Why declining delinquencies are good for mortgage REITs
The Lender Processing Services (or LPS) Mortgage Monitor is a monthly report that provides delinquency and foreclosure data
Lender Processing Services is a vendor to mortgage originators, handling mortgage processing and default management outsourcing. So it comes across a wealth of top-down mortgage information that many professionals and analysts use to help make strategic decisions. The information in the report is useful to forecast delinquencies and prepayments, which are key inputs for both agency and non-agency REITs.
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90-day mortgage delinquencies increase to 6.4% in September
Mortgage delinquencies are falling as home prices rise and the foreclosure pipeline clears. While 6.4% seems low compared to the peak of 10%, 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 (like HARP, the Home Affordable Refinance Program, and HAMP, the Home Affordable Modification Program) to allow distressed borrowers to refinance or modify their mortgages into something more affordable.
The foreclosure pipeline is clearing and is mainly an issue in what have been dubbed “the judicial states” (like New York and New Jersey). 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.
New delinquencies are dropping
The report goes into a lot of different data points that I’ll discuss later, but one thing that’s important is that new delinquencies are approaching their pre-crisis levels, which you can see in the chart above. Interestingly, there’s a difference between the judicial states and the non-judicial states. The new problem loan rate in the judicial states is 1%, while it’s 0.8% in the non-judicial states. Economic strength could explain the difference. In the states where the shadow inventory has been largely disposed of, you’re seeing a lot of construction, which creates jobs and a stronger economy. In the judicial states, new home construction is still very tepid and has concentrated in multi-family units, which are mainly rentals. House prices aren’t increasing at the same pace, and that could at least partly explain the difference in delinquencies. Incentives could be the other explanation—New York is legendary for how long someone can stay in their home without paying their mortgage. Foreclosures are a multi-year process there.
Declining delinquencies mean 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 that invest in government-guaranteed or government-supported mortgages—such as Annaly (NLY) and American Capital (AGNC)—do not. While agency REITs don’t take credit risk, defaults act like prepayments, which means these REITs have to reinvest at lower rates. So they aren’t completely insensitive to delinquencies. 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 that had been given up for dead are up ten-fold over the past year due to the rebound in distressed MBS.