Decisions by U.S. homeowners to walk away from mortgages they can afford account for an increasing share of defaults, according to Morgan Stanley.
About 12 percent of all mortgage defaults in February were “strategic,” up from 4 percent in mid-2007, New York-based Morgan Stanley analysts led by Vishwanath Tirupattur wrote in a report today. Borrowers are more likely to stop paying their mortgages the higher their credit scores and the larger their loans, the analysts said.
Defaults by borrowers who owe more than their homes’ values are among the biggest risks for the housing market, according to analysts including Zelman & Associates’ Ivy Zelman and Amherst Securities Group LP’s Laurie Goodman. Last month, the Obama administration said it would adjust its anti-foreclosure program to encourage reductions to borrowers’ principal amounts, instead of just the payments they make, to address the issue.
That change “gives us hope that policy makers are serious about curbing future strategic defaults,” the Morgan Stanley mortgage-bond analysts wrote.
Strategic defaults also increase based on how much more borrowers owe in housing debt than their homes are worth, they said in the report, which made use of consumer credit data from Transunion LLC and Standard & Poor’s home-price indexes.
That finding concurred with reports by Goodman, a New York-based mortgage-bond analyst, who has said there will be as many as 12 million foreclosures over the next few years unless lenders can effectively modify borrowers’ debt.
A fifth of U.S. homes carrying mortgages were worth less than their loans in the fourth quarter, according to Seattle- based Zillow.com, which runs a real estate data Web site. Home prices in 20 metropolitan areas tumbled 33 percent from July 2006 through April 2009, then rose for five months before falling for the next five, leaving them up 2.8 percent from lows, according to an S&P/Case-Shiller index.
Morgan Stanley said many previous studies of strategic defaults have been limited by a lack of a “precise definition” of when they are occurring.
The analysts classified a default as strategic only when homeowners who hadn’t been previously delinquent were making on-time payments one month, then skipped them for the next three, even while staying current on other consumer debt of at least $10,000.
For mortgage-bond investors, the data signals a problem with prime-jumbo debt and strengthens the case for investing in subprime, the analysts wrote. That’s in part because strategic defaults are less prevalent among borrowers with subprime characteristics and they may benefit from government-aid programs that don’t target large loans, the analysts wrote.
Jumbo mortgages are larger than government-supported Fannie Mae and Freddie Mac can finance, currently from $417,000 to $729,750 in high-cost areas.
Details needed to implement the planned changes to the federal “Home Affordable” mortgage-modification program for delinquent borrowers are expected by “early fall,” Phyllis Caldwell, the Treasury Department’s chief homeownership preservation officer, told lawmakers April 14. The program will then push for cuts in the principal amounts of some borrowers that owe more than 115 percent of their home’s value.
“If the banks are not going to hold them accountable, then why not” stop paying, Gregory Martineau, 39, a teacher in Las Vegas, said in a telephone interview. “I have a few friends renting their places to roommates and not paying their mortgages. The hypocrisy is I’m supposed to teach our kids to be responsible and accountable, yet our government and banks don’t do the same.”
A total of 9.47 percent of all home mortgages were delinquent at the start of this year, with an additional 4.58 percent in the foreclosure process, according to seasonally adjusted Mortgage Bankers Association data.
Housing won’t recover for three to five years as mounting foreclosures hold down prices, mortgage-bond pioneer Lewis Ranieri said yesterday in a panel discussion at the Milken Institute Global Conference in Beverly Hills, California.
“There’s another big leg down,” he said. “You can’t have much of a rally when you’ve got this big overhang.”
In an April 13 congressional hearing, JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp., and Wells Fargo & Co., the biggest U.S. home lenders, said their foreclosure-prevention efforts are working and rejected plans that could force them to reduce balances for distressed homeowners.
Cutting Loan Principal
“Broad-based principal reduction could result in decreased access to credit and higher costs to consumers because lenders will price for forgiveness risk,” said David Lowman, head of New York-based JPMorgan’s mortgage unit.
Bank of America last month agreed to cut the principal on some loans that exceeded 120 percent of the value of underlying properties as part of a settlement with 44 state attorneys general over lending by Countrywide Financial Corp., which the Charlotte, North Carolina-based bank bought in 2008.
Strategic defaults are also increasing in the commercial real-estate market, where prices are down 42 percent from their peak in October 2007, according to Moody’s Investors Service.
Morgan Stanley last year defaulted on a $2 billion loan two years after it bought Crescent Real Estate Equities Co. and handed over 17 million square feet of office buildings to lender Barclays Capital. The bank also agreed to relinquish five San Francisco office buildings to its lender, two years after buying them from Blackstone Group LP.
Biggest Property Deal
In January, Tishman Speyer Properties LP and BlackRock Inc. defaulted on a $3 billion mortgage on Manhattan’s Stuyvesant Town and Peter Cooper Village apartments, the largest residential enclave in New York City. Its sale in 2006 for $5.4 billion marked the biggest U.S. real estate transaction.
California and Arizona are among states that generally don’t allow lenders to pursue court judgments against consumers if seized-home sales fail to cover loans, Moody’s Investors Service said in a report last month. Other states do, such as Florida, New Jersey and New York. Commercial loans are often non-recourse.