90-day mortgage delinquencies tick up in Q1
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Mortgage delinquencies are falling as home prices rise and the foreclosure pipeline is being cleared. While 7.25% seems low compared to the peak, the “normal” level prior to the housing bubble was in the 4% to 5% range. This also reflects the mortgage modification push by the Obama Administration, which has used various programs (HARP, HAMP) to allow distressed borrowers to refinance or modify their mortgage into something more affordable.
The foreclosure pipeline is being cleared and is mainly an issue in what have been dubbed “the judicial states” (New York, New Jersey, etc.). Non-judicial states have shorter timelines between delinquency and foreclosure. Judicial states require a judge to approve foreclosures, and they often press the borrower and lender to find a way to keep the borrower in their home.
Declining delinquencies and the shadow inventory issue
The theme of the real estate market lately has been one of restricted supply. Many hedge funds and private equity firms raised capital in anticipation of a massive wave of distressed sales that never really occurred. The shadow inventory was estimated at 5.3 million homes at its peak in 2010. It has subsequently fallen; those properties were never dumped on the market. The banks chose to hold foreclosed properties instead of selling them at distressed prices, and the government never insisted that they get these assets off their balance sheets. The government pushed the Federal Housing Administration to modify loans as much as possible and to avoid dumping foreclosures onto the market. Instead, the government established the Real Estate Owned (REO)-to-rental program where portfolios of foreclosures were auctioned off and buyers had to commit to not selling the properties for a specified time period.
As delinquencies fall and shadow inventory declines, buyers are realizing that a massive, distressed sale isn’t going to happen. Instead, buyers are starting to aggressively bid on properties. In some of the hardest hit states, like Phoenix, prices are up 20% year-over-year.
Declining delinquencies means good things for non-agency REITs
Non-agency REITs, such as Pennymac (PMT), Two Harbors (TWO), or Redwood Trust (RWT), take credit risk, while agency REITs, like Annaly (NLY) and MFA Financial (MFA), invest in government guaranteed, or government supported, mortgages. Agency REITs don’t worry about delinquencies because their principal and interest payments are guaranteed. Falling delinquencies are extremely important to non-agency REITs, especially those that invest in the junior tranches of securitizations. These bonds are high-risk and high-reward. This portion of the mortgage-backed securities market has rallied significantly over the past two years. Some REITs, which had been given up for dead, are up 10-fold over the past year due to the rebound in distressed MBS.