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Amherst sees at least 11 million mortgages headed for default [ClearOnMoney]
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Amherst sees at least 11 million mortgages headed for default

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Commentary

Amherst sees at least 11 million mortgages headed for default

14 Oct 2010 by Jim Fickett.

Laurie Goodman of Amherst Securities looks at default rates in five different classes of mortgage loans, and concludes that over 11 million mortgages are currently headed for default. This is higher than many numbers being tossed around, but is probably realistic, because more cases are being taken into account. Goodman thinks this will cause the government to keep trying new modification programs. Another possibility (assuming resolution of current legal issues) is that liquidations could stay high for many years.

Laurie Goodman and colleagues at Amherst Securities have, at several points in the last few years, given an overall estimate of the likely mortgage defaults coming. These have gotten progressively simpler and clearer over time. The latest estimate is approachable, believable … and quite worrying.

This post will first give the bottom line, then summarize the reasoning behind it, and finally look at consequences. This summary will be much shorter than the 18-page Amherst report; I hope it gives the central facts clearly, though it leaves out all the policy suggestions, which are thoughtful and worth a read.

Bottom line

Class of loans Millions of likely defaults
Non-performing: Currently 60+ days delinquent 4.94
Re-performing: Formerly , but no longer, 60+ dq 2.31
Always performing and > 20% negative equity 1.30
Always performing and 0-20% negative equity 1.00
Always performing and positive equity 2.02
=== ===
Total 11.57

Reasoning behind the estimates

One thing Goodman does differently from most, that helps clarify the analysis, is that she treats separately “Dirty Current” loans – those that are only current because, by way of modification, they have been declared so. These loans do behave differently, so that is a useful distinction.

Non-performing: Based on CoreLogic's servicing database of loans backing private-label securities, one year after a loan first defaults, there is only a 14% chance that it will have been paid off or be current. After two years this drops to 8% (i.e. many of those that became current in the first year were only able to remain so for a short time). Thus Goodman estimates that, in the long run, only 5% of non-performing loans will pay. The other 95% give the 4.94 million in the first line of the table above.

Re-performing: Each year 55% of re-performing loans default and 5% pre-pay. From this, and a supposition that things may improve a bit over time, Goodman estimates a 70% eventual default rate. (Note: in case you think this is too pessimistic, Goodman points out that the average ratio of combined first and second lien loans to the current value of the property is 1.2, i.e., on average these loans are 20% underwater. And further, less than half were loans with full documentation.)

Always performing: The three sub-categories of “Always performing” are chosen because the level of negative equity has been shown to be a strong predictor of default. Again using the one-year default rates (19% for >20% negative equity, 11% for 0-20% negative equity, and 3% for positive equity) and pre-payment rates, and assuming that things improve somewhat, Goodman estimates that the eventual default rate in the three “Always performing” categories will be 50%, 25% and 5%. Multiplying these rates by the numbers of loans in those categories gives the numbers in the table above. The last category of loans in the table is the best quality, with the lowest eventual default rate. But it is also by far the largest category, so that the absolute number of estimated defaults is high.

Consequences

To put the possibility of 11-12 million defaults in perspective, foreclosure sales are currently running at about 100,000 a month. At that (very high) rate, it would take 9-10 years to liquidate all the default cases.

Exacerbating the situation, Goodman points out that a large fraction of current homeowners will end up with impaired credit histories, at the same time that credit standards are at their tightest in many years. So not only will the supply of distressed properties be high, but a large fraction of potential buyers will not qualify for loans.

Goodman's conclusion is that the government will keep trying different modification strategies until it finds something that works.

If governmental policy does not change, over 11 million borrowers are in danger of losing his or her home (1 borrower out of every 5). Politically, this cannot happen. The government will attempt successive modification plans until something works.

She may well be right.