Subprime Delinquencies: Numbers Improving, Slowly But Surely

by: Tom Brown

Have I told you I believe consensus expectations for eventual cumulative subprime mortgage losses are too high? Oh, right, I mentioned it here, here, here, and here. Sorry.

I’ve been hammering away on the topic for weeks now and, for the most part, people seem to think that I’m nuts. One reason why, I suspect, is that my view is so at odds with the nasty mortgage-delinquency data they’ve gotten used to seeing in the headlines month after month. As the L.A. Times reported just a few weeks ago, “U.S. mortgage delinquencies, foreclosures at record highs." Case closed. What’s to argue with?

Actually, plenty. First, the overall delinquency and foreclosure data so beloved of headline writers are terrible indicators of coming changes in subprime-mortgage credit quality. Yes, overall delinquencies—that is, loans at least 30 days past due—are at record highs. Take, for instance, the group of loans we’ve spent a lot of time studying lately, the ones that make up the ABX 06-1 subprime mortgage index. At the end of June, delinquencies on those loans came to $5 billion, compared to just $4.2 billion back in October of 2007. So on the raw numbers, things seem to be getting worse. Take a look:

But as I say, the raw numbers are misleading. Why? Because the oldest, ugliest delinquent loans still haven’t dropped out of the totals. So the overall numbers aren’t showing what’s happening now.

It takes nearly forever, remember, for a delinquent loan to turn into an official realized loss. To understand why, think about how long it takes for a mortgage borrower to go from being current, to delinquent, to having his house repossessed and sold by the bank. First, he has to be 90 days delinquent before the lender will even begin foreclosure proceedings. After that, several more months will have to pass before the property will actually be repossessed. Then the bank still has to sell the darn thing to realize a loss. If you’ve ever sold a house, you know that that it can take six months or more--and you’re not a lumbering bureaucracy.

Get the idea? Add it all up, and a delinquent loan can stay delinquent for close to a year and a half or more before it becomes a realized loss. Until that happens, it remains a delinquent loan. Around here, we have a term for this process. It’s called “getting the pig through the python.”

Relating this to the chart above, yes, overall delinquencies are still rising—but that’s largely because, as I say, the oldest delinquencies are still being counted in the totals. But who cares about them? They’re old news and shouldn’t be a surprise to anybody. A more revealing way to view the numbers is to look at delinquent loans by delinquency bucket, like this:

See what’s going on? The grey bars on the right, especially loans in the process of foreclosure or that have become REO, are the pig in the python I mentioned. Once those properties are repossessed and then sold, which should be any month now, they’ll finally leave the overall delinquency numbers--and the numbers will actually start to fall.

The real, encouraging part of story is what’s going on the left side of the chart. See how newer delinquencies, especially 30-to-60 day and 61-to-90 day, are lower now than they were last October? That’s a big deal: new delinquencies are falling, regardless of what’s gone on with total delinquencies. Once the later-stage delinquencies drop out of the total, the overall delinquency numbers will fall, and everyone will start to see what we know now, that subprime credit quality has indeed turned the corner.

It is, as I say, not a concept most observers are on board with yet. But the numbers are pretty clear. It’s just a matter of time before everyone realizes it.

Tom Brown is head of