Must-know: Why state foreclosure laws matter
State foreclosure laws influence borrower behavior
Borrower behavior is heavily influenced by consumer protection laws, particularly at the state level. States that have a judicial review of foreclosure activity tend to have higher delinquency rates and a bigger foreclosure shadow inventory.
New York state is legendary for how long a borrower can live in a home without paying the mortgage. It can be several years. Judges push servicers, who aren’t directly involved, to keep modifying the underlying mortgage.
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Six of the top ten states for total non-current loans are judicial
Just under half of all states are judicial, but they’re concentrated at the top of the non-current leader board.
Mississippi is the highest, with 14.1% of all mortgages non-current—12.4% in delinquency and 1.7% in foreclosure. Mississippi isn’t judicial, but the majority of the remaining top ten are. These states have high levels of shadow inventory. In fact, New York and New Jersey have incredibly high pipeline ratios.
Massachusetts is increasing its pipeline ratio due to foreclosure prevention programs. Massachusetts is actually suing Fannie Mae, Freddie Mac, and the Federal Housing Finance Agency (or FHFA) over its foreclosure prevention programs.
The states with the lowest delinquencies are North Dakota and South Dakota, with 2% and 3%, respectively.
Judicial states have had low home price appreciation
We’ve seen that home price appreciation varies widely by location. In the active California markets, there’s tight supply because the foreclosure pipeline has been worked through. In several California markets, you’re seeing over 20% annual home price appreciation.
In the judicial states—particularly New York, New Jersey, and Connecticut—you’re seeing much lower home price appreciation. The shadow inventory is still huge. As a result, buyers are reluctant to step up in the face of such supply.
Implications for mortgage REITs
Real estate prices are a bigger driver of non-agency real estate investment trusts (or REITs)—like CYS Investments (CYS), Newcastle (NCT), and Redwood Trust (RWT)—than they are of agency REITs like Annaly (NLY) and American Capital (AGNC).
When prices increase, delinquencies drop. This is important because non-agency REITs face credit risk. Even for agency REITs, that invest in government mortgages, rising real estate prices can drive prepayments. This negatively affects their returns.
Rising real estate prices also help reduce the financial system’s stress. This makes securitization easier and lowers the cost of borrowing. Finally, the REITs with large legacy portfolios of securities from the bubble years are able to stop taking mark-to-market write-downs. They can revalue their securities upwards. Since REITs have to pay out most of their earnings as dividends, higher earnings mean higher cash flows to the investor.