BofA Analyst: Mortgage correction just ‘tip of the iceberg’
June 29th, 2007, 3:00 am · 13 Comments · posted by Mathew Padilla, Reporter
Robert Lacoursiere, an analyst with Bank of America, is not drinking any corporate Kool Aid. In a recent report, he said losses on home loans will peak in the second half of 2008.
He starts with this:
• Mortgage borrowers are in a weaker position than in the last cycle with less equity cushion, higher levels of income devoted to debt servicing and facing higher rates in the upcoming waves of rate resets.
• Meanwhile softening housing market makes repayment by sales an unlikely option, setting the stage for loss severities last seen in the early ’90s.
He delves deeper into the reset issue:
According to BofA’s estimates, approximately $515 billion of ARMs are scheduled to reset in �07, followed by approximately $680 billion in �08. Furthermore, of these ARMs, we estimate that subprime loans consist of $400 billion (78%) in �07 and $500 billion (73%) in �08.Recently released data from Fannie Mae (FNM) confirms our view that ARM resets will lead to higher rates of credit deterioration, particularly for 2/28 subprime ARMs. … Of the subprime ARMs that reset in 2006, 76% of borrowers were able to successfully pay off their loan (either through refinancing or selling their home). However, of the borrowers that did not pay off their loan 50% went bad (delinquent, in foreclosure or REO). According to FNM, subprime ARM borrowers facing resets in �06 on average faced a 250 bps (2.5 percentage points) contract rate increase. Meanwhile, though the data is only as of March �07, of all the subprime ARMs scheduled to reset in �07, already 18% have gone bad (delinquent, in foreclosure or REO) or 29% of loans that have not been paid off. As a larger number of loans will hit the reset throughout the rest of the year and �08, and due to less favorable market conditions (higher rates, tightened underwriting standards, already stretched borrowers, and home price stagnation) the delinquency ratio will only increase from the 1Q07 level.
Here’s his reset chart. You can click on it for a larger, clearer image.
And here’s what he says on declining home equity:
As a result of high LTVs and slowing home price appreciation (or even depreciation), the home equity cushion continues to shrink. According to the latest Federal Reserve release, equity as % of total housing value was 52.7% at 1Q07.
The calculated equity cushion represented below with the blue line however uses the Fed data which is for all homes, including those home-owning households that do not have a mortgage. Similar to our above adjustments for the debt servicing ratios using data from HUD�s biannual American Housing Survey, we adjusted the equity ratio to include only households with a mortgage. …. The red line in the following chart shows that using these assumptions, by 1Q07 equity as % of house value for homeowners with mortgages dropped to 35.6% from 1985�s level of 52.8%. This demonstrates that households with mortgages are borrowing a greater proportion of the house�s value, leaving less equity remaining in the house.
Here’s his chart. Once again, click on it for a larger image.
June 29th, 2007 at 7:18 am
This article has a critical flaw. Fact is, after the recent real estate run, most LA and OC homeowners are sitting on huge equity positions. His chart shows the opposite. This is because his chart is drawn from a national perspective. The midwest and gulf coast regions are a real estate basket case. Hence, his conclusion does not apply to California. California has had heavy ARM concentrations for decades. This article is not relevant.
June 29th, 2007 at 8:26 am
Jimmy-
Good for you for making that point. I’m sure you will get pounded by the people that like doom and gloom. Good point though.
June 29th, 2007 at 8:37 am
You guys are a little slow. Talk with a few people in the mtg industry and you’ll get a different perspective. There is a large % of homeowners mostly in the IE followed by Riverside, OC and then LA that are at 95-100% LTV. What do you think will happen to those people, which most of them have mediocre incomes, do you think they will walk away??? And CA has had heavy ARM concentration for decades??? Dog decades? You mean the last 6-7 years…
June 29th, 2007 at 10:23 am
Jimmy,
There is no flaw because his estimates are based on the implication that resetting ARM loans were taken out in 2005 (3 year ARMs in 2008 originated in 2005). The run-up from 2005 to 2006 was 10-15% at best. By 2008, that 15% equity cushion is pretty much gone because Buyers will be aggressively negotiating price reductions - they know full well that these are “motivated sellers”. When a Seller knows that he can’t even sell his house for a profit, then there is really no reason to put any effort into selling at all — just walk away.
Your statement assumes that the people with these ARMS purchased prior to 2003, but the sad truth of the matter is that almost all of these subprime ARMS the article is referring to originated in 2005/2006.
The equity cushion is simply not there for ARM borrowers how purchased in late 2005 to 2006.
June 29th, 2007 at 11:59 am
ARMS have been a big part of the SoCal housing scene for 20 years. And, during that whole time, they have been resetting. Plus, many of the recent ARMS were on refis where the homeowner is loaded with tons of equity. OCTrojan, your read is the same as the authors, which is the most negative spin on the data. Anyone can take data, and find some way to filter it for a desired negative conclusion. The trick is to be smart enough to see through it.
June 29th, 2007 at 12:49 pm
Exactly. The sold called equity is gone. How can people refi when the home is worth less or nearly less than they paid for it. When the banks put all the REO’s on the market the sale prices will bring the average price down. Homes will not appraise for as much so no equity. Any home is only worth as much as the market demands or what a person is willing to pay for it. The easy money is long gone. Incomes are not keeping pace with the reset of these loans. I wonder Jimmy, what will it take for you to realize the boom is over?
June 29th, 2007 at 1:38 pm
Samson, problem is most OC/LA homeowners are sitting on huge equity, and many of them refied. I don’t know where this theory is born that claims all homeowners are underwater. In reality, most homeowners are flush with equity.
June 29th, 2007 at 1:43 pm
Equity means nothing unless you sell your house. If you refinance and take money out you are just borrowing from yourself but charging yourself interest. Isn’t it better to keep your housing expenses low and put money in other investments such as tax exempt bonds, stocks, CD’s and earn real interest on real money? If you can’t afford to save money every month as well as meet all of your financial obligations, than you should not buy a house until you are able to AFFORD it with a traditional loan. I know this all sounds really boring and vanilla flavor but this is the key to a happier life and a stronger financial future.
June 29th, 2007 at 2:08 pm
Jimmy…how much Kool-Aid have you drank today?
Here is the nuts of it:
1) California has the highest default rate / foreclosure rate in the nation. No Jimmy this is not b/c California is one of the highest populated states it’s b/c California has had some of the highest appreciation rates and speculative buyers market in the US.
2) California and ARMS, correct me if I am wrong but California had a huge bust in the 90s…but then again you are going to want to blame that on Aerospace, right?
3) If all these hedge funds start collapsing then somebody is going to start asking for higher premiums on loans. Thus Sally and Joe in the near future are going to get stuck with higher mortgage rates regardless if the Feds cut short-term rates, the treasury note demand increases, or foreign captial keeps pouring into the US Bond Market.
Sorry to rain on your parade but the Kool-Aid on the West Coast is the same as it is on the East Coast. Depreciation will sent in, as it already has, and will be around for the next of years. Hopefully, you are a bitter renter or atleast a homeowner that has some equity to cushion yourself.
June 29th, 2007 at 2:52 pm
More smoke. Most homeowners in LA/OC are doing just fine. And, the east coast is also doing just fine. Historically, foreclosure rates on the east and west coast are not a problem. The numbers you must be referring to is RealtyTrac. It has been documented that RealtyTrac numbers count the same house multiple times, and each mortgate is counted also. The hedge fund world is not collapsing. There is no problem getting a loan. People are not dumping OC properties. The bond market and stock market is in good shape. Jobs are everywhere. Where is the problem?
June 29th, 2007 at 4:45 pm
Yo Jimmy,
Cut back on the Kool-Aid. The reality of the situation is about to hit home for millions of homeowners that took the home to the bank. Home equity lines are adjusting upward and Daddy can’t refi due to collapsing home values. Mommy got a new SUV thats totally worthless with $70 barrel of oil and Daddy can’t afford to put that new boat on the water, it’s no fun sitting at the dock in the bay afterall. Daddy ain’t sellin cars or homes and he lost his other job at Circuit City. And by the way when you walk away from that home they are still coming for the cars, boats, quads and all that other crap you bought with that eeeeasy home equity line.
September 21st, 2007 at 11:07 am
Jimmy …
You are trying to hard - ppl show you statistical data. You just keep saying “flush with equity”.
Where is YOUR data, put a spin on it - what is the average LTV
Ask your buddies that DID buy a house, if you have any.
Very few ppl who I work with are “flush with equity”, and no they are not even SUV buying types, just making home for their kids.
So yeah those doom sayers are all tin-foil-hat conspiracy nuts, sure. But at least they put some work into their theories to make them look realistic with data etc. - you don’t even get a “E” for an “E”ffort.
And don’t listen to anybody - go drink that kool aid or that sorry excuse for a beer (what is it “?oors light”) .