State foreclosure laws influence borrower behavior

Borrower behavior is heavily influenced by consumer protection laws—particularly at the state level. States that require 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 to keep modifying the underlying mortgage. The saga of Ocwen means regulators and judges will probably get more aggressive pushing for foreclosure relief.

Why state laws influence borrower behavior and mortgage REITs

Six of the top ten states for total non-current loans are judicial

Just under half of all states are judicial. However, in terms of delinquencies, the majority of the leaders are judicial states.

Mississippi is the highest. It has 14.9% of all mortgages categorized as “non-current.” Of these, 13.3% of mortgages are in delinquency and 1.6% are in foreclosure. Mississippi isn’t judicial, but the majority of the remaining top ten states are. These states have high shadow inventory levels. In fact, New York and New Jersey have incredibly high pipeline ratios.

Judicial states have 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, there’s over 20% annual home price appreciation.

In the judicial states—particularly New York, New Jersey, and Connecticut—there’s much lower home price appreciation. The shadow inventory is still huge. As a result of the supply, buyers are reluctant to step up.

Implications for mortgage REITs

Real estate prices are a bigger driver of non-agency real estate investment trusts (or REITs)—including CYS Investments (CYS), Newcastle Investment (NCT), and Redwood Trust (RWT)—than they are of agency REITs such as Annaly Capital Management (NLY) and American Capital Agency (AGNC).

When prices increase, delinquencies drop. This is important because non-agency REITs face credit risks. Even for agency REITs that invest in government mortgages, rising real estate prices can drive prepayments. Many borrowers who were underwater during the last refinance wave are now able to refinance due to home price appreciation.

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