Signs show strategic default on the decline

The trend of borrowers choosing to default on their mortgage when they otherwise might have been able to afford payments is on the decline, JPMorgan Chase (JPM) analysts said Monday. Definitions for what qualifies as a strategic default varies. But analysts took a deeper look in the report. One widely held requirement for strategic default is that the borrower stops making payments when the property loses equity, meaning the mortgage is worth more than the underlying home. JPMorgan analysts used Standard & Poor’s/Case-Shiller indices and tracked prices against original loan amounts on a metro level. Then, analysts collected counts for all defaulted loans since 2007 and tracked those that started missing payments once the loan went underwater. They found 60% of all defaults were strategic by the middle of 2009, more than double the percentage in January 2008. But analysts wanted to get more specific. Using data from Equifax, the JPMorgan analysts looked at which borrowers did not experience a monthly payment increase before defaulting. Then, they added in which borrowers were still making payments on other debts after missing their first mortgage payment. The final definition of strategic default used was the “percentage of defaults from underwater borrowers who started missing payments once underwater, continued paying their other debt, and had no payment increase on their mortgage.” While the analysts admit they might still be overestimating the amount of strategic defaults when accounting even for all these variables, they noted the trend is going down. Across the private-label mortgage-backed securities market, the analysts found 10,000 strategic defaults fit their definition, down from nearly 20,000 one year ago. “Overall, strategic defaults have stabilized as home prices flattened, and initial jobless claims declined,” analysts said. “A trend worth watching, no doubt, but we can comfortably say that strategic defaults are less than 30% of all defaults, and the pipeline of borrowers [delinquent more than 90 days] has even lesser strategic delinquencies.” But there is still the possibility of the trend heading upward. The latest offer from the 50 state attorneys general in the foreclosure investigation includes provisions that allow for some borrowers to receive principal reduction. In March, at least four of the AGs sent a letter to the others, warning that such requirements may only attract more borrowers into strategic default. Currently, 42% of underwater borrowers remain current on their mortgage, according to the JPMorgan Chase analysts. And they also warned of the risk these borrowers pose. “Of course, the moral hazard of potential strategic defaults in the future is still present. Even though these borrowers have not been defaulting in large numbers, the event risk remains that they could,” analysts said. Write to Jon Prior. Follow him on Twitter @JonAPrior.