California delinquencies push shortsales

The 90-day delinquency rate on home mortgages for California and its most populous counties, presented in these Market Charts, is a leading indicator of the trend in foreclosures and shortsales

Chart 1

Q1 2012

Q4 2011

Q1 2011

Total CA Employment

7.7%

8.4%

9.5%

Data courtesy of the Federal Reserve Bank of New York (FRBNY).

Gray bars indicate periods of recession.

Chart 2

March 2012

February 2012

March 2011

Total CA Employment

6.5%

6.6%

8.7%

Data courtesy of CoreLogic, a Data and Analytics Company.

The above charts depict the percentage of California mortgage loans 90 or more days delinquent: the point for commencing foreclosure.

Loans unpaid and unlikely to be paid (in full)

With employment still improving only incrementally from its recession lows, and bankruptcy-ordered cramdowns for occupying homeowners a political impossibility, homeowners continue to default on their mortgage loans in record numbers. In the fourth quarter (Q4) of 2011, 8.5% of all California mortgage loans were 90 or more days delinquent, headed for a notice of default (NOD) and on to foreclosure if a pre-foreclosure workout is not arranged. This is down from 12.8% peak delinquency level in Q4 of 2009, but still far above the quarterly average of 1.4% during 2000-2006, as reported by the Federal Reserve (the Fed).

In many of these instances, mortgage delinquency leads directly to foreclosure. Of course, completion of foreclosure brings the property back into the real estate market via either fix-and-flip speculators at a trustee’s sale or as a real estate owned property (REO) for eventual resale. This is a vicious circle for pricing since lenders will accept lower prices for instant liquidity – cash – at trustee’s sales and for their REOs. This continues the cycle of depressed home prices.

Thus, future potential buyers have a happily prolonged wait in which to buy a home, until demand for homes begins to drive up sales volume to match pre-recession highs – double today’s volume (which is nonetheless inflated thanks to the influence of speculators).

The above charts depict the most serious delinquencies — those most likely to lead to foreclosure — as an annual percentage of California mortgage loans 90 or more days delinquent. As trend lines indicate, delinquencies jumped exponentially from an artificially low level during the Millennium Boom to new 70-year heights following the start of the Great Recession in December 2007.

Today, the peak in serious delinquencies has passed, and a slow decline in the rate of delinquency is underway, held up by the lack of jobs.

Delinquencies and foreclosures

Delinquencies are the first of several crucial markers of the current financial well being of today’s homeowners, as well as a forward looking indicator of market conditions. The 90+ day delinquency rate (shown above) is a direct indicator of homeowners’ ability and willingness to continue paying their mortgage loans. The rate’s movement up or down is used to anticipate future levels of::

  • NODs: generally (though not always) recorded on mortgages 90+ days delinquent, NODs are the lender’s first step in the foreclosure process;
  • shortsales: in the present market, selling a home for less than the value of the mortgage remains the only way for many Californians to relocate;
  • trustee’s sales: the homeowner’s point of no return, when the lender takes the home through foreclosure, leaving no  further ability to reinstate the mortgage or redeem the property;
  • REO and related resales: the sale of property acquired by the lender at the trustee’s sale.

NOD recordings peaked in Q1 of 2009, with 135,431 NODs. Q1 of 2009 was also the peak moment for REOs as a percentage of all home sales (excluding trustee’s sales), with REO properties comprising 53.9% of all homes sold statewide. For comparison, the average from 2000-2006 was 1.7%; historically, REO resales have made up around 7% of the properties for sale.

Since 2009, NODs, trustee’s sales, and REO resales have all declined significantly, albeit fitfully, in a staircase movement. However, this drop has now slowed almost to a halt, and REO resales show few signs of declining back to pre-2007 levels until sometime after 2016.

Further, much of the recent drop in foreclosures and REOs is merely attributable to an equal increase in shortsales. For the homeowner, however, a shortsale is often as deleterious to the homowner’s credit score as an actual foreclosure, and does not represent an improvement in the financial well being of a delinquent homeowner.

Related articles:

NODs and trustee’s deeds: less depressed but still grim

REO resales in CA

Default and foreclosures in a steady decline, for now

Shortsales: what you need to know

The FICO score delusion

In contrast, the 90+ day delinquency rate peak ended comparatively late, in the first quarter of 2010, and has since seen a gradual but constant fall – with a long way to go to return to normal.

This difference between delinquency (which indicates the homeowner’s ability or willingness to pay a loan) and foreclosure (which indicates the lender’s willingness to penalize the homeowner for his financial condition rather than provide a workout) shows that lenders’ decision to foreclose depends on other factors than simple delinquency.

Instead, lenders appear to be limiting their foreclosure filings, possibly building up a shadow inventoryThe real estate demand created by potential households whose formation is delayed by poor economic conditions of future foreclosures. For this reason, first tuesday anticipates that foreclosures and REO resales will remain relatively constant for years even if delinquencies continue to drop.

Nor do we expect delinquencies to continue to fall indefinitely. Several years still remain, through at least 2016, before delinquency levels return to their pre-recession lows. As with foreclosures and REOs, the trend in delinquencies in that time is likely to be downward, but also to be slow, halting, and subject to occasional reversals as the housing market sputters back to ignition and take off.

Historical standards

In 1999-2000, the average 90+ day delinquency rate for California was 1.6%. At the time, home sales volume and prices were both rising, and the market had fully recovered from the 1990-91 recession.  At that point, the Fed had already put the brakes on the economy by raising interest rates beginning in mid 1998, driving the economy into a mild and controllable typical recession in 2001.

When the delinquency rates fall back to turn of the century levels, our economy, and the real estate market, will have attained full recovery.  We currently anticipate this state of recovery to arrive in approximately 2016, and certainly no later than 2017 (based primarily on the pace of job recovery).

At the moment, however, negative equity homeowners and those delinquent on their mortgages are effectively imprisoned in their homes. Unlike in 2000, sales conditions from 2006-present have not permitted homeowners who bought or refinanced to sell their property for the amount of the mortgage balance, much less at the price paid. Of course this means any sale of property purchased or refinanced in the 2000s will lead to a financial loss. As such, many owners have decided to stay in their homes as long as possible, postponing job opportunities, retirement, or other relocation-based concerns while waiting in the hopes of improved pricing.

Several factors are at work to reduce delinquencies, including especially the now-rising levels of employment. At the time of this writing we still have over a million jobs to be gained before employment returns to December 2007 peak levels (and another 600,000 jobs needed to account for the increase in state population). As time passes and jobs develop, new employment will lead to increased demand for housing. Increases in income determine a family’s ability to “pay and stay”: to make payments on their negative equity mortgages, averting default;In the meantime, those who remain tragically unemployed will turn with increasing frequency to strategic default.  Over two million California homeowners owe more on their mortgage than the current or foreseeable sales price of the property. Many of these homeowners will eventually become frustrated at the lack of upward price movement in homes and will cease to pour their money into an insolvent homeownership situation. Instead they will exercise their put option right to walk away from their home, mortgage and all, leaving the recalcitrant lender to deal with the property;

Delinquent inventory will also inevitably be cleared by means of foreclosure. For those who remain unable to pay their loans for lack of sufficient earnings, foreclosure is the only alternative. The home is disposed of through a shortsale or trustee’s foreclosure sale.

Related articles:

Jobs move real estate

The morality of strategic default: businesses vs. homeowners

The equilibrium trendline: the mean price anchor

Raising the bar of real estate advice

Forecasts

For a real estate recovery to take place, the single most important factor in generating a demand for homeownership is the wealth of the population, as determined by employment.

When California employment numbers reach a much more accelerated pace than today, with 300,000 to 400,000 new jobs created annually for two consecutive years, sales volume will then begin to rise. Eventually prices will be driven up by rising demand for homeownership. Rising prices, in turn, will help current homeowners develop equity in their property sufficient to sell without seeking short payoff approval on a sale, and then, finally, the delinquency rate will return to normal.

first tuesday does not anticipate any such sales volume recovery until at least 2016. For recent years, home sales volume has maintained a “bumpy plateau”: rising and falling from quarter to quarter, but showing little to no long-term change annually.  first tuesday anticipates conditions in sales and pricing will remain relatively level until 2016, except for spates of speculator activity on the bet that the market will get a jump start and produce a payoff profit with a resale within one or two years of purchase.

As soon as asset prices (including home prices) do begin to rise, it is likely that the Fed will raise interest rates, as they did in the middle of the 1980s and 1990s recoveries when the economy was heating up at an unsustainable pace. This time, the Fed will have the additional task of withdrawing a huge portion of the dollars they infused into the economy to drive the recovery. Increased interest rates will restrict price gains to the rate of inflation (historically maintained at approximately 2%). Thus, delinquencies and REOs will most likely remain high even into 2017 and beyond.

This recovery is going to test the patience of all involved in the real estate market. In the end, speculators now stepping into the shoes of sellers will learn of the liquidity trap that exists in markets with zero interest rates, as was last experienced in the 1950s after the recovery from the Great Depression.

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