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All Up in ARMs and No Relief in Sight
By Ted Cornwell
The decline of mortgage credit quality has been well documented, and there is plenty of blame to go around, but when people look back at today's credit crisis, my guess is that adjustable-rate mortgage loans will look like the bad kids in the back of the room whose rowdiness got the whole class in trouble.
Once again, the MBA said that adjustable-rate mortgages - especially those to subprime borrowers - drove the increases in overdue payments and foreclosures. And two big states that have seen home values slide, California and Florida, continue to drive the national numbers. 21% of the nation's outstanding home loans are from California or Florida, and those states have an even greater market share by dollar volume.
MBA Chief Economist Doug Duncan (who is leaving that post to take a position at Fannie Mae, by the way) said that falling home prices are "clearly the driving factor" behind the bleak foreclosure picture, though he said the magnitude and underlying reasons for rising defaults vary from state to state.
In the industrial Midwest, job losses and population out-migration in Michigan and Ohio have left people who need to sell homes with few potential buyers. The one silver lining is that, barring a full-scale recession, defaults may be peaking in the industrial Midwest, Mr. Duncan said.
In sunnier states such as California, Florida, Nevada and Arizona, Mr. Duncan said that overbuilding and speculative home buying generated too much supply, which is now depressing home values.
Subprime ARMs, which represent 7% of loans outstanding, accounted for 42% of foreclosure starts during the fourth quarter. Those loans were especially popular in states like California.
"Roughly a third of subprime adjustable rate loans are late on their payments," Mr. Duncan said during a conference call with reporters to discuss the MBA's quarterly delinquency survey.
Moreover, the performance of subprime loans will likely deteriorate further due to adverse selection, he said, as stronger subprime borrowers refinance into prime or government backed loans and leave the pool of outstanding subprime loans with a riskier profile.
While subprime loans -fixed and adjustable rate - only account for about 13% of loans outstanding nationally in the MBA's delinquency survey, they loom large in some of the states hardest hit by the housing bust, including California, Nevada, Arizona and Florida.
Loose underwriting and declining home values are behind the weak performance of subprime ARMs, Mr. Duncan said. Many were originated with no income verification, with little equity, and reflect the general weakening of underwriting standards that afflicted loans produced in 2005 and 2006, he said.
Noting that many first mortgages were originated along with a home equity loan in recent years, Mr. Duncan said that loan-to-value ratios are much higher today than they were in the mid-1980s, when delinquency levels last exceeded today's rates. And there's no guarantee that the 6.07% delinquency rate record set in 1985 won't be exceeded in future quarters. (In the fourth quarter of 2007, the overall delinquency rate stood at 582%, it's highest level in more than 20 years. Add in the foreclosure inventory, and some 8% of borrowers were not making payments).
"As long as house prices are declining, you should expect to see some continued rise in delinquencies and foreclosures," Mr. Duncan said.
The popularity of ARMs was something of a mystery at the height of the housing boom, since the yield curve was fairly flat, making long-term, fixed-rate financing very affordable. But borrowers did everything they could to stretch their buying power. And in many cases, the teaser rate on ARM loans looked just too tempting to ignore.
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