First came the spike in delinquencies and defaults. Then came the fallout for subprime lenders. A market correction in the mortgage industry is squeezing out the excesses in pricing and underwriting. Most predict the industry will emerge stronger once the transition is complete.
By Robert Stowe England
Like a steak of lightning that comes out of the blue and sets the barn on fire, the signs of distress in the mortgage marketplace seemed to appear rather suddenly late last year. The spike in delinquencies and defaults in subprime loans was notably sharp. There were also increases in delinquencies and defaults for alternative-A loans and, to a far lesser extent, even for prime borrowers. The seasoning of a huge wave of loans from the most recent housing boom made the overall delinquency uptick not entirely unexpected.
Yet, the fallout in terms of failing subprime lenders and in the financing environment for new residential mortgage-backed securities (RMBS) was particularly strong and swift.
By the end of the first quarter, the number of subprime players was sharply reduced, while many of the surviving monoline subprime players either were seeking to be acquired, in the process of being acquired or filing for bankruptcy. And it was hard to find willing investors for the lower-credit-rated tranches of RMBS deals.
"There's an old saying: You don't know who's swimming naked until the tide goes out," said Angelo Mozilo, CMB, chairman and chief executive officer of Countrywide Financial Corporation, Calabasas, California, in a March 13 interview televised on CNBC, the financial news network. "Obviously, the tide has gone out," he continued, with monoline subprime lenders being the ones "exposed." It is not yet clear how much more adjustment will be needed to bring the mortgage industry back into balance-an outcome that also depends on a recovery in home sales and a return to historic averages in home-price appreciation.
The fate of the residential real estate market and the mortgage industry-always closely tied-became even more intertwined as a result of changing lender practices in recent years that allowed more borrowers to obtain high loan-to-value (LTV) loans up to 100 percent of the value of the house. With home prices retreating, borrowers are finding themselves with little or no equity, and a few are even walking away from their homes. Thus, it has become more difficult to cure a delinquent loan by selling the property. And homeowners with shaky finances have less motivation to hold on to the house and ride out the difficulties.
With tightened underwriting and some loan terms no longer available due to regulatory constraints, it is not clear how far lenders will be able to go to keep homeowners in their homes by offering refinancing options. These options will be critical for borrowers facing payment shock due to adjustments in interest-only (IO) adjustable-rate mortgages (ARMs) and payment-option ARMs. A substantial number of two-year and three-year ARMs are slated to reset this year, with the potential to further increase defaults.
Lower mortgage volume
One of the key impacts from distress in the housing and mortgage markets has been a decline in origination volume. This, in itself, is partly due to the tightening of credit, which Mozilo warns could inadvertently exacerbate the problem of the "so-called crisis," which he believes is not a crisis but a market correction that is squeezing out the effects of recent housing speculation.
The tightening of underwriting is turning the problem into "a liquidity crisis," he told CNBC in the March interview. "There is a rush to judgment, throw the baby out with the bathwater" reaction, he said. Lenders need to be ready to work with borrowers so as not to force them into default and thereby cut back on the levels of homeownership, especially among minorities, and to add to the excess supply of unsold homes, Mozilo cautioned.
Part of the slowdown in origination volume can be attributed to the exit of some of the major subprime players, according to Guy Cecala, publisher of Inside Mortgage Finance. With the departure of so many major subprime lenders, "we see (one-)third of the origination volume [in subprime] vanishing," says Cecala.
In 2006, according to Inside Mortgage Finance data (see Figure 1), there was $600 billion in originations of B and C credit, with $543.2 million of the total coming from the top 25 lenders-including No. 1 lender HSBC Finance Corporation, Prospect Heights, Illinois; and No. 2 lender New Century Financial Corporation, Irvine, California. In early April, New Century filed for bankruptcy, ceased new originations and announced its intention to sell its servicing operations.
Last year's $600 billion of B and C credits represents 20.1 percent of the total $2.98 trillion in originations for 2006.
"The real question is how much of the slack can be taken [up] by the other guys," Cecala adds. While the remaining lenders say they will be replacing the lost origination volume, Cecala has his doubts. "A lot of that business is never coming back," he says-especially "the no-down-payment, no-income-verification subprime loan." He predicts there will be a knee-jerk reaction to remove the problem loans altogether, and that a big chunk of subprime business will largely disappear.
Not everyone agrees that overall subprime origination capacity is likely to be significantly reduced. For one thing, Freddie Mac has announced new products are under development targeting the subprime market, and Fannie may make similar moves to capture a larger share of the subprime market, according to Michael Youngblood, managing director of asset-backed securities (ABS) research for FBR Investment Management Inc., Arlington, Virginia.
Further, notes Youngblood, consolidation among surviving subprime lenders means those companies will be far better capitalized, so they can be stronger players in the market. Subprime origination capacity is moving "from thinly capitalized to lavishly capitalized companies," such as what occurred when New York-based Citigroup Inc. purchased San Diego-based Accredited Home Lenders, Youngblood says.
Mortgage originators cannot recapture origination volume if there is not sufficient investor interest in purchasing the mortgage-backed securities (MBS) that have typically financed subprime lending. Just as the subprime meltdown claimed its share of lenders, the fallout is evident, too, on the securitization side, where investors are reluctant to buy BBB credits. Those willing to buy A-minus and higher credits are demanding a greater return to cover the perceived increase in risk.
To the extent the mortgage originator remains financially capable, investors may be partly protected by loan buybacks, which for certain originators peaked in the fall at a high of 4 percent to 5 percent of outstanding loans, according to Tom Warrack, managing director of residential mortgage-backed securities for Standard & Poor's (S&P), New York.
Going forward, "bond investors are significantly less interested in seeing bonds with the profile of significant underperforming loans," says Warrack.
Due to the widening of credit spreads, the overall profitability of securitization has declined, Warrack adds. "Investors are demanding more yield."
Standard & Poor's continuously updates its loss expectation, and in response to deteriorating credit parameters announced significant increases to its credit-support requirements in the second quarter of 2006. These criteria changes are incorporated into S&P's loan-level model LEVELS(TM), its primary credit model used to evaluate securitized RMBS deals, according to Warrack.
In spite of the cloud hanging over the securitization business, life goes on, even with reduced vigor. "The marketplace, the syndicate, the business-it's still up and running," says Peter DiMartino, managing director, RBS Greenwich Capital Markets, Greenwich, Connecticut. In the last week of March, he says, there was $10 billion to $12 billion of subprime mortgage financings, even after the onslaught of the subprime meltdown.
"So, the deals are still being done. Investors are buying bonds," he says.
"Investors are demanding higher yields in the various rating classes," adds DiMartino, as the appetite for riskier tranches of securitizations is considerably dampened, even as spreads across the board are wider than three to four months ago. "It seems there's more interest in AAA and AA than there is in A and BBB," DiMartino says.
Although single A's are getting done, he says, BBB bonds are still in a period of dislocation. "People are kicking the tires, sniffing around, having a conversation," he says.
"At this point in time, it's more talk. Only in a minority of instances do I see new issues of triple-B being executed," he says. "Dealers, as well as investors and everyone else, are in a period of price discovery, trying to figure out where these things should price."
Collateralized debt obligation (CDO) managers, who have in recent years been major buyers of riskier tranches, have a reduced appetite for those tranches, according to DiMartino. Some CDO managers and hedge funds are still active, he adds. "There are definitely some value-seekers in the market, buying the bonds at really high loss-adjusted yields. However, it is clearly not the market it was prior to 2007,"ne says.
What went wrong?
Understandably, mortgage lenders and Wall Street dealmakers are not saying much about how things got off track. Yet, a common conclusion is emerging-that during 2006, underwriting discipline seriously slipped among some lenders as they tried to maintain volume.
"It's not much guesswork anymore," says DiMartino, who traces the rise in delinquencies and defaults to a failure in "quality control" in subprime underwriting at a number of lenders that began in the second half of 2005, perhaps the fourth quarter, and lasted until the third quarter of 2006.
DiMartino has done an analysis of the problem loans, and identifies several characteristics that tend to define the underperforming loans that were originated during that time. The loans tend to be originated in California, are low- or no-documentation loans, have a high LTV and often involve piggyback loans. There was a layering of risk with most or all of these attributes, DiMartino says.
While there have been some worries about alt-A lending and loans with lower forms of documentation, he thinks the secondary market still is willing to invest in low-documentation and no-documentation loans, citing the "long history of successful low-doc mortgages with high FICO® scores."
Low documentation, DiMartino adds, is "a characteristic that at some level is an acceptable risk, and at another level is not an acceptable risk."
The problem arises when lenders started marketing these loans to first-time homebuyers who were also borrowing some of the down payment. The secondary market no longer supports that kind of lending, he says.
Mortgage insurer AIG United Guaranty, Greensboro, North Carolina, also points to 2006 originations as the major source of the poorerperforming loans, but adds another twistlocal home-price appreciation or depreciation trends are a bie factor.
"The performance we're seeing is closely aligned to what your intuition tells you would be the case," says Kurt Smith, senior vice president at United Guaranty. Where appreciation is disappearing and depreciation exists, the delinquencies are up sharply. Where there continues to be some home-price appreciation, the delinquencies are not up sharply, Smith notes.
"For a small percentage of those in markets without appreciation, or where prices are declining-especially those who bought the house hoping for a 15 [percent] to 20 percent gain-those properties are coming back to the market," he says.
As a group, A-minus loans are one of the product areas hardest-hit in the surge in delinquencies, Smith says, and particularly for high-LTV loans of 95 percent loan to value, where often there has been a second mortgage used to close the transaction. He predicts prime credits with limited documentation and high LTVs of 95 percent or higher "are probably next in line" for developing delinquencies.
Among A-minus and other nonprime loans, "delinquency rates are up-and up substantially," Smith says. Insurance covering A-minus loans represents "no more than 8 [percent] to 9 percent of our book of business in force," says Smith. Of that, the vast majority are Fannie Mae and Freddie Mac A-minus products. Limited-doc products also represent about 8 percent to 9 percent of United Guaranty's book of business, he says.
The vast majority of problem loans are occurring in the limited-doc, stated-income books of business, he adds. "Delinquencies are materially worse than in prior years," says Smith, who adds that even borrowers with a fixed-rate mortgage with no equity in the house and struggling to make payments are questioning their motivation for sticking it out.
Smith also points out that around mid-year 2006, the cost of renting versus owning a home shifted in favor of renting. "Borrowers squeezed into a home have a $1,500 monthly payment, and are looking at $500 to rent a similar space," Smith says. When this happens, "it becomes more attractive to walk away from the house and the loan. That's what I think is occurring in the marketplace," he adds.
Smith offers some of the data from United Guaranty's book of business to give a snapshot of what is happening. For example, noincome, no-asset (NINA) loans, which had delinquencies in the upper 4 percent range in December 2005, had delinquencies at 5.8 percent in December 2006, he says. This increase has occurred while delinquencies for the overall book of business was flat at 3.72 percent in December 2006, compared with 3.7 percent in 2005, Smith reports.
"While 5.8 percent is not the end of the world in NINA loans," it is startling compared with the trend in the overall book of business, notes Smith.
The insured NINA loans actually had a higher average FICO score of 710, compared with an average score of 698 for all insured loans in United Guaranty's book of business, he says. "A 10-point range is meaningful," he says, and should not be producing significantly higher delinquencies. Smith suggests that United Guaranty's 2006 experience with NINAs draws into question the assumption that a higher FICO score can protect the lender in low- and no-documentation loans.
Smith maintains that the deterioration in overall loan performance has come, in part, as a result of a disproportionate growth of 100 percent LTV lending coupled with deteriorating credit quality. He notes that the 90 percent LTV loans have not seen a significant deterioration in performance. He adds that more than 50 percent of the lender-designated A-minus borrower population United Guaranty insured in 2006 has 100 percent LTV loans.
"When the volume falls off, we see higher concentration of high LTVs," says Smith. What happens is that everyone who has the means to put down 10 percent or 15 percent has done so, so in order to keep up volume, lenders have to turn to borrowers who can put down less than 10 percent or even nothing at all. This means there has been growth in new homeowners without a lot of equity, Smith explains.
One of the lessons learned from the spike in delinquencies and defaults in the current cycle is that stated income is good for the self-employed, but probably not for salaried workers, for whom it is best to rely on the pay stub and the W-2 form, according to Smith. "Credit quality doesn't always trump everything else," he says, noting these loans haven't yet been stressed with payment adjustments.
Smith says he has been through business cycles like the current one before, and that lenders and mortgage insurers have to find a delicate balance between correcting the credit appetite of lenders and overtightening. "If the market responds too aggressively, it can shut down the sale of homes and refinancings of transactions," he warns.
United Guaranty is monitoring trends in the nontraditional product areas, such as option ARMs and IO loans, too. "This is one of the fastest growth areas, from a delinquency standpoint," he says. These delinquencies are occurring before the pay-option ARMs adjust, he says.
Smith says borrowers looked for the lowest payment options in 2006, and resorted to stated income because it was otherwise difficult to purchase a home. The federal interagency guidelines for nontraditional loans states that lenders should qualify borrowers at the fully indexed accrual rate. Smith says that if a borrower could qualify for that with the option ARM, the borrower could qualify for the 3O-year, fixedrate full-doc loan and remove interest-rate risk associated with the ARM.
Early payment defaults for pay-option ARMs (with the potential for negative amortization) in the 2006 book of business was 2.2 percent in December 2006, compared with 1.8 percent in the fixed-rate loans for 2006, according to Smith.
The 2005 book of business for pay-option ARMs insured by United Guaranty had a 4.6 percent delinquency rate as of December 2006, while the 2004 book of business had a 3.5 percent delinquency rate as of December 2006.
The credit quality for the 2006 business for pay-option ARMs at United Guaranty is about the same as it was in 2004, which has a much better performance record, Smith explains. The difference is that the 2004 business was mostly full-documentation, while the 2006 business contained a lot of stated-income loans, according to Smith. Of course, the 2004 borrowers are also helped because they have more equity, since the flattening out of housing appreciation did not occur until the fall of 2005, Smith says.
The origination market for loans is now in a "dramatically different world" in 2007, and we will see a significant decline in the origination of pay-option ARMs, Smith predicts.
Outlook for delinquencies
Three factors in the outlook for the home market will affect delinquency and default rates, say Smith. They are employment, flexibility and appreciation; that is to say, a strong employment market, flexibility by lenders for troubled borrowers and a return to home-price appreciation.
"Expect problems with markets where unemployment is high," he says. Michigan, Indiana and Ohio will "take it on the chin," says Smith.
Lenders can play a key role in how the housing market shakes out and how well the mortgage industry weathers the high delinquencies. "To the degree that lenders have staffed up in servicing and can find ways to work it out, life will be easier," says Smith. "If they are staffed thinly, we will not have as favorable a turnout as we could hope for."
Finally, if home prices resume some modest appreciation, that, too, will help.
The recasting of adjustable-rate mortgages-especially IOs, but also pay-option ARMs-will test the ability of the market in 2007. "Probably the first significant event will be midyear 2007, when the first wave of 2004 loans that were 3/1 ARMs are recast," says Smith. Some lenders will have to do some loan modification, he says. They could, for example, extend the IO period for another three years.
"It serves no one any good to foreclose," he says. "It's best to find a solution." Another way out is to refinance at a lower rate and put the borrower into a 10-year IO, he adds.
Chicken or the egg
Mortgage market players and observers are looking closely at the factors that led to the current situation and hoping to correct those factors and put the mortgage market back on the road to full recovery. So far, all the attention is on lax underwriting, according to Mike McMahon, managing director at Financial Stocks Inc., San Francisco. He suggests that one should look across the market at all players to see how each contributed to the problem.
"I suspect the market has over-reacted. But that's consistent with how markets react-an over-reaction one way and an over-reaction the other way," says McMahon.
"We had been through an over-reaction the other way throughout 2002 and 2003, when interest rates hit a 4o-year low. Everybody qualified [for a mortgage], and investors were scooping up the securities in a wonderful virtuous-well, I'm not sure it was virtuous-but in a wonderful cycle."
There were, however, "a lot enablers along the way, starting with the buyers of the securities, the underwriters, the rating agencies, the companies themselves and the brokers. It's kind of a chicken-and-egg thing. It's hard to say where it started," says McMahon.
"All of those parties I mentioned were at the party and were assisting in the good times," he says. "The brokers are going to originate anything they can sell and the mortgage bankers are going to buy anything they can turn around and sell, and the [Wall] Street firms are going to buy product they can securitize and sell," he says.
McMahon adds, "the rating agencies rated every one of those transactions that contained all the [problems], and determined the level of credit support necessary to attain certain ratings for tranches of the securities. They were very much involved with this." He cuts them some slack, however. "It's hard to tell you're in a bubble when you're in a bubble. I can understand how the rating agencies would look at the historical performance of securities and make some educated judgments on the level of credit support needed to attain certain ratings, while being aware of the current conditions at the time-which everybody agreed [were] easy money, high appreciation and low interest rates," McMahon says.
"And there didn't seem to be a loan that was originated that couldn't be securitized. And there are a lot of parties involved. Now, it's payback," he says.
McMahon identifies one key area of vulnerability in this cycle: the reliance on overnight money. "When you have the scenario financed with essentially overnight money on repo lines that are subject to margin calls, you're doubling your risk," he says. "So, we have a number of companies closing their doors because they can't repurchase loans or because the volume of repurchases are too high. And the providers of credit are making margin calls, because the value of collateral in the warehouse lines is going down."
The current meltdown, he adds, is similar to what happened in 1998, when there were about a dozen subprime independent mortgage companies. "It was a little different then. There were margin calls on what were called residual lines of credit," he says. The subprime mortgage companies in the 19905 had lines of credit supporting residual securitizations, which he identifies as "the credit support bonds at the bottom of the security, the non-rated, noninvestment-grade, first-loss, second-loss pieces, such as interestonly pieces." These pieces of the deal today are held by the hedge funds, but they were not in 1998, McMahon says.
So in 1998 the subprime lenders, like today, were holding a risky asset-the residuals-which were needed in the deals to credit-enhance the tranches at the top. "Then came the meltdown of Long-Term Capital Management, and Russia and Asia, and all that stuff. Liquidity dried up from the broker-dealers who made margin calls, and the subprime lenders couldn't make them and they went out of business," he explains.
The same thing "is pretty much happening now," says McMahon. "We have lines of credit supporting mortgage loans that are to be securitized. The value of these has gone down so much, they cannot be sold at par, in many instances, because they were priced improperly to begin with. At the same time, you have mortgage banks facing demands to buy back millions and hundreds of millions of dollars of mortgages, and they don't have financing for that-so they're going out of business. That's basically what happened to all these subprime lenders."
The outcome of the current subprime meltdown, however, will be good for the securitization market, McMahon says. "What is going to be left is rational underwriter-securitizers," he says. Countrywide's Mozilo made a similar point to CNBC in March, when asked about the failure of some subprime lenders. "It's good for Countrywide and the industry," he said, because "it is going to remove irrational pricing" from the market.
McMahon explains why the market will be more rational after the current wave of consolidation is done: "Until recently, the origination aspect of the subprime world was not directly linked to the sellers of the securities. So a broker would originate a loan and sell it to New Century, an aggregator, who would sell the loan in a securitized format to an underwriter, who would then sell the securities," McMahon says.
Now, he explains, "Merrill [Lynch], Lehman [Brothers], Bear [Stearns], Goldman [Sachs] and Countrywide, Wells Fargo [Home Mortgage] have the origination and securitization capabilities, and underwriting and placement of the security-the whole thing."
In this emerging mortgage market, then, one company will control the whole process, which will squeeze out the irrational pricing of loans by individual lenders. "What will happen is that the securities will be sold forward, and they will originate loans to go into the security at a price and underwriting that fits the terms of the security, such that companies won't have inventories of loans that can't be sold at a market rate, at a rate at which they won't lose money," McMahon says.
"Now, you go make the security by originating the loans, and you've already sold it forward and you know what rate or price you have to charge on the loans. So, if you control the whole process, it becomes a much more rational, controlled process. So, what's going to be left standing are rational, market-disciplined participants who control A to Z, originations to sales. As a result, you'll have much more rational behavior in the market," McMahon says.
How long will it take?
In the meantime, many are wondering: Just how bad will the delinquencies and defaults get? And how long will it take for the mortgage market to return to a sense of normalcy? As can be expected, views vary on both fronts.
Default rates continued to rise in January for all classes of securitized non-agency loans. Subprime defaults, for example, rose to 10.52 percent from 6.83 percent in the prior year, according to FBR Investment Management. If there was any silver lining in the mortgage performance cloud, it was the slowdown in the rate of acceleration in subprime defaults, according to FBR's Youngblood. He points out that while default rates for subprime had increased an astonishing 314 basis points in the five months before November 2006, the rates rose only another 43 basis points over the months of December and January.
"The string of rapid gains in defaults seems to have been broken in December," Youngblood says. He adds, "We believe that the majority of loans originated in 2006 that were poorly underwritten have already surfaced." FBR Investments predicts that default rates on subprime will slowly "drift upward" to 10-97 percent by December 20x57.
Overall default rates are likely to continue to rise due to the aging of the huge volume of originations in 2004 to 2006, according to Youngblood, even if labor market conditions remain the same in all markets. "Significant further erosion will depend on changes in labor-market conditions," he says.
Youngblood does not find the level of increase in defaults for alt-A loans particularly troubling. "Although there has been some erosion of alt-A, it is modest by any absolute or relative standard," he says. Default rates for altA loans have risen from a low of 0.74 percent in October 2005 to 1.86 percent in January 2007, according to FBR.
FBR Investments' forecasts only slightly higher default rates through the rest of the year include "some expectation of erosion due to resets," Youngblood says. When the resets hit, many borrowers will be eligible to refinance into agency conforming loans, alt-A or prime jumbo loans, he says.
Borrowers with improved credit "should be able to refinance into lower rates than the reset," Youngblood says.
In the great majority of markets, then, borrowers with 2005 ARMs resetting in 2007 "will have an ability to refi," Youngblood says. He notes that two-thirds of subprime loans in recent years have been 2/28 ARM loans. He points out most of the home purchases for 2005 have had two years of appreciation-anywhere between 5.8 percent for those originated at the end of the year to 19.9 percent for those at the beginning of 2005.
"There does not seem to be a grave threat for 2005 subprime originations," Youngblood says. As for the bad loans made last year, by the time of the reset in 2008, "the weakest credits from 2006 will have already defaulted on their loans," he says.
Some observers see the market correction taking longer. While mortgage lenders will eventually be in better shape based on tightened underwriting, they will continue to face difficulties with loans originated under looser standards, according to Stuart Feldtsein, president of SMR Research Corporation, Hackettstown, New Jersey.
The key problem is lack of sufficient equity. He says loans with a combined LTV of 94 percent or higher are problematic, because "you can't cure a delinquency" by selling the home. Even if the house sells at the appraised value, the seller generally pays a 6 percent commission to a Realtor® for selling the home and also pays closing costs. In such instances, "it will be better to work out the loan terms rather than go to foreclosure," Feldstein says.
Because workouts have been commonly occurring for some time, he adds, the fact that foreclosures are rising suggests "there's an impact from falling house prices." Thus, a full recovery from the mortgage industry's foreclosure woes depends on a recovery in the residential real estate market, he explains. "The best thing for the mortgage markets is to get home prices moving up again," Feldstein says.
Closing the gap
Feldstein claims that the mortgage market cannot get back into good shape until the gap between home prices and income is substantially reduced. "The gap has started to close, but it is not closed," he says. In order for home prices to rise, there has to be an increase in home sales. In order for home sales to increase, more buyers have to be able to afford to buy homes.
SMR has developed an index to measure growth in home prices and household income. Setting 1990 home prices and incomes as the base of 100, SMR found that for much of the 1990$ incomes rose faster than home prices, increasing the affordability of housing. By 2001, SMR's home-price index stood at 149 while the household income index stood at 153. In 2001, he explains, "Home prices had plenty of room to grow."
A gap appeared between home prices and income in 2002 and grew rapidly through the second quarter of 2006, when the SMR home-price index stood at 234, while the income index stood at 186-a very substantial gap of 48 points.
"That's way too big a gap in affordability to exist for a long period of time," Feldstein says. "So things have come to a screeching halt" while incomes catch up with house prices. By the fourth quarter of 2006, rising incomes and static and falling home prices had reduced the gap to 31 points.
Feldstein believes artificial demand from speculators drove up home prices. With that piece of artificial demand gone from the market, Feldstein is predicting that, absent an interest-rate cut, problems for the mortgage industry will continue through 2007.
The Mortgage Bankers Association's (MBA's) April forecast is that mortgage originations this year will fall 9 percent to $2.55 trillion from the $2.81 trillion in 2006. Home-purchase mortgage originations will drop 8 percent to $1.34 trillion from 2006's level of $1.45 trillion, due to a projected decline in home sales (and prices). Refis should be strong through the first half of 2007, according to MBA, as interest rates dropped in late 2006 and early 2007. A significant share of loans will face their first reset this year, and MBA expects a portion of those loans will be refinanced. Overall, refis should drop by 10 percent from 2006, to $1.21 trillion, MBA forecasts. For 2008, MBA is predicting a modest 2 percent increase in mortgage originations as home sales and prices recover modestly. However, with interest rates flat next year, refis should fall by 17 percent. Total originations in 2008 are predicted to fall to $2.37 trillion.
"It's possible the delinquency problem will get worse before it gets better-but by the end of 2008, we will likely see the tough times come to an end," Feldstein predicts.
In the meantime, mortgage lenders are keenly aware that loss-mitigation efforts-proactive management of existing loans by their servicing arms-can do much to keep foreclosures in check. One such servicer that takes a very proactive approach is GMAC ResCap, Minneapolis. "We have been very progressive in developing loss-mitigation strategies to help homeowners avoid foreclosure and maintain their homeownership," says Javid Jaberi, senior vice president with GMAC ResCap's servicing operations.
"For example, three years ago, we formed the HOPE [Home Ownership Preservation Enterprise] program, a special team of loss-mitigation specialists whom we have embedded in 10 cities throughout the United States to work face-toface with customers who are facing foreclosure. These specialists are part of a broader, assertive outreach strategy that we use to help homeowners who are facing difficult financial challenges." ?
GMAC ResCap services more than 3 million mortgages through its GMAC Mortgage and I Homecomings Financial servicing operations. GMAC ResCap services a total portfolio of $424 billion in unpaid principal balance (UPB) as of August 2006, according to Inside Mortgage Finance.
As part of its proactive approach, GMAC ResCap's servicing operations actively engage its customers on a number of levels to help homeowners avoid foreclosure. For current ARM customers, those who are not delinquent on their mortgage payments, the company distributes information and proactively contacts customers to make sure their customers understand the terms of their mortgage and to suggest various options for those customers when the interest rate on those mortgages reset, according to Jaberi.
For customers who have become delinquent on their mortgage payments, GMAC Mortgage and Homecomings Financial rely on their loss-mitigation specialists to employ a number of tactics to maintain a dialogue with their customers and help their homeowners avoid foreclosure.
In addition to typical tactics such as mail, outbound calling, inbound calling and educational campaigns, as well as other incentives, the company relies on its HOPE team to work directly with struggling customers to maintain their homeownership. The company's HOPE team members maintain offices in Chicago, Dallas, Detroit, St. Louis, Philadelphia, Cleveland, Indianapolis, Atlanta, Houston and Memphis, Tennessee.
It is not clear what share of the homeowners with potentially troubled loans will get the extra attention needed to keep their loans from defaulting. However, to the extent lenders make a determined loan loss-prevention effort, the severity and length of the market correction in the industry will be reduced. And to the extent lenders are not forced to over-react and tighten underwriting beyond what is necessary, it will help the home real estate market recover sooner.
In the end, the mortgage industry is likely to emerge stronger and with more rational pricing of loans, although it's not clear whether it will regain the same capacity to lend to subprime borrowers as it had before the current meltdown.
Copyright Mortgage Bankers Association of America May 2007
Reprinted With Permission.