The Wall Street Journal has a page one story today on the role of resets in the supbrime mess. While the story mainly covers familiar ground, it does have some new bits of information, and I’ve excerpted them below.
One item is that the profile of troubled borrowers is shifting from ones resulting from “higher frequency of fraudulent loans…and loose underwriting” to ones triggered by ARM resets. While there were doubtless some con artists who availed themselves of cheap credit, for the most part, “fraud” is code for stated income loans. As Tanta at Calculated Risk has pointed out, while a full-doc loan that went outside the bounds of normal loan to income ratios would not only require extra review internally, but would also show up in regulatory reports, while no docs not only get rid of all that inconvenient paperwork, but also make the borrower liable for his income representation.
There probably isn’t enough data yet, but I wonder what proportion of resetting loans will default. The most granular and thoughtful analysis came from Christopher Cagan at American CoreLogic in March, but its assumptions are out of date.
From the Journal:
Next year, interest rates are set to rise — or “reset” — on $362 billion worth of adjustable-rate subprime mortgages, according to data calculated by Bank of America Corp.
While many accounts portray resetting rates as the big factor behind the surge in home-loan defaults and foreclosures this year, that isn’t quite the case. Many of the subprime mortgages that have driven up the default rate went bad in their first year or so, well before their interest rate had a chance to go higher. Some of these mortgages went to speculators who planned to flip their houses, others to borrowers who had stretched too far to make their payments, and still others had some element of fraud….
Banc of America Securities, a unit of the big Charlotte, N.C., bank, estimates that $85 billion in subprime mortgages are resetting during the current quarter, and the same amount will reset in the first quarter of 2008. That will rise to a peak of $101 billion in the second quarter. The estimates include loans packaged into securities and held in bank portfolios.
Larry Litton Jr., chief executive of Litton Loan Servicing, says resetting of adjustable-rate mortgages, or ARMs, has recently emerged as a bigger driver of defaults. “The initial wave was largely driven by a higher frequency of fraudulent loans…and loose underwriting,” says Mr. Litton, whose company services 340,000 loans nationwide. “A much larger percentage of the defaults we’re seeing right now are the result of ARM resets.”
More than half of the subprime delinquencies and foreclosures this year involved loans that hadn’t yet reset….
The majority of subprime ARMs due to reset next year are so-called 2-28 loans, which carry a fixed rate for two years, then adjust annually thereafter….
Besides the $362 billion of subprime ARMs that are scheduled to reset during 2008, $152 billion of other loans with adjustable rates are set to reset, according to Banc of America Securities. The other resetting loans include “jumbo” mortgages of more than $417,000 and Alt-A loans, a category between prime and subprime. The latter category is the riskier, in part because it includes borrowers who provided little or no documentation of their income or assets…
The mortgage industry opposes a blanket move to modify loans that are resetting, says Doug Duncan, chief economist of the Mortgage Bankers Association. While modification may make sense in some cases, he says, it may also simply postpone the inevitable or reward borrowers who didn’t manage their finances wisely. Mr. Duncan says the industry is working with government officials and consumer groups to develop principles that could be used to determine quickly who qualifies for a modified loan.
The political efforts are aimed at keeping the U.S. economy out of a housing-triggered recession. The Mortgage Bankers Association estimates that 1.35 million homes will enter the foreclosure process this year and another 1.44 million in 2008, up from 705,000 in 2005.
The projected supply of foreclosed homes is equal to about 45% of existing home sales and could add four months to the supply of existing homes, says Dale Westhoff, a senior managing director at Bear Stearns. This is a “fundamental shift” in the housing supply, says Mr. Westhoff, who believes that home prices will drop further as lenders “mark to market” repossessed homes.
Foreclosed homes typically sell at a discount of 20% to 25% compared to the sale of an owner-occupied home, analysts say. Lenders are eager to unload the properties, and the homes tend to be in poorer condition….
The big concern is a vicious cycle in which foreclosures push down home prices, making it more difficult for borrowers to refinance and causing more defaults and foreclosures.
