December, 6 2009 | markmti
Happy Holidays. This reports contains material from various 2009 Mortgage Pages reports and is a great segue into 2010 events. Talk to you then. Mark Hanson
Why Millions More Homeowners are At -Risk than Most Think
- Up to 20 Million Borrowers may be in Imminent Risk
- What 50% DTI Really Means Relative to Time-Tested 28/36
- Going Exotic in Plain Sight
- Borrower’s Always Borrowed the Max
- The GSEs – A Culture of Fraud
- Affordability – Out of Control
- HAMP – More Exotic Than Bubble-Year’s Loans
Our mission is to provide our clients a significant edge. This is done by turning the daily, market-moving real estate and mortgage news flow and events into old news by the time it makes headlines. – Mark Hanson
- Overview – Millions More Homeowners are At -Risk than Most Think
Most look to loan type and equity position as two of the most important factors when forecasting loan default. In fact, I believe that epidemic negative-equity is the overarching reason that the default, foreclosure and housing crisis remains in the early innings. But…negative-equity with a caveat.
While negative equity is a threat in and of itself, being in an over-leveraged household debt position is the true default catalyst for most in a negative-equity position. And being over-leveraged is also the primary default catalyst for those is a positive equity position. Being in a negative-equity position with lots of top line and disposable income each month is generally more of a mental burden than a reason to fly the coop.
How many homeowners are over-levered and at imminent risk of default? This answer is…a lot more than most think, especially those who got a loan from 2003-2007 due to a radical, yet subtle shift in loan guidelines across the mortgage spectrum that kicked-off the bubble-years.
Yes, even Prime full-doc borrowers in 30-year fixed mortgages with 20% equity who got their purchase or refi from 03-07 are at much greater risk than most think. Being over-levered was condoned – all the lenders, investors and loan programs operated in the same manner.
In my research, I often assume that everybody knows the subtle idiosyncrasies of how loans are really structured. I understand this is not the case. So, in an attempt to highlight why the total residential mortgage risk exposure is so much greater than anybody’s expectations, this report drills down on Prime, Alt-A and Subprime allowable debt-to-income (DTI) ratios that were made ridiculously lax relative to pre and post 2003 – 2007. This, in my opinion, is the real tempest in the mortgage teapot that buckets millions more loans that are still in existence today across all loan types, as risky.
- Time-Tested DTI Standards Thrown out the Window
A long time ago in a mortgage market far, far away (circa-2000 and before!) there was responsibility in lending. Age-old underwriting standards only allowed fully-documented debt-to-income ratios of 28% for housing and 36% for total debt (referred to as front and back DTI). On Jumbo loans, the ratios were 33/38 because Jumbo borrowers typically have more disposable income. On occasion, banks would make exceptions to this rule if the borrower had a large equity position or liquid reserves. At 28/36, homeowners can pay debt, shop, take their annual vacation, and even save money. At 28/36 DTI a house is a place to live first and an investment, second.
Bubble year’s loan guidelines not only pushed the boundaries of risk by exotic loan structure but also income leverage. Circa-2002, time-tested DTI standards went out the window. Allowable DTI ratios on Prime loans rose to 50% and much higher when considering that so many loans were made with limited or no income documentation. Alt-A and Subprime full-doc loans would routinely go to 55% DTI…and full-doc are supposed to be the safe loans. Given that full-doc only represented 50% of Subprime and 25% of Alt-A loans it is understandable why these two loan types are experiencing the worst trouble, even though across the Alt-A universe the average FICO was above 700 at the time of origination.
Around this same time, the investment bank’s participation and non-Agency lending and securitization began to really heat up. Guidelines expended further…hey, if the loan was going to be off the books in a few months, who cares how over-leveraged the borrower is.
- Going Exotic in Plain Sight
Before too long — circa-2003 — lending guidelines were fundamentally changing with many lenders allowing leverage through increased DTI ratios never seen before. Obviously, this expanded affordability sharply. When all of a sudden you can spend 50% of your gross income on debt vs 36% before, you can afford to buy much more house or take a much larger cash-out refi.
Subtly changing loan guidelines by raising the allowable DTI on traditional loans, such as a 30-year fixed, was a more sneaky way of easing credit and going exotic than blatantly advertising for ‘no doc’. In fact, 30-year fixed loans and the borrowers that chose them were deemed to be so safe, the underwriting was much more lax than on an exotic structured loan, such as a Pay Option ARM.
By 2004, as property values pushed house prices to levels that were unaffordable and stated income was not the norm yet, the new-normal in mortgage lending was allowing up to 50% of gross income to go to total debt. The mortgage obviously was the largest chunk.
And remember, the 50% is only mortgage PITI and other debt listed on the credit report. It does not include income taxes, auto insurance, food or all the other things that individuals spend money on over the period of a month.
And it didn’t stop there. As the mortgage credit strengthened the borrower’s credit profile, other credit was made available, including second mortgages, that could take total DTI far above 50%. Nevertheless, at 50% DTI, the house becomes the largest investment of a person’s life because there is no way for most to put out half of their gross income to debt each month and invest elsewhere.
- Borrower’s Always Borrowed the Max
When buying or refinancing, most got a purchase or refi loan for as much as their banker or Realtor said they could, which was what 50% of their gross income paid for in most cases. Most borrowers don’t say “we know we qualify for $500k but just to make sure we have some wiggle room in our budget, let’s stick to a $400k loan”. Bottom Line – everybody borrowed too much because all of the lenders and loans — from the safest full-doc Prime loans to Subprime trash — allowed it. And after the fact, most expanded their credit portfolio because all credit was so easily attained until a couple of years ago.
- GSE Loans – A Culture of Fraud
During the bubble years the GSE’s looked at DTI secondarily to credit score, LTV, and cash reserves as measured by liquid cash and 70% of retirement. Both Fannie and Freddie have automated underwriting systems called DU and LP respectively. During the bubble years, if the LTV was low enough and/or score and cash reserves high enough, the system would approve virtually anything.
Many lenders, especially the big banks, had in-house DU and LP underwriting ‘trainers’ that would go around to the various mortgage branches and teach underwriters how to ‘trip’ the systems in order to achieve automated loan approvals when a declination was certain, or simply get fewer approval conditions on a loan that was borderline. Getting a loan approval out of DU/LP on a borrower with a 100% DTI — with limited documentation required on the automated findings — was not uncommon.
In fact, many that needed to pump up a borrower’s strength who was light on income — instead of lying about the income — would pump up another aspect of the loan. The most common was to increase the borrower’s cash reserves, particularly retirement. This way, the retail sales worker buying a house well beyond their means would not need an obviously fraudulent income level, rather a believable household retirement total of maybe $100k. Doing it this way simply raised fewer red flags for the underwriter and investor.
Few Loans Were Ever Denied at First Pass
During the bubble years, very few loans were ever denied. Denying loans was not ‘production oriented’. The culture across all lenders was to ‘approve everything subject to’. If you did not do it this way, your competitors would get all of the business.
The approval process was for the underwriter to run the loan through DU/LP and if the system did not issue an approval (or an approval the borrower and the loan officer were happy with) to go back into the input file and edit the income, assets, retirement (or all three) until the system approved it. Some loans were edited 30 or 40 times until the GSE system issued an approval.
Then, the approval was sent out to the borrower and loan officer even if it required them to verify $100k more in retirement reserves than the borrower had per the original loan application. Within a few days, a new back-dated loan application and a retirement account statement reflecting adequate reserves would arrive, the underwriter would sign it off and the loan would be on its way to the doc department. There was no way to verify if the document was a fake, unless it physically looked altered. In many cases the borrower never even knew this was happening.
Note – this process was not GSE exclusive…this is just how it was done across all lenders.
- Affordability out of Control
Then circa late-2004, as affordability declined sharply even with 50% DTI the norm, stated income came into play in a big way. This super-charged affordability and house prices in ways we will never see again in our lifetime.
Stated income was around for years prior but limited to verified self-employed borrowers. The new-era Stated income loan allowed anyone with a two year job history to get a loan. All of a sudden, everybody earned $150k a year. From then on, the housing market had no shortage of purchases, cash-out refinances or HELOCs and house prices never looked back…well, until the exotic loan programs went away in late 2007.
Circa early-2006 when it became obvious that Stated income was being abused because everybody (hair dressers, public sector workers, and anyone that said they were self-employed for two-years and could provide a fraudulent CPA letter that the lender never verified) suddenly was earning $12k a month, lenders became more cautious.
What was the answer? Begin to push Pay Option ARMs with low teaser rates and payments. This way the borrowers could earn less so their fake income looked more believable. In addition, this is about the time that No Doc and No Ratio doc type options began to show up on every lender’s rate sheet, which provided the ultimate in plausible deniability.
Bottom line - 80% of all Alt-A (including Pay Options), 50% of Subprime, 50% of Jumbo Prime and 30% of Prime loans from 2003-2007 were limited documentation loans for a reason – because the borrowers didn’t even have the 50% DTI needed for full doc.
- How Big is the Total At-Risk Mortgage Universe?
Of the loans in existence today at least 75% were refinanced or attained through a purchase from 2003-2007 – the bubble years. On several occasions in the past couple of years, Jim Cramer has quantified the at-risk loan universe as being around 14 million, which represents everyone who purchased a home between 2005-2007. But then he says ‘”here is no way everybody who bought a house from 2005-2007 will ever default”. So, he pairs it back to 20% or 25% of 14 million – whatever. He is incorrect on a number of levels.
First off, the bubble years were really 2003-2007. But aside from that, the number of people who purchased a home is only a small piece of the entire pie. The bubble years was not about purchases, rather refi’s. During the bubble years refi’s, cash-out refi’s and HELOCs were at least 4:1 over purchases. A purchase is no more risky than an existing homeowner with a great payment history who pulled out 90% or 100% of their equity at a 50% DTI. In fact, the latter are more risky…purchases in general are always considered the safest loans.
This means the true potential at-risk loan universe is any Prime, Alt-A, or Subprime borrower that did a purchase or refi from 2003-2007. Obviously, not every single borrower is at-risk but we have no way of really knowing how many of the 43 million + loans from that period still in existence today are destined for trouble. This is especially true when even borrowers with 800 scores and 70% LTV’s are at risk of default because their DTI started out at 50% and after the fact, they expanded their credit portfolio because all credit was so easily attained until a couple of years ago.
- 13 to 15 Million Loans at Imminent Risk of Default
- Potentially, 20 Million Homeowners over the Next Few Years
The chart below breaks out all of the loans in existence by loan type. Of the loans originated during the trouble years, the far right columns show the conservative number of loans in which the borrowers either borrowed at 50% DTI or went Limited Doc (stated income, light doc, no doc, no ratio). The two columns are not mutually exclusive.
The last Mortgage Bankers Association report estimates that the total number of loans in some sort of delinquency, default, or foreclosure status to be about 8.2 million, or 14.41% of all loans. If the true number of Imminently at-risk loans is somewhere between 13 and 15 million, the default and foreclosure crisis is about 60% over.
The problem with the final 40% is that it crushes everyone other than Subprime households and likely happens over a longer period of time than the two-year Subprime Implosion.
In addition to the imminent defaulters, a large percentage will default for various unforeseen reasons tied to the macro. Throw in top strategic defaulters and we could easily see a situation over the next few years in which 20 MILLION homeowners are either delinquent, defaulted, or in the foreclosure pipeline.
- What a 50% DTI Really Means
- Time-tested 36% DTI Means 60% MORE Disposable Income Each Month
1) What a 50% DTI Really Means?
Borrower Earnings: $100k per year
50% Total DTI: $50,000 per year to housing PITI & all other debt on credit report
25% Fed & State Taxes: $25,000 per year
Disposable income: $25,000 per year, or $2,083 per month
How does this well-above average household SAVE MONEY AND pay for utilities (power, water, cable, garbage, insurance (car, life, health), gas, food, car payment, fuel, clothes, household maintenance and more on $2,083 per month? How do they save an emergency fund or take even a drive-away trip for the weekend?
How do they shop this holiday season when over a trillion dollar in consumer credit was taken away in the past year?
A 50% housing DTI turns the house into the largest investment of your life and ruins most household’s balance sheet at the same time unless the gross income — and disposable income — is much larger.
For most in a serious negative equity position, it is better to walk away. Earning your way out of a $200k hole is impossible with disposable income of $2,083 per month less expenses. Why not walk – the borrower’s credit will be trashed for a few years but as long as they maintain their credit rating on all other credit, their overall rating will not be damaged for as long as their house remains underwater.
2) Now, let’s look at this with 28/36 time-tested debt-to-income ratios.
Bottom Line - 60% MORE disposable income each month.
Borrower Earnings: $100k per year
36% Total DTI: $36,000 per year per to housing PITI & all other debt on credit report
25% Fed and State Taxes: $25,000 per year
Disposable income: $39,000 per year or $3,250 per month
With $3,250 per month, a $100k household can likely save $20k per year. Still, this is not enough to make a real dent in a $200k neg-equity position. But, with this much disposable income the homeowner is not missing out on much and they are saving money, meaning their house is a place to live.
What do households spend money in every year? The U.S. Census bureau provides the answers:
• $200 billion on furniture, appliances ($1,900 per household annually)
• $400 billion on vehicle purchases ($3,800 per household annually)
• $425 billion at restaurants ($4,000 per household annually)
• $9 billion at Starbucks ($85 per household annually)
• $250 billion on clothing ($2,400 per household annually)
• $100 billion on electronics ($950 per household annually)
• $60 billion on lottery tickets ($600 per household annually)
• $100 billion at gambling casinos ($950 per household annually)
• $60 billion on alcohol ($600 per household annually)
• $40 billion on smoking ($400 per household annually)
• $32 billion on spectator sports ($300 per household annually)
• $150 billion on entertainment ($1,400 per household annually)
• $100 billion on education ($950 per household annually)
• $300 billion to charity ($2,900 per household annually)
The average homeowner household spends $22,785 per year, or $1900 per month on the above. When making an allowance for some of the items that are typically financed, the outgo is still roughly $1500 per month.
At 50% DTI, the $100k earner with a disposable income of $2083 per month will have extra monthly income of $583 based upon typical spending. That does not leave a lot for savings, or items not listed such as auto insurance, vacations, gas etc. That definitely is not enough to ‘earn their way out’ of their negative equity hole.
However, the 36% DTI borrower will have an extra $1750 month, which allows for living life and saving money, significantly reducing the chance of loan default due to negative-equity..
Bottom Line - This shows vividly why 50% DTI — even with borrowers making $100k a year and with 20% equity in their property — is in fact over-leveraged and a recipe for loan default for any number of reasons.
- HAMP — More Exotic than Bubble-Years Loans
Now you know why I have been calling HAMP “the most exotic loan ever created” since its inception.
But from the HAMP headlines you could not tell. All that is ever focused upon is the 31% DTI. But that is the front DTI…the housing-only DTI. If you read the guidelines, the back DTI (total debt) allows borrowers to go to 55%!
In fact, if the borrower’s DTI is over 55%, the borrowers are required to go to credit counseling. A little news for ya – a borrower paying out 55% of their gross income to debt does not have time for credit counseling because they have a second job.
Bottom Line: HAMP was designed to lower ‘payments’ for underwater borrowers, but also designed to suck every bit of disposable income every month to the bank. Being underwater in a high-DTI situation is the recipe for default, so it is no wonder the program is not performing as thought.
Borrower’s realize this and are simply using the HAMP multi-month processing and approval process as a way of staying in their home rent-free for a longer period of time. At the end of the day, those that do make it to a permanent mod — but have a high back DTI — will ultimately fail.
For a small percentage of those that fit the HAMP sweet-spot, it is great and absolutely the right medicine. However, at what cost? For many that can technically afford the house and would have gone on paying for 30-years — but can’t qualify for a new-vintage refi — a pre-meditated loan default and subsequent HAMP mod is an easy route to a government subsidized no cost refi.
For all of these reasons and more, I believe HAMP will be fundamentally changed in 2010, perhaps to finally include principal balance reductions. Principal reductions are the only way many modifications will stick. I hate the idea of any gov’t interference, but if they are going to be spending hundreds of billions anyway, they may as well target it.
But I think the stronger possibility is that HAMP will be wound down due to its lack of effectiveness…they have the cover to do so now, as the lion’s share of borrowers are doing a terrible job returning the required documentation in a timely manner if at all. I do not believe there will be a fundamental change in the program, such as significantly easing the qualifying guidelines or allowing borrowers to qualify without income documentation, in order to drive a larger number into the program. It is quite possible that the new HAFA program will replace HAMP as the primary focus in 2010 and beyond, as the can his been kicked so far it finally hit a brick wall. I endorse HAFA to the fullest extent.
I also believe that HAMP will be ultimately responsible for a sizable wave of foreclosures beginning in the near-term from those who do not make it through their trail period, which as of recent data, is most. With foreclosures averaging 80k a month for the past six months and 700k foreclosures held up in the pipeline due to HAMP, even a trial mod failure rate of 40k a month would increase foreclosures by 50%.
However, this is housing market bullish. The biggest threat to the housing market in 2010 is a lack of distress inventory, which is some states still makes up 70% of all sales. Foreclosures are what is in demand and the biggest unintended consequence of HAMP is that it’s keeping those who can’t afford their houses in them and others that can afford — and want to buy them — away.
- Fannie Mae to Tighten DTI Guidelines
Lastly, the following story talks about a recent move by Fannie to raise minimum credit scores and to lower the max allowable DTI to 45%. Operating in a pro-cyclical manner like this will suck major liquidity out of the mortgage and housing market, but will make for safer loans in the future. It is also validation that DTI and household leverage — something rarely focused upon any any analysis I have ever read — is beginning to get the attention it deserves.
Fannie Mae to Tighten Lending Standards: Report
Published: Thursday, 26 Nov 2009 | 6:40 AM ET
By: Reuters
Fannie Mae plans to raise minimum credit score requirements next month and limit the amount of overall debt that borrowers can carry relative to their incomes, The Washington Post reported on Thursday.
Starting Dec. 12, the automated system that the government-controlled mortgage finance company uses to approve loans will reject borrowers who have at least a 20 percent down payment but whose credit scores fall below 620 out of 850, the newspaper reported. Previously, the cut-off was 580.
Also, for borrowers with a 20 percent down payment, no more than 45 percent of their gross monthly income can go toward paying debts, the newspaper said.
A Fannie Mae spokesman told the newspaper that the limits reflect the company’s recent experience.
Loans to people with credit scores below 620 fell seriously behind at a rate approximately nine times higher than other loans purchased in the same period, Fannie Mae spokesman Brian Faith said.
Loans taken out by borrowers with lots of debt also suffer higher levels of serious delinquency, he said “It’s not enough to help borrowers buy a home — we must also ensure that they can stay in the home over the long term,” Faith said in a statement to The Washington Post.
Copyright 2009 Reuters.
http://www.cnbc.com/id/34162049
Have a great Holiday Season.
Best Regards,
Mark Hanson
This document is for your private information only. In publishing research, Mark Hanson and M Hanson Advisors are not soliciting any action based upon it. Mark Hanson and M Hanson Advisors publications contain material based upon publicly available information, obtained from sources that we consider reliable. However, Mark Hanson and M Hanson Advisors does not represent that it is accurate and it should not be relied on as such. Opinions expressed are current opinions as of the date appearing on Mark Hanson and M Hanson Advisors publications only. Mark Hanson and M Hanson Advisors are not liable for any loss or damage resulting from the use of its product. Mark Hanson and M Hanson Advisors are Limited Liability Corp registered in CA.
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December, 3 2009 | markmti
The following is an excerpt from The Mortgage Pages research series on 11-13-2009.
- Los Angeles County – YEARS of Mid-to-High End Shadow Supply
Our mission is to provide our clients a significant edge. This is done by turning the daily, market-moving real estate and mortgage news flow and events into old news by the time it makes headlines. – Mark Hanson
Yesterday, LPS put out its national monthly default and foreclosure report confirming what we already knew — that actual foreclosures are being held artificially low while banks and servicers shoe-horn anyone with a heartbeat into a trial mod putting off the years of reckoning ahead. (
LPS report link)
This report is a great flip-through overall, but pay special attention to pages 31-33. The cut out below is of page 32, LA County. What this says is that based upon the current foreclosure-related inventory, potential inventory and sales rate for houses valued at $500k and above there is:
- 115 months potential supply based upon the number of props at the 90+ delinquency stage
- 71 months potential supply based upon the number of props at the foreclosure stage
- 62 months potential supply based upon the number of prop at the REO stage
(supply estimates do not include houses already listed on the MLS and counted in the Realtor Association’s supply estimates other than a portion of the REO bucket – this is ADDITIONAL supply)
However, when you move down price bands to $250k and below, there is hardly any supply – only a few months. This sums up the CA Real Estate market(s) perfectly. The “buyer frenzies” you hear about are in the price bands in which there is no supply while the mid-to-upper end price bands are in turmoil.
BUT, I do not completely agree with the methodology here. Counting potential inventory using supply in the foreclosure pipeline is solid – we have been doing that since this all began. However, I think LPS is far too aggressive because they are comparing supply (REO) and potential supply (90+ & FC) with specific distressed purchase counts for that supply stream.
What they should have done is take the supply and potential supply and divide by Total Residential Sales. This decreases the Months Supply significantly but is likely closer to reality based upon current sales rates and what sales rates would be if the supply was on the market at distressed prices. (see page 2 for my revised charts using this methodology)
The chart below is of the same supply and potential supply data, but divides the data by Total Residential Sales to come up with more realistic Shadow Inventory estimate for LA County.
At the 90-days late (NOD) stage there is 31 months of potential supply for houses valued at $500k and above. Obviously, not all 90-day lates will end up as short sales or foreclosures, just most of them. At the Foreclosure (Notice-of-Trustee Sale) stage there is 19-months of supply. Once again, most of this will end up as for-sale housing supply.At the REO stage inventory drops considerably to just over 5-months for reasons we all know.
Bottom Line - Based upon housing supply in the foreclosure pipeline, which is greater than ever before, the CA housing market has a long way to go until it finds its true bottom, especially at the mid-to-high end. By not including potential supply from the foreclosure pipeline in analysis, traditional economists looking at historical primary indicators such as Housing Starts and Building Permits, which are dwarfed by foreclosure starts, will continue to miss.
I often run similar analysis on various MSA and most regions in the all-important bubble states look similar to Los Angeles County.
Best Regards,
Mark Hanson
This document is for your private information only. In publishing research, Mark Hanson and M Hanson Advisors are not soliciting any action based upon it. Mark Hanson and M Hanson Advisors publications contain material based upon publicly available information, obtained from sources that we consider reliable. However, Mark Hanson and M Hanson Advisors does not represent that it is accurate and it should not be relied on as such. Opinions expressed are current opinions as of the date appearing on Mark Hanson and M Hanson Advisors publications only. Mark Hanson and M Hanson Advisors are not liable for any loss or damage resulting from the use of its product. Mark Hanson and M Hanson Advisors are Limited Liability Corp registered in CA.
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November, 14 2009 | markmti
The report was first released to clients as part of The Mortgage Pages series on November 12th, 2009. Think of this report as more of a summary rant derived from a couple of years of exhaustive research on the sector.
Mid-to-High End Housing and Borrower Reality
- A Slower Moving Train Wreck
- Price Dumping & Short Sales Destroy Neighborhoods Just Like Foreclosures
- A $1 Million House is Now the House of a Millionaire
- Mid-to-High End Reminiscent of 2007 Broad Market Conditions
- Mid-to-High End Isolated – HOGWASH
- Extreme Leverage in this Sector
Our mission is to provide our clients a significant edge. This is done by turning the daily, market-moving real estate and mortgage news flow and events into old news by the time it makes headlines. – Mark Hanson
Mid-to-High End Mortgage & Housing Market – A Slower Moving Train Wreck
One market segment that will not catch fire from anything being done is the mid-to-high end (MTH). This is where the next crisis is building right now. Only significant house price depreciation and sustained low rates can spur sustained sales in this market segment.
Many are counting in large part on the MTH homeowner carrying the housing market, consumer spending, and the broader economy straight into a full-blown economic recovery.
That is a lofty premise if they are talking about the same MTH borrower with whom I worked for years as a West Coast mortgage banker; who are my neighbors, friends, and family, as an MTH CA resident; and whose loan performance I track daily across all originators and servicers through our proprietary data.
Contrary to a growing recent popular opinion that the MTH homeowner is feeling great, it remains my strong opinion that the negative wealth-effect across the MTH homeowners remains powerful, increasing especially over the past few months as end-of-season price dumping and increased short sale activity continued to push prices lower.
The reason why the MTH has not tumbled in the same fashion as the lower price bands is simply because this group of Jumbo Prime, Pay Option and Interest Only borrowers have a) much more leverage-in-finance with loans such as the Pay Option ARM making up a large percentage of the total b) loans that were structured with interest only or neg-am teasers that typically last a minimum of 5-years vs 2-years on a Subprime loan c) more options available to them such as cashing in retirement to keep kicking the can d) more stable employment e) a better chance of qualifying for a mortgage mod.
Bottom Line – the MTH is a slower moving train wreck, which in the macro may be worse than the way Subprime imploded. Subprime borrowers who got wiped out a couple of years after getting their 2/28 are way down the de-levering road — renting a property and living within their means, which is when spending can begin again if they chose. At the end of the day, defaults and foreclosures across the MTH will be in the double digits with a respectable number in front, but stretched out over a longer period of time pressuring this housing and borrower segment for the duration.
The Mid-to-high end collapse will keep its borrowers financially strung out for years, as conscientious home owners sell other assets or cash in retirement to keep making payments while others opt for a pro-bank mortgage mod in which most of their disposable income each month goes to repay their massively underwater monument to stupidity. Some that simply bought at the wrong time with larger down payments, perhaps most of their savings — and who have seen all of their equity evaporate — will opt to earn their way out of it, which is a long process during which spending is restrained. Still, many will choose the route of default and foreclosure because with negative-equity so extreme in the MTH, they are renters anyway, unable to refi, sell or re-buy, and foreclosure is the fastest road to household balance sheet recovery.
Price Dumping & Short Sales Destroy Values Just Like Foreclosures
Make no doubt about it…peak-to-trough the MTH has been devastated in the past year. Millions who purchased, refied, or took out HELOCs on the way up, at the top, or moving back down the other side are in such a serious negative-equity state there is no traditional way out.
The hot period for MTH Real Estate was 2003-2007. During this time 75%-80% of all houses either a) changed hands b) were refinanced (including cash-out, which increasing the loan balance c) were built and purchased for the first time d) or leveraged further through the addition of a second or third mortgage. Yes, the potential at-risk population is the vast majority of MTH owners.
Later in the 2009 season we finally saw more MTH houses turn-over but at sharp discounts or on short sale. Unlike the low end of the market the increased activity was not spurred by a surge in buyer demand, rather due to end-of-season seller panic and increased short sale activity. That being said, there is pent-up demand for this sector at the right price. The problem is that the right price on one sale destroys the net-worth of scores more. This type of increased activity in the earlier innings of the MTH collapse is not a positive market factor because it sets comps and locks-in values for everybody.
Bottom Line – price dumping and short sales destroy neighborhoods just like foreclosures. In fact, they are a leading indicator to house price deflation, defaults and foreclosures. Remember, for every person who gets a ‘great deal’, scores more are thrown into a negative-equity or greater negative equity position exponentially increasing their likelihood of loan default. This sector is a negative-equity time-bomb across all loan types, even 30-year fixed.
A $1 Million House is now the House of a Millionaire
A $1 million house is now the home of a millionaire…someone who can put down $270k and show proof of over $200k per year income for the past few years. Oh, and a 740 credit score is paramount. Unlike the bubble years when a $1 million house could be purchased by a moderate income household — one working as a checker at Safeway and one a mailman (both great jobs with a combined gross income of over $100k) — now the buyers must be rich.
There are far more MTH houses on the MLS — and coming at the market in the foreclosure pipeline — than there are rich buyers who a) do not already own b) who are liquid enough to be able to buy a new house and rent their present house c) or that are in the enviable equity position to be able to sell, pay a Realtor and put a large down payment on their new house.
Mid-to-High End Reminiscent of 2007 Broad Market Conditions
In the mid-to-upper end price bands, the same market dynamics are in play right now as were in the broader housing market in 2007. This market segment has absolutely gone over the top of the mountain and has begun its steep descent down the other side. In fact, there are more Notice-of-Defaults each on Jumbo loans each month in CA then houses sold in the Jumbo price range. The house price compression over the next year or two will be so severe it will undermine any stability found in the low-to-low mid bands especially if stimuli are removed.
In the MTH the foreclosure pipeline has never been as full. But just like with the lower end, the foreclosures have been held back as banks try to retrofit every borrower with a mortgage mod. To date, most MTH foreclosures have only been from a) vacant houses b) those that absolutely do not qualify for a mod c) those that turn down a mod realizing they are better off walking away or in foreclosure. This is changing fast.
The Bottom Line is that MTH foreclosures and foreclosure starts have been held down artificially, no doubt. This is because of the national foreclosure prevention programs but also because more Jumbo whole loans are owned by financial insti’s as portfolio loans. This allows the bank the flexibility to do what they want unlike Agency or Subprime loans for example serviced for others, such as an MBS investor. They always fight harder when it’s their own money on the line — think of Jumbo sort of in the same fashion as commercial but to a lesser extent with respect to tampering by the lien holders.
The negative-equity across the MTH is extreme and high-LTV HELOCs are also common with this crowd. In fact, HELOCs behind Jumbo loans attached to MTH properties can be $250k – $1 million, which is even greater motivation for the banks to kick the can as far down the road as possible.
Because of incurable negative-equity, tumbling rents, and overall harsh reality that they have become a renter in a 5000 square foot house, premeditated defaults are a favorite among mid-to-high end homeowners. For those in a serious negative equity position, a pre-mediated loan default, short sale or deed-in-lieu is usually much better than any alternative because a) they can rent the same house down the street for much less than the cost to own b) leaving the house begins the savings, de-leveraging and credit repair clock c) earning their way out of a $500k negative equity hole is simply out of the question for most.
Mid-to-High End Isolated – HOGWASH
Extreme Leverage in this Sector
Most think the MTH homeowner is somehow isolated from the broader housing market collapse – hogwash. They are more impacted because unlike the low-end hand-to-mouthers, these borrowers may have assets to attach or protect and perhaps something called a budget. Right now in cities across America there are married, working couples in MTH houses sitting around the dinner table saying “honey, we make $150k a year. Why can’t we save any money? Where does it all go each month?”
Jumbo Prime, Pay Options, Interest Only etc loans routinely allowed up to a 50% debt-to-income ratio, even on a 30-year fixed. When purchasing a house or pulling cash out through a refi or HELOC, most borrowed what their banker told them they could qualify for, therefore, a large percentage of mid–to-high end owners with a mortgage are highly levered coming out of the gate. Of the 50% DTI, most goes to the mortgage, taxes, insurance and maintenance. And of course, about half got a HELOC after the purchase taking the DTI to 60%. That does not leave a lot for taxes, food, insurance and every other expense not listed on their credit report let alone robust consumer spending.
But in reality the majority of MTH homeowners purchased or refied with a stated income or no doc feature making it impossible to know the true extent of the leverage across the sector. One thing is for sure…it is higher than if it were full-doc or there would have been no reason so many used limited doc loans.
To think the MTH earner will somehow pull through this unscathed, lead high end retail sales this holiday season, etc is verging on laughable. Yes, stocks pulling off the bottom have likely benefited sentiment. But not to the degree that house prices plunging, their HELOC being shut down from further draws and credit card limits being slashed have hurt it. You can’t easily spend and IRA or 401k at the Good Guys for a home theater system.
Just like most everyone else, a large percentage of MTH homeowners live virtually paycheck to paycheck — they just had more stuff and more debt. Without easy and available credit, this group of homeowners and spenders by and large is as hamstrung as the rest.
What happens to the economy when you knee-cap the MTH earner the same way the low-to-low mid was knee-capped in 2007 when housing first fell off of a cliff? Stay tuned.
Best Regards,
Mark Hanson
This document is for your private information only. In publishing research, Mark Hanson and M Hanson Advisors are not soliciting any action based upon it. Mark Hanson and M Hanson Advisors publications contain material based upon publicly available information, obtained from sources that we consider reliable. However, Mark Hanson and M Hanson Advisors does not represent that it is accurate and it should not be relied on as such. Opinions expressed are current opinions as of the date appearing on Mark Hanson and M Hanson Advisors publications only. Mark Hanson and M Hanson Advisors are not liable for any loss or damage resulting from the use of its product. Mark Hanson and M Hanson Advisors are Limited Liability Corp registered in CA.
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November, 7 2009 | markmti
This report was first published as part of the Mortgage Pages series on August 11, 2009.
- Affordability is the Housing Market’s Red Herring
- Ultimate Affordability-Through-Leverage From 2000 – 2009
- Median House Prices & Monthly Payment Affordability From 2000 – 2009
- Ready Home-Buyer Population Considerably Smaller than Ever Before
- Jumbo Affordability – From ‘Everyone’ to ‘No One’
Our mission is to provide our clients a significant edge. This is done by turning the daily, market-moving real estate and mortgage news flow and events into old news by the time it makes headlines. – Mark Hanson
You hear continually that
‘affordability is through the roof’ after such dramatic house price deprecation across the nation. The affordability factor is an especially important validation metric to speculators in the hardest hit bubble states such as CA. But because most are gauging today’s affordability relative to house prices during the bubble years (“prices are down 50% from the peak!”), it’s not an apples-to-apples comparison. I argue that in this unprecedented time very little is as it appears or can be measured using historical context, especially the bubble years.
From 2003-2007 we saw mortgage and housing risk-taking and leverage conditions that never existed before and won’t for a long time (that is if you don’t count mortgage mods as the most exotic loan ever). Therefore, even after an outright collapse in CA house prices, affordability for like-priced properties today is not as favorable as it was during the bubble years when loans were easy and leverage extreme.
Additionally, the available pool of buyers has shrunken considerably, which is a key element for any meaningful analysis, always left out by the traditional economists. First timers and investors can’t carry this market for much longer. In fact, there are signs right now that these two buyer groups are getting full and negative YoY CA comp sales will be coming soon. That should make for interesting news. This housing market has no comparable.
Ultimate Affordability-Through-Leverage From 2000 – 2009
If houses were most commonly purchased for cash, they are no doubt cheaper relative to income and rents than they were during the bubble. That is why buy-and-rent and flipper investors make up such a large percentage of present day buyers. But household affordability is a different story. Since most owner-occupied buyers finance their house, in order to really compare today’s affordability relative to the bubble years you must also analyze the most popular financing types during each phase of the market.
In CA, from 2000 – 2009 the top financing types changed dramatically from primarily a fixed rate market in 2000-2002; to an interest-only ARM market in 2003 – 2005, which was responsible for the bubble’s first turbo-appreciation period; to a stated income, Pay Option ARM, 100%, and HELOC market from 2006 to 2007, which prevented house prices from falling in 2006; and finally back to a fixed rate market for the past two years, which looks much closer to circa-2001 and prior than any time since.
Below is a nine year chart of the monthly payment amount it took to buy today’s CA median priced house. This chart captures all phases of the mortgage and housing space since 2000 and the affordability-through-leverage that the bubble years provided.
In the past nine years — depending upon which loan program was in favor — borrowing $254k cost anywhere from $1125 per month at the height of the bubble in 2006 during the Pay Option phase to $1970 per month in 2000 at the early innings of the bubble. Today that same home costs $1800 per month. Yes, income has risen since 2000 but household debt levels and unemployment have risen as well. Wages are left out of this chart purposely because compared to the payment increase from 2006 to 2009, the wage gains are insignificant. The bottom line is that like-kind affordability has fallen dramatically in the absence of exotic loans.
- Median House Prices & Monthly Payment Affordability From 2000 – 2009
- The Housing Market is in a Very Fragile State
- Ready Home-Buyer Population Considerably Smaller than Ever Before
Obviously, not every loan made during the various bubble market stages were exotic high-leverage, but enough were to keep goosing prices higher and forcing buyers to chase the market. As prices rose, many kept their personal affordability in check by putting more cash down while others chose exotic loans or zero down. Whatever it took, buyers, lenders, Realtors and builders were there with the solution. Unlike today, high-leverage exotic loans put houses in most communities within reach of the median household income.
Yes, based upon the monthly payment needed to afford the median CA house price today as depicted in the chart below, the traditional definition of affordability is better. But when you factor in total debt load, unemployment and epidemic negative equity — the latter which has sidelined the majority of the move-up buyers indefinitely — the housing market is in very fragile state. There is only one thing that can permanently fix this market…lots of time.
With interest rates relatively low, the monthly payment for the median price house today is even less than in 2000 through 2002, which was when mortgage finance last looked closest to today. However, today’s buyer is much different than before and the available home buyer population is considerably smaller.
With home ownership rates and negative equity as high as they got during the bubble, who is left to take advantage of this new found historical definition of affordability?
You got it — most sales are to the first time homeowner and investor population, who can’t carry the real estate market in their own for very much longer. Throughout history — and especially since 2000 — the move-up buyer controlled the market. With exotic loans, nearly every homeowner could sell and move-up. Even if you had no equity you could sell and get a 100% loan to move up. Now, only the minority of homeowners have that luxury. And even for those organic move-up buyers that do exist today, buying a house is much more difficult with respect to qualifying and the required down payment.
For the sake of not getting too complicated, in the chart below I did not make any allowances for stated income or stated asset loans, both of which provided the ultimate in affordability to anyone with a job for two consecutive years. Over 80% of Alt-A loans during the bubble were limited documentation loans. The effects this had on the affordability factor goes without saying. It is also important to note that the household debt is much greater in 2009 than it was at the beginning of the decade making the amount of household income that can go toward a house payment less.
Interesting observation: In 2002 and again in 2005 when the monthly payment amount for the median house grew to a level that made housing unaffordable, new higher-leverage loan programs came out that brought housing back to an affordable level. Again, the assumptions below are based upon fully documented loans. When stated income loans became mainstream in 2004, it simply allowed the bubble to continue unabated until exotic loans went away in 2007.
Bottom Line: In order to qualify for today’s median house price of $254k a monthly income of approx $5500 is needed with little other debt. In 2006 at the height of the bubble — when Pay Option ARMs made up 25% of all mortgage loans in CA and the median price was $556k — the monthly income needed to legitimately qualify was $6000. In 2003, the income needed to buy the $372k median priced house was only $4900 a month. Now, that is what I call affordability.
Jumbo Affordability – From ‘Everyone’ to ‘No One’
The chart below is the same as the first chart in this report but tracking a $700k loan through the past nine-years of bubble. In 2000 – 2002 and again in 2008 – 2009, the monthly income needed to qualify is $15k, or $180k a year with little other debt. However, at the height of the bubble in 2006 when Pay Option ARMs were en vogue, a household income of $110k per year could legitimately qualify for the same loan amount.
A household income of $110k is not out of question for working couple — one as a checker at Safeway and one a mailman (both great jobs with a combined gross income of over $100k). But, now the buyers must be rich. During the bubble, buyers in this price range were everywhere especially since they could easily sell their present property for the down payment (if needed) for the new house. However, an income of $180k per year needed to qualify today — in addition to a hefty down payment — has reduced the available buyer population dramatically.
Last but not least, a good story came out of the Journal today that highlights the trouble in finding buyers that the housing market faces going forward, although the story focused on stocks. The indented excerpts below are what few consider when evaluating housing affordability. In order to read the full story, click the link below.
AUGUST 10, 2009
Debt Burden to Weigh on Stocks
Consumers’ Inability to Drive Economic Growth Likely to End Big Gains
By E.S. BROWNING and ANNELENA LOBB
“The debt data are striking. According to the Federal Reserve, total household indebtedness peaked at the end of 2007 at 132% of disposable income. That was by far the highest level since at least the end of World War II, nearly quadruple the 36% of 1952. By the end of March, with families boosting savings, repaying debt and defaulting, the ratio had fallen to 124%, a tad lower but still miles from the level of, say, 69% in the middle of 1985.
Consumer spending today accounts for two-thirds or more of economic output. But as they boost savings and cut borrowing, consumers can’t be the drivers of economic growth that they were at the end of other recent recessions.
Consumer borrowing fell in June for the fifth consecutive month. The savings rate, which had fallen below zero in 2005 as a profligate nation spent more than it earned, was back to 6.9% of disposable income in May. It pulled back to 4.6% in June, but as people struggle to repay debt, many economists expect the savings rate gradually to return to the 7% to 10% range of the post-war years.
“Consumers are under significant financial pressure,” Goldman notes in its report. “The weakness in household income — partly resulting from the sharp slowdown in hourly wage growth — will make it harder to raise saving without significant constraints on consumption.”
“In an effort to make sense of the increasingly intense disagreement, Bridgewater Associates, an often-contrarian money-management firm that oversees about $72 billion in nearby Westport, Conn., has recently sent clients a series of reports.
Although the reports are complicated and detailed, their essence can be summarized simply. The optimists see signs that the recession is ending, and they forecast the normal next step: a stronger stock market. The pessimists believe the most important development isn’t the end of the recession, it is the long process of debt reduction by families and businesses. Bridgewater lines up with the pessimists. It has been trying to avoid stocks tied to the U.S. economy in favor of those linked to the emerging economies of the developing world, notably China.
The bulls believe the economic and stock-market recoveries will continue to look like a V. The pessimists fear they will be more like a W — or even a succession of W’s.”
Best Regards,
Mark Hanson
This document is for your private information only. In publishing research, Mark Hanson and M Hanson Advisors are not soliciting any action based upon it. Mark Hanson and M Hanson Advisors publications contain material based upon publicly available information, obtained from sources that we consider reliable. However, Mark Hanson and M Hanson Advisors does not represent that it is accurate and it should not be relied on as such. Opinions expressed are current opinions as of the date appearing on Mark Hanson and M Hanson Advisors publications only. Mark Hanson and M Hanson Advisors are not liable for any loss or damage resulting from the use of its product. Mark Hanson and M Hanson Advisors are Limited Liability Corp registered in CA.
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October, 24 2009 | markmti
Yesterday’s Existing Home Sales number made for good headlines but there was little else to cheer about. In fact, sales once again are following a very predictable seasonal pattern despite massive stimuli being thrown at the market and were down 5.2% from August. This reality is in stark contrast to the “9.5% surge over August” and “sales are at highest rate in two years” plastered all over the headlines.
September’s not-seasonally adjusted results were also in contrast to the past couple months of significant headline press covering the ‘30 offers on each foreclosure‘ and ‘buyer frenzy’ happening all over the nation. The headlines have painted a picture that seasonality is out of the window and it is a buyer’s horse race to the November tax credit sunset. This is just not the case. In fact, September sales in CA were LESS than a year ago, one of the worst years on record for housing.
The following chart shows the past five-year of sales — NOT seasonally adjusted unlike the popular reports yesterday. The seasonality of it all is obvious. In fact, taken in context the booming housing sales ’surge’ and ‘recovery’ looks rather anemic especially considering a trillion dollars was thrown at the housing market through tax breaks, artificial historically low interest rates, and mortgage mod initiatives and foreclosure moratoriums meant to tip the supply/demand balance back in favor of housing. Additionally, new loan defaults are not following the same seasonal pattern, which means in the shadows, supply is building.
The next chart is the same as above but is a cut out of the past three years. The blue boxes represent that past few months when housing sales were actually stronger than the year prior.
In fact during the May to Sept selling season only 45k additional houses sold in total in the US. But when extending that out for the full year, sales are DOWN 20k sales in 2009 vs 2008, one of the worst years on record. In addition, Year-on-Year median prices were down yet again albeit at a slower pace.
The largest threat to a housing recovery is negative-equity…period. Remember, organic move-up/across/down buyers have always led the market. First timers and investors have always been the weakest segments and cannot carry the market for long. This highlights the most important factor plaguing the housing market — epidemic negative equity prohibiting the typical homeowner from selling and re-buying. Epidemic negative equity is only fixed by ‘years’.
Last but not least is a new phenomena that is also responsible for goosing reported sales this year – flip sales. Over the past year, investors have been very active in the foreclosure market with at least half intent upon fixing up and reselling the house within six months. These foreclosure resales are counted twice before an end user finally occupies the property. When backing out flip resales, September’s actual sales count was 418,859 (red), which was 53k below the not-seasonally adjusted sales print of 472k, and within a few thousand sales in September 2007 (yellow), the worst on record.
Yesterday’s headlines of a sales “surge of 9.5%” was based upon a Seasonally Adjusted Annualized pace, which uses historic data to smooth and report the data in a fashion that is consistent month over month.
But seasonal adjustments can’t pick up one-off events such as the present tax credit set to expire at the November. The tax credit essentially pushed out the purchase season a month into the month of September — a historically much weaker month than August. This goosed-up the Seasonally Adjusted number reported yesterday and headlines today are talking about a sales surge when in fact, sales fell Month-on-Month by 5.2%.
The sad part about this type of misinformation is that is sets the market up for a major disappointment when conditions reverse in the near term when it never had to happen if the Existing Home Sales report was portrayed for what it was in the first place. The association should have dedicated at least a paragraph explaining the September anomaly instead of going out with the ’sales surge’ headline knowing full well how 99.9% of population would perceive it.
When seasonal sales go away suddenly for the season, which will happen in the near-term whether the tax credit is extended or not, it sets reported sales and prices up for the largest swing lower since all this began two years ago. This is because a) an extension of the credit buys buyers a lot of time to shop and spreads hasty purchases out of a longer period of time b) when the seasonal buyer goes away what remains are mostly distress buyers on much lower priced houses, which will swing the reported median and averages prices back to the distressed market price over a very short period of time.
Unintended Consequences on the Housing Market of Foreclosure Moratoriums & Mortgage Mods
So, on one hand the Gov’t through massive spending as managed to cause a rush to buy low-end houses by first-timers and investors. This was done at the right time and is a success, no doubt.
But on the other hand they put out HAMP, which prevents foreclosures and is keeping the very low-end supply that is in such high demand off of the market. In fact, the low foreclosure counts are undermining the housing market at this point in time, which is why house sales are falling at the same time you are hearing stories of 30 bidders for each foreclosure resale and sellers not dealing with buyers who require financing in favor of cash buyers, even at a lower price.
Keeping troubled borrowers in houses and good buyers away is a perfect example of an unintended consequence of government action that will push out a true recovery indefinitely. As a matter of fact, because of the neutralizing effect that housing market gov’t stimuli vs HAMP has, if hundred of billions were not thrown at the market, we would likely be sitting right where we are now anyway…tax payers would just be that much richer.
HAMP and the other mod initiatives and foreclosure moratoriums have effectively served as the longest foreclosure moratorium seen yet.
Millions of underwater, over-levered zombie renter-homeowners squatting in their house because of a loan mod simply ensure the housing market remains a heavy and volatile asset class for years.
Another unintended consequence of HAMP will be a foreclosure surge eventually. The in-process foreclosure pipeline has never been as full and the first wave of Obama-mod three month trials are expiring now. Those that don’t make the trial go directly to foreclosure.
The number of trial mods eclipsed 500k last month and because of the massive backlog that led to a large number of servicers now granting trial mods to virtually anybody that requests one — subject to missing documentation being submitted as of a condition to turning the trial mod into a permanent mod — monthly trial mod starts are likely well over 100k per month.
If the HAMP performs worlds better than other mods and only 33% fail their trial mod, then up to 100k additional monthly foreclosures could be coming soon. With foreclosures in the US average roughly 80k per month over the past 6 months — and most loan mods that fail being foreclosure-ready — this could double foreclosures over a very short period of time.
But the fact is that over the period of 9-12 months, most HAMP mods will fail based upon historic cure and re-default rates making HAMP the largest can-kicking experiment to date. When HAMP is acknowledged as a failure the only place left to go will be massive principal balance reductions, which will cause a whole new set of problems — about 3 trillion of them.
On a positive note, a HAMP failure will be the first step to a housing market recovery, as millions of qualified low-to-low mid price range house buyers who deserve a shot at home ownership will have their crack at a foreclosure resale. These are people who will ultimate own their home one day vs HAMP modifyees, many of whom still owe 100% more than the present value of the property and have no intention of staying around for the duration. To the majority, HAMP is way to get cheap rent while they hope that in the future their financial condition turns around.
Housing headlines are about to get very interesting.
Mark Hanson
Data source: National Association of Realtors
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