As the first quarter report released from the Office of the Comptroller of the Currency and The Office of Thrift Supervision grabbed headlines with happy talk regarding the encouraging data about a 55% increase in loan modifications, a different study on foreclosure and modification activity in the second quarter provided data that wasn’t nearly as cheerful.
The picture provided by second-quarter mortgage data, however, shows that progress so glowingly referred to in the first quarter may take much longer than anticipated to gain any meaningful traction. It is also raising the possibility that the government, banks, and mortgage investors are do not have the right strategy to effectively deal with the growing foreclosure debacle.
Overlooked by the Bush Administration while throwing hundreds of billions of dollars at failing financial institutions, residential foreclosures increased at an unchecked pace to the point where they now have become one of the biggest obstacles to turning the economy around. Originally convinced that foreclosures would be contained to the riskiest of the subprime borrowers, Bush never paid much attention to the growing plight of homeowners. Evidence of the administration’s apathy toward the foreclosure issue can be found by looking at the results of their only homeowner based initiative, Hope for Homeowners (H4H). The program, which was originally touted as a solution for 400,000 struggling homeowners, ultimately resulted in the origination of one (not a typo) mortgage.
Arriving on the scene with foreclosures already out of control, the Obama Administration introduced The Making Home Affordable Plan in late February with its emphasis on home loan modifications, refi’s, and incentives paid both to homeowners and their lenders when those modifications were successful. Preliminary data from the second quarter indicates that the program has a long way to go to get anywhere close to its objective of helping between 4 and 5million homeowners. In fact, a study out of Valparaiso University shows that loan modifications on subprime and Alt-A mortgages held or serviced by Wells Fargo, Bank of America, Chase Home Finance, and Litton Loan Servicing actually declined in the second quarter, never reaching the high made in February of over 23,000 modifications. It should be noted that the fastest growing category for foreclosures, prime mortgages, is not included in the Valparaiso study.
One statistic in the study stands out among the rest and could change how home loan modifications are constructed in order to keep borrowers in their homes. That data is provided in the June foreclosure sales which show that in almost 32,000 sales, the average loss was 64.7 percent of the original loan balance. On average, with loan balances starting at $223,000, homes were sold at auction for $79,000, a loss of $144,000.
That statistic, should it stay relatively constant, will bring two issues to the forefront:
1) What is the difference between the stated and actual value of mortgage based assets on the books of lenders and investors?
2) Could principle reductions as part of a home loan modification deliver better returns to investors than foreclosure and sale?
Also bearing on that statistic is that the losses on the sale of foreclosed properties are getting bigger as the supply of foreclosed properties increases. In November of 2008, the average loss came in at 56.1% of the outstanding mortgage balance. It has grown steadily since then as more properties have come to the auctions. Whether that trend continues or stabilizes, when weighed against losses coming in at roughly two-thirds of the original value, principle reductions ranging from 10 to 30% of the mortgage value look like a steal for investors. Added benefits include:
* Less severe value mark downs
* Mortgage interest being charged at a higher base
* The avoidance of damage to the property whether done intentionally by (soon to be) former owners or from neglect.
* Modifications which include principle reductions perform better than other modifications
The June numbers are persuasive here as well, as principle reductions resulted in $45 million in losses due to the write-down of principle, interest, and/or fees. That seems like a large number until it’s compared to the $4.59 billion in losses incurred at the sales of foreclosed properties. As attitudes toward principle reductions inevitably change, it may come down to a decision for investors between the lesser of two evils. Judging by the small amount of principle reductions so far it may take a while for them to be seen as that lesser evil but it looks like their time is coming.