rate/term, the principal would reach 100% LTV within 12 months. They simply aren’t interested.
“They simply aren’t interested.”
The are betting that despite your frustrations, you will keep paying on the original mortgages. They are probably right.
It will be interesting to see how the strategic default statistics change if prices start going up again. I suspect much of the reason for banks withholding inventory — and thereby slowing the return of their capital through liquidation — is to slow the rate of strategic default. A cascade of strategic defaults is what drove Las Vegas prices into the dirt. People who are deeply underwater and watching values decline are prone to give up because the situation looks hopeless. If lenders can engineer a bottom and prices begin to rise, borrowers have hope of future equity and are more likely to keep paying.
Yes, they’re placing a winning bet. They can always choose to work something out with me after a couple missed payments. However, if those missed payments are strategic, how enticing would their offer have to be, for me to accept? That’s my point to them. At that time, my credit will already have taken a huge hit, so why not then live rent-free for ~18 months stringing them along and eventually allow foreclosure?
You see, today, with low-800s scores, I’m willing to pay-down $50K immediately in exchange for a reasonable rate (4%-5%) for a ten year term. After a couple missed payments, with our scores in the low-700s, what will I be willing to do? I won’t want to part with cash; and the rate will have to be very low to entice me to remain in the underwater home.
I don’t know. It all feels like a game, and I’m very tired of playing (thinking about my position every day). I’m still waiting to hear if either mortgagee is going to offer anything related to the National Mortgage Settlement…
Housing prices are never going to go back up to what they want unless liar loans come back. Even if they did the party would last 3 or 4 years tops then we’d be even worse off.
Particularly out in Las Vegas. It will be thirty years or more before natural wage growth provides the borrowing power to reach peak pricing. The people out there who haven’t strategically defaulted are fools.
Uh-oh, the next hard leg down has officially begun; just confirmed.
”the crash is over,” Mark Zandi, chief economist for Moody’s Analytics Inc. in West Chester, Pennsylvania, said in a telephone interview yesterday.
http://www.bloomberg.com/news/2012-04-25/housing-declared-bottoming-in-u-s-.html
With so many people calling the bottom, I question whether it really will be. Barry Ritholtz did a great 5-part series on why the bottom is not in earlier this month.
“…The ongoing bailout of the banking system has largely been paid by retirees on fixed incomes…”
If you’re going to “tax” a group to pay for bailouts to keep the economy afloat, then this is the best group to select. Seniors are by far, the wealthiest group of Americans. Seniors with significant savings, enough to be harmed by sub-1% rates, are “rich.” I hate that term, but if anyone is “rich,” then it’s the people who have an SSI pension paying them far beyond their contributions and “growth,” and who have significant savings.
You’re probably right, but this voting block has tremendous clout in Washington. That’s why the “tax” is coming from the federal reserve policy. Since the federal reserve is independent, politicians can impose this tax on seniors without concern they AARP would hammer them.
The next tax on seniors will come when these low interest rates devalue their holdings through inflation. First, the tax was low interest returns, and finally it will be actual loss of value on their holdings when inflation exceeds the interest rate they are paid.
These taxes hit all who save in banks, but since this group is largely ultra-conservative seniors, they get hit the hardest.
For what it is worth: if one reads the FDIC press releases when they shut down a bank on a Friday, they give their best estimate (believe what you will about its accuracy) of the loss to FDIC of closing that bank. It becomes quickly apparent that “solvent” banks can cost the fund an eighth to a third of the bank’s gross assets as last reported for FDIC purposes. As to HELOC reported defaults not matching first position mortgage defaults, lots of HELOCS etc have very small or zero balances, so numerically the ocean of small balance HELOCS (or even HELOCS open with no balance) means one is really comparing an apple to an orange. Two hundred “small” banks can’t even get their tarp loans repaid, wsj said yesterday.
Banks make a LOT of their net income on refinancing, and the banks remain a large part of the stock market.
Good is evil, evil is good. So now because people can’t make money for doing absolutely nothing…AKA usury, AKA interest, AKA sin, it’s a horrible tragedy.
Bummer. I guess I’ll continue to squat and cause the OLD people, who had the best opportunity known to man to accumulate wealth, to not be able to eat because they cannot make interest for doing nothing.
I silently am cheering for the Iran to win against the war of enslavement to the bankster cartel. I wholly expect WW3 if the banksters cannot get their way, and just like 911, maybe the US will drop a dirty bomb on it’s own people in order to justify going to war. If you do not think our government is capable of doing such, read history on every war since the Civil War. All manufactured, all manipulated, all based on deceit.
Swiller,
If you don’t mind sharing, since this is anonymous, what was your FICO score before you strategically defaulted? Did the bank have any reason to fear you would default other than you were underwater?
No problemo IR, there be three that report:
760 787 783
Remember, that was way back in 2008/2009. I can’t get credit at JC Penny now (and got 30% off for proving it to the store manager!)
But it’s all good because I do not use credit anymore…at all.
I figured you had a good FICO score. The anger that comes through many of your posts comes from the frustration of having done everything right and still getting shafted. I would be angry too. You are the prototypical borrower that scares the hell out of mortgage lenders. There is nothing in your past that would indicate you would strategically default, yet the circumstances lenders created pushed you to the point you did what you would never have considered prior to the housing bust.
Thank you for sharing. If I didn’t have a background in real estate finance, I could just as easily ended up in your circumstances. Many with my training did. I was lucky as much as anything. I hope this works out for you in the end.
WOA!!! that is some circuitous path to take just to justify your theft of a house!
So, since earning interest is sin, i propose we all hang out with you and you lend us your money with 0 interest. you can think of it as a public service we will be providing for you so your soul remains unsoiled.
Good thing OBL was stupid enough to take the blame and the consequences for the banking cartel.
I guess he was a true believer, eh?
Swiller, I usually agree with you, but I must respectfully take issue with the notion that savers who have spent a lifetime denying themselves and put their money away instead of spending it, are “doing nothing” and aren’t entitled to a consideration (referred to as “interest”) for the use of their money.
That is like saying that a cash-flow real estate investor who lets a house he bought cheaply and collects rent is doing “nothing.”
Those who have substantial savings did it by denying themselves new cars, meals out, expensive homes and fine new furniture, vacations abroad. They ate beans and rice and hamburger helper prepared in kitchens that haven’t been renovated since 1939, shop consignment stores for clothing, and drive the 12-year-old Honda Civic for another year so that they don’t have to be dependent in their old age. I know these people- they are the people who live in a 1963-vintage 1000 sq ft split level in an un-trendy suburb but have their houses paid off by age 35.
We used to be a country of such people, and it was their SAVINGS that drove the incredible industrial boom of the 50s and 60s. We need for many, many more people to be saving much larger portions of their incomes if we are ever again to see the kind of industrial development we had in the early and mid-20th century. We will never see that kind of development in an economy built on borrowed money used for short-term investments in flipping more financial products around, and we will never see it in a country that punishes savers while rewarding deadbeat borrowers and financial swindlers.