Apr 17, 2014 — National Mortgage News
Thanks to the housing recovery, legacy subprime mortgage bonds are performing better than they used to. Home price gains only go so far, however, in areas where foreclosures take longer because they go through the courts.
"In 2013 and 2014, we've seen some improvement in the loss rate on subprime MBS thanks to home price appreciation. But when it comes to judicial states, we sometimes don't," says Jiwon Park, analyst at Moody's Investors Service and the author of a recent report on the topic.
Some investors are surprised that the loss rates on the MBS they hold have failed to improve, given that home prices have generally increased, Park says. "We got a lot of questions from investors asking, 'What's driving this trend? Why is it so negative?'"
The answer highlights the higher expenses servicers and investors have to incur to take back their collateral in judicial states compared to non-judicial ones.
"We see in judicial states the foreclosure timelines lengthening, with that comes increased costs. With that comes the lost opportunity of getting some of the home price appreciation gains," says Brent Taggart, senior vice president at Green River Capital, a manager of foreclosed properties based in Salt Lake City. Judicial state liquidation costs are likely to grow at a faster pace than home price increases, Park says. Liquidation costs are likely to rise about 10% or more in the coming year. National home prices are on track to increase about 5% during the same period, Moody's Analytics projects.
"There is a tremendous difference in terms of impact when it comes to judicial versus nonjudicial, mainly because of the maintenance involved for the property as well as taxes, legal fees and internal employee costs," says Sanjeev Dahiwadkar, the chief executive at IndiSoft LLC, a servicing technology provider in Columbia, Md.
"In the big picture, 5% doesn’t count enough in a judicial foreclosure situation. One percent to 1.5% is the value of the property tax alone," he says. The advances servicers must make to investors to cover payments homeowners miss also adds to costs, notes Taggart. If home prices increase enough, they can outweigh longer foreclosure timelines and other performance concerns and improve bonds' performance, Park says, but this has yet to happen.
"We would need at least a 7% housing price increase to offset the risk. If foreclosure timelines continue to lengthen, we will need more than a 7% home price appreciation," he says. For now, foreclosure timeline risks are rising and appear likely to a continue doing so. Top servicers are making headway in reducing foreclosures and loan performance is improving in general. The foreclosure rate for the top 15 players was just 1.84% as of yearend 2013, according to the Quarterly Data Report. This was down from 2.82% as of Dec. 31, 2012. However, the subset of loans backing the private-label securities from 2005-2007 are a different story. As these deals have aged, delinquent mortgages in the pools have become increasingly concentrated in states with longer foreclosure timelines. "Judicial states are dominating in terms of volume for the current foreclosure pipeline, especially in subprime," Park says.
Generally, in pools that have more loans in non-judicial states, recent home price increases might be sufficient to reduce loss severities. Where judicial states dominate, however, there are higher loss severities. Still, Park advises not to paint all private-label MBS with the same brush when it comes to these trends. "It depends on the deal, the tranche and the bond," Park says.