Are Investors Overexposed To Non-Guaranteed RMBS?

August 31, 2015

by Keith Jurow

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Everyone knows that real estate markets are in recovery. Right? Everyone except me – the one holdout.

For five years, I’ve shown readers that the so-called real-estate recovery is only a mirage that disappears when you approach it. Wall Street and most pundits disregard the data, charts and graphs I have published. They stick to their familiar sources regardless of whether they are accurate or reveal anything useful.

Let’s look at some recent data that shows the extent of the delinquencies in these mortgages with a focus on the most exposed large metro areas. We’ll then examine the implications for advisors whose clients own funds, ETFs or REITs that hold securities with underlying RMBS mortgages.

The clear failure of mortgage modifications

The Obama administration unveiled its Home Affordable Modification Program (HAMP) in the spring of 2009. Since then, “do something” advocates have pinned their hopes on mortgage modification as a solution to the mortgage delinquency crisis that erupted out of the housing crash. Let’s see how it has fared.

According to HOPE NOW, an alliance among companies in the mortgage industry, roughly 7.5 million permanent mortgage modifications have been granted by mortgage servicers since late 2007. This includes both the government-sponsored HAMP modifications and what became known as “proprietary modifications” offered by the mortgage servicers.

What you are probably unaware of is that another 14.1 million “workout plans” have also been provided to borrowers who claimed a hardship. Some of these plans include repayments, payment reductions and forbearances. Spokespersons for Fannie Mae have told me the purpose of these plans is to enable delinquent borrowers to keep their homes.

How successful have all these plans been to date? Not very. In April 2013, the Treasury Department’s overseer of the HAMP program reported that more than half of these modifications had been canceled because the borrower failed to meet all the requirements for maintaining the modification. Modifications from the peak year of 2010 were showing re-default rates of more than 30%. One of the main reasons for this high failure rate is that many of the HAMP participants still had very high total debt-to income ratios even after modification.

A year earlier, Trans Union, a credit-reporting firm, issued the results of a study based on an examination of roughly 600,000 borrowers from its database who had received a mortgage modification sometime between January 2008 and July 2011. It found that nearly six out of every 10 borrowers had re-defaulted within 18 months of receiving the modification.

The most recent research from the Federal Reserve Board is an article abstract that was posted in December 2014. It took a detailed look at 60,000 private securitized loans in the database of Loan Performance Securities (a subsidiary of Core Logic). These loans had been modified after January 2008. As of the end of 2013, only 38% of the loans modified in 2010 were still current. The year 2010 was when the number of modifications peaked.

Modifications from 2011 fared little better. Roughly 54% of these modified loans were current at the end of 2013.

Why is the re-default rate so shockingly high? One important factor is that the vast majority of modification recipients had either purchased a home or refinanced one during the bubble years of 2004-2007. Hence most of them owned properties that were still underwater. Underwater homeowners default at a much higher rate than those with equity in their property.

Another key reason is that there are concrete benefits for defaulting and even re-defaulting. It is the delinquent homeowner who receives a modification. According to TCW’s latest Mortgage Market Monitor, servicers wait an average of 15 months before modifying a delinquent non-agency prime jumbo mortgage.

Most discouraging to owners of the non-agency RMBS holding these loans is that the re-default rate is getting worse. According to Black Knight Financial Services’ April 2015 Mortgage Monitor, the recipients of roughly 70% of all new trial modifications and repayment plans had already been through one or more home retention actions. That number was only 45% in 2011.

Black Knight also showed this deterioration in a different way. The percentage of properties in active foreclosure where the borrower had already been through at least one home retention action has risen steadily over the last five years. That number climbed from 26% in 2010 to 53% in 2015.

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Non-Guaranteed RMBS