Monday, November 19, 2012

Borrowers with modified mortgages re-default as homes re-enter shadow inventory

According to the Fed, banks had a visible increase in resi mortgage charge-offs in the third quarter.

Source: FRB

This could be a cause for concern. However, banks have some leeway in when they actually take charge-offs during the year, so it is worth taking a look at a more up to date delinquency data. JPMorgan recently published the October delinquency results. Indeed there was an increase in delinquencies, mostly in October (there seems to be some delay in reporting delinquencies that the Fed picked up in Q3, particularly by Bank of America). But delinquencies seem to the heaviest in sub-prime mortgages. Is this another wave of subprime defaults? Is Kyle Bass going to feel the pain from this increase by having half his book in sub-prime (see story from Bloomberg)? Here is what the data is telling us.

The chart below compares two populations of subprime mortgages:

1. "Always Current to 30" = % of subborrowers who missed payment for the first time (30 days overdue)
2. "All Current to 30" = % of all borrowers who missed payment (30 days overdue)


Source: JPMorgan

The pool of first-time delinquencies is clearly less impacted. Furthermore according to JPM, prime and Alt-A mortgage delinquencies for the "first-timers" did not go up at all. We are therefore seeing a sharp rise in re-defaults from modified mortgages.

Source: JPMorgan

This is telling us that mortgage modification programs have not been very successful, as the probability of re-default rises. By modifying mortgages, banks in many cases are simply kicking the can down the road - and now some are writing down these mortgages (which may be what is driving the higher charge-off numbers). We are therefore seeing an increase in delinquencies, but mostly among modified mortgages and concentrated in sub-prime portfolios. This in turn is having an impact on another important housing metric.

Note that once a mortgage is modified, the house is no longer counted as part of the so-called "shadow inventory". Modifications certainly contributed to a significant recent reduction in shadow inventory (see discussion - "mods" in the pie-chart). And now some of these homes are moving into the "shadow" once again.
JPMorgan: - It appears that mod re-defaults drove the increase. The number of re-defaults jumped 24% from the previous month.... We have argued that the sharp decrease in shadow inventory over the past two years was to some extent the result of aggressive modification activity. We think we are now seeing a wave of re-defaults from the modifications over the last two years that failed. This wave should last through 2013, and a greater share of current-to-30 rolls will come from re-defaults going forward.



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