The Anticipated Prime Mortgage Problem Has Arrived

A little over two weeks ago I posted an article highlighting the looming threat of increased prime mortgage defaults. Since then it has been reported that one in three foreclosure actions are now prime mortgages. It had been one out of five foreclosures in the first quarter this year.

Calculated Risk (here) has two charts relating to this. The first shows the distribution of mortgages by type.

More than 75% of all mortgages are prime. The second chart shows that prime mortgages now constitute more than half of all serious delinquencies (90 days or more delinquent) and foreclosures. The percentage of prime mortgages in serious trouble may be smaller than other classes (especially subprime), but the absolute number of prime loans is so large that prime foreclosures will equal or exceed the numbers from other categories in coming months.

Subprime mortgage delinquencies and foreclosures are still large, more than doubling their share of the market. But the implication is that, in absolute numbers, prime will provide substantially more foreclosures over the next 6-12 months.

It may be inferred that the rise from 20% of foreclosures being in prime mortgages in the first quarter, which grew to to 33% in the second quarter, is about to go to 50% or more in the coming quarters.

In another post, Calculated Risk reported on the conference call by MBA Chief Economist Jay Brinkmann on August 20.

• The problem is moving to prime loans, and fixed rate prime loans. Although the delinquency rate is lower for prime fixed rate than for other loans, these loans make up 65.5% of all loans - so the increase matters.
• Brinkmann expects delinquencies to peak in mid-2010.
• Brinkmann expects foreclosures to peak at the end of 2010.

  Note: The MBA data shows about 5.8 million loans delinquent or in the foreclosure process nationwide. I believe the MBA surveys covers close to 90% of the mortgage market. Many of these loans will cure, but the foreclosure pipeline is still building.

The following graph, from the Mortgage Bankers Association, courtesy of Calculated Risk, shows how the rate of subprime foreclosures is showing a leveling, while the number of delinquent loans is accelerating.

There is a logical disconnect here. Since foreclosure comes after delinquency, one would expect that the growth rate of delinquencies should decline before foreclosures. The fact that it is happening exactly in reverse implies that:

1. A significant number of delinquencies are being resolved without going into foreclosure proceedings OR
2. A wave of additional foreclosures in subprime will come to catch up with the higher delinquency rate.

I have heard nothing to indicate that 1. is occurring, so my expectation is for 2. to be the outcome.

Although I have pointed out in a recent article at TheStreet.com that comparing prices to historical references might imply that we are within 10% of a price bottom (on average nationally), it is hard to conceive that house prices can bottom before foreclosures peak. If that peak really is 16 months away, the bottom in national average home price could be more than 10% down from here.

It is possible that the the burden of increased foreclosures on the national average home price could by offset by a change in sales patterns, Currently the increase in sales volumes over the past several months has been dominated by large increases of sales in the lowest cost homes (below $200,000). Above $200,000 sales volumes are still falling; the higher the price the greater the decline in sales.

If this were to change and expensive home sales were to start increasing, the average price per house could increase. An example: If you sell 50 homes for $100,000, obviously $100,000 is the average. If you add one sale at $600,000, the average for the 51 sales is $109,800. This is an increase of almost 10% in the average price per house with an increase of only 2% in sales volume.

A related news item Friday morning came from the National Association of Realtors (NAR). In their monthly news release (here), they report the fourth consecutive month of increasing existing home sales. There was an all-time record jump of 7.2% from the previous month.

The report includes a statement that some areas in the country have demand for foreclosure properties outstripping supply. If that becomes a trend, then median and average home prices in those markets should rise, since distressed properties sell for 15% to 20% less than corresponding "normal" sales.

So there is another factor that could put a floor under the national average home price.

However, I have to add five caveats to this seemingly bullish existing home sales report:

1. The potential for a greater flow of homes into foreclosure may increase the supply more than the NAR reported demand can absorb going forward.
2. In July, 31% of all sales were distressed properties.
3. Inventory remained at 9.4 months in spite of higher sales volume. Obviously, supply increased proportionately to sales.
4. The pattern of rising sales volume this year repeats the same pattern experienced last year, when sales volumes increased for five months in a row. This year there have been four consecutive increases. This is a seasonal pattern seen most years and was discussed here.
5. The entire rise in in sales volume in July was due to higher condo sales. Single family existing home sales actually dropped slightly.

Not only is the anticipated prime mortgage default problem arriving, it is growing and will probably be with us for more than a year. This author did not anticipate this would be a big problem six months ago; I (and many others) were focused on Alt-A mortgages and variable mortgage resets. They may still have a contribution to this mess. I will be doing further analysis to try to sort out all this.

Note: This week Zachs had a good Seeking Alpha article on prime mortgages here.

Comments

[Steven Hansen:]

agree that the NAR sales increase is transient. John Mauldin blogged in his Frontline Weekly Newsletter www.investorsinsight.c... the following:

"And before we get too celebratory, my friend John Burns of John Burns Real Estate Consulting suggests we may be seeing a false bottom. What we are seeing is the result of a government program that offers first-time home buyers $8,000 if they buy a home by November 30; and that program is working, especially at the lower end of home prices (as you would expect, and as it should.) 31% of home sales in July were involved with this program. But like Cash for Clunkers in automobiles, this is pushing demand for homes from next year into this year."

basically his assertion is that their was a false market bottom in april 2009, there will be a false peak in november 2009, then the real bottom will occur in summer 2010.

i think even that is optimistic, i believe there are 10 million home oversupply, a massive unrealized home backlog of home owners (spelled baby boomers) who want to sell but held back putting the home on the market, as well as the foreclosure issues that are well stated in this article.

one final point, this real estate market weakness will dampen consumer sentiment, and may create a second leg down. The commercial real estate crisis will also play its role on cooling the economy. i published an article today in SA quantifying this issue.

Aug 23 04:09 AM

[Roger Knights:]

"prime mortgages now constitute more than half of all serious delinquencies"

Thank you for not (mis) using "comprise"!

(Comprise is almost always misused. It means "includes in toto"; "the flag comprises the colors red, white, and blue" would be an example of proper use. It helpfully and concisely clues the reader in that there aren't any other colors. All other uses are hideously wrong.)

Aug 23 04:27 AM

[Clive Corcoran:]

Reading this article reminds me of just how nonchalant most commentators and policy makers - including Bernanke and Greenspan - were when the sub-prime problems surfaced more than two years ago.
Their inability to extrapolate from sub-prime to massive problems across the whole mortgage market is surely a further indictment of the "Who could have seen this coming" mythology which has been perpetrated by those who were receiving compensation which suggested that they were able to think outside of the box but clearly couldn't.

Aug 23 04:31 AM

[markfl:]

"If that peak really is 16 months away, the bottom in national average home price could be more than 10% down from here." I think this is probably valid, based upon your analysis. In an LA Times Story www.latimes.com/busine... , the Mortgage Bankers Association said it "predicts that U.S. job losses will continue at least until the middle of 2010, meaning that mortgage delinquencies and repossessed homes will almost certainly continue rising."

In that same story, they quoted Mark Zandi regarding the timing of a housing market bottom: "The broadening of the foreclosure crisis to include prime loans due to high and rising unemployment will delay a bottom in the housing market and threatens the economic recovery."

Aug 23 04:40 AM

[dpnstl:]

I think Mr. Lounsbury has made some excellent points in this post and brought attention to the "800 lb gorilla" that is out there....his comments parallel those I made in a post at: (partial excerpt is below)
realestateinvestordail.../

"My take on this situation is that the record number of mortgage delinquencies we are seeing is going to continue to fuel the record levels of foreclosures we have seen of late and the foreclosures will continue to have a negative affect on the overall housing market as well as house prices. Recently we have seen, in home sale statistics, that the negative impact of foreclosures is lessening on the real estate market a result of prices being beaten down enough to bring buyers back out however a flood of foreclosures over the next few months could very well disrupt this delicate balance we have presently in the real estate market.

So the $64 question is; has the market recovered enough to withstand the impact of these delinquencies and foreclosures or will we start hearing that sickening sound of air escaping from the bubble again? Let’s hope its the former and not the latter."

Aug 23 08:33 AM

[Leftfield:]

A reminder that the top tier, our leaders, have received record shares of national wealth and income which has been rising for decades. Over and over we see their failures to foresee and do anything helpful to earn this amazing haul except that they outsourced and downsized American's livlihoods and grabbed first and multi-$trillion bailouts.
We're frozen in denial, hoping for it to all go away. The stock market isn't positioned for the kind of bad news these mortgage figures show. It seems with the kinds of shocks and adjustments we're in for, reversion not just to, but far beyone the mean is quite possible.

Aug 23 08:57 AM

[Daniel Herkes:]

Your right. But when, during the past 3 months, has the stock market been operating with free market conditions? All that funny money - TARP, TALF, CARS, etc, has distorted the trading parameters to the point that almost all of the current rally is due to large traders operating with public cash. I fear, but do not wish for, another downturn in the stock market.

There are a lot of people out of work right now. Many of them will have lost pretty much everything when this is over - houses, retirement accounts, mobility. This equates to a lower standard of living.


On Aug 23 08:57 AM Leftfield wrote:

> A reminder that the top tier, our leaders, have received record shares
> of national wealth and income which has been rising for decades.
> Over and over we see their failures to foresee and do anything helpful
> to earn this amazing haul except that they outsourced and downsized
> American's livlihoods and grabbed first and multi-$trillion bailouts.
>
> We're frozen in denial, hoping for it to all go away. The stock
> market isn't positioned for the kind of bad news these mortgage figures
> show. It seems with the kinds of shocks and adjustments we're in
> for, reversion not just to, but far beyone the mean is quite possible.

Aug 23 09:51 AM

[john s. gordon:]

'51 sales @ 109800' -
outliers skew the average so median prices are more meaningful than average/
> jack

Aug 23 10:31 AM

[John Wake:]

Great analysis of the supply side.

Now, let's talk about the demand side or, rather, the quantity demanded. The prices are so low and the number of sales is so high, in Phoenix for example, that markets are clearing. In a several low cost areas of Phoenix, the quantity demanded is so high that they could clear MORE supply.

To give you an idea how crazy the market is in Phoenix, let's look at homes sold within the City of Phoenix, not metro Phoenix. The median sold price was $64,000 in March. That means, of course, that half the homes sold for $64,000 or LESS. By June the median price in the City of Phoenix increased to a whopping $78,000. (Based are Arizona State University data.)

Prices are so low in a several zip codes in the City of Phoenix that the quantity demanded has exceeded supply and prices have increased. At their current price level, those zip codes could likely clear continued high levels of foreclosure supply and, indeed, prices have likely bottomed out in those zip codes already.

Prices, however, haven't fallen to that point in most metropolitan Phoenix zip codes and at current prices the quantity demanded is less than the supply.

Aug 23 01:54 PM

[John Lounsbury:]

John Wake - - -

I am working on a couple of articles (at least) on the demand side analysis. The primary issues are demographics, unemployment, savings destruction, restrictive credit underwriting, rate of credit impairment and median income levels. There will be at least one article here on Seeking Alpha that will try to put supply and demand pictures together. I've been organizing data for several weeks. Now I've got to boil it down to conclusions.

Aug 23 03:43 PM

[Mayascribe:]

Appreciate the article, John.

Another scary aspect of our economy to ponder.

Aug 23 05:27 PM

[Troyhector:]

I think the nation's housing market is facing new downward pressure as holders of subprime-mortgage bonds inundate the market with foreclosed homes at prices that are much lower than where many banks are willing to sell.

"Experts say this is a bad omen for residential real-estate prices and homeowners trying to sell or refinance, because the fire sales, many to cover soured subprime loans, put downward pressure on the value of nearby homes. All of this undermines federal efforts to stabilize the housing market and revive the broader economy.

Read More: www.housingnewslive.co...

Aug 24 04:41 PM

[Autolander:]

I believe it comes down to jobs and income. We're currently at a high level of delinquencies on mortgages. If the job/income side of the economy doesn't improve, then how will the currently delinquent lenders become current? Obviously, they won't and many of these will fall into foreclosure. Of course some are delinquent on purpose (to set up the banks for re-modification). I believe these are the minority.

If the job market deteriorates further, then the housing market must also follow. Until we get incomes to the point where families can pay for the mortgages, then we'll continue to see foreclosures.

Aug 25 01:18 AM