Mortgage Finance Players Begin to Measure the “Shadow” Shadow Inventory

The recent data that shows delinquencies rising, mixed with reports that a lack of borrower equity is one of two major reasons for mortgage default, is propelling mortgage finance analysts to attempt to measure the pipeline of borrowers who are likely to lose their home, via strategic default or loss of income. Call it the “shadow” shadow inventory. “The good news is that the US mortgage delinquency rate appears to be past its peak and will probably fall further from here,” said US economist Paul Dales in a report from Capital Economics. “The bad news is that the recent economic slowdown will limit the size of any future fall meaning that up to 4m households could still lose their home.” According to the Mortgage Bankers Association‘s quarterly delinquency index released today, the delinquency rate for a prime adjustable-rate mortgage (ARM) increased 47 basis points (bps) to 9.3% while the rate for a fixed-rate mortgage (FRM) increased 8bps to 4.75%. Foreclosures for both types of mortgage loans remained relatively flat quarter-over-quarter, ARMs dropping only 4 basis points to 3.92% and FRMs increasing 1bp to 1.11%. All these measures are now below their peaks, and the falls are probably due to the fact that employment is rising once again. The problem, however, is that delinquency and foreclosure rates remain very high by historical standards. “What’s more, the absolute number of households in trouble is sobering. 5.3m households are currently delinquent on their mortgage,” Dales said. “Add in the 2.5m that are already going through the foreclosure process, and a total of 7.8m households are in danger of losing their home.” Dales adds that not all of those homes will be foreclosed, but if only around half do, 4m, it would be enough to double the number of homes currently up for sale. The CoreLogic numbers found that the largest improvements in negative equity positions occurred among properties with a loan-to-value ratio of over 125% — ostensibly as borrowers decided to stop paying on their mortgages and walk away from their debts. But this is a disproportionate slice of the housing pie, according to one analyst who spoke off the record because his data was not yet public. Most of the nation’s homes, more than 65% anyway, are at around 20% equity. “You need to take where prices are heading. If prices drop 10%, I lose half of that,” he said, “but it also will create an environment of impending negative equity for many borrowers, who even with jobs may feel like walking away.” Estimations on the shadow inventory abound. According to Morgan Stanley, the shadow inventory of foreclosures could top 7m properties and take nearly four years to clear. The credit rating agency, Standard & Poor’s, put the total aggregate balance of the shadow inventory at $480bn worth of loans that would take nearly three years to clear. Barclays Capital reported that it could peak at 4.7m in the summer of 2010. The VP of sales and analytics at Altos Research, Scott Sambucci, agrees that the negative psychological effect of the news may push the number of homes facing default even above the estimations of Capital Economics. “In a growing underwater situation, borrowers are going to see neighbors walking away and not question that logic, being that they are in the same situation, with likely the same options,” Sambucci said. “It’s possible the ‘shadow’ shadow inventory may reach past 4m.” Write to Jacob Gaffney. Additional reporting by Jon Prior