June 29, 2007
BofA Analyst: Mortgage correction just 'tip of the iceberg'
Robert Lacoursiere, an analyst with Bank of America, is not drinking any corporate Kool Aid. In a recent report, he said losses on home loans will peak in the second half of 2008.
He starts with this:
• Mortgage borrowers are in a weaker position than in the last cycle with less equity cushion, higher levels of income devoted to debt servicing and facing higher rates in the upcoming waves of rate resets.
• Meanwhile softening housing market makes repayment by sales an unlikely option, setting the stage for loss severities last seen in the early ‘90s.
He delves deeper into the reset issue:
According to BofA’s estimates, approximately $515 billion of ARMs are scheduled to reset in ’07, followed by approximately $680 billion in ’08. Furthermore, of these ARMs, we estimate that subprime loans consist of $400 billion (78%) in ’07 and $500 billion (73%) in ’08.
Recently released data from Fannie Mae (FNM) confirms our view that ARM resets will lead to higher rates of credit deterioration, particularly for 2/28 subprime ARMs. ... Of the subprime ARMs that reset in 2006, 76% of borrowers were able to successfully pay off their loan (either through refinancing or selling their home).
However, of the borrowers that did not pay off their loan 50% went bad (delinquent, in foreclosure or REO).
According to FNM, subprime ARM borrowers facing resets in ’06 on average faced a 250 bps (2.5 percentage points) contract rate increase.
Meanwhile, though the data is only as of March ’07, of all the subprime ARMs scheduled to reset in ‘07, already 18% have gone bad (delinquent, in foreclosure or REO) or 29% of loans that have not been paid off. As a larger number of loans will hit the reset throughout the rest of the year and ’08, and due to less favorable market conditions (higher rates, tightened underwriting standards, already stretched borrowers, and home price stagnation) the delinquency ratio will only increase from the 1Q07 level.
Here's his reset chart. You can click on it for a larger, clearer image.
And here's what he says on declining home equity:
As a result of high LTVs and slowing home price appreciation (or even depreciation), the home equity cushion continues to shrink. According to the latest Federal Reserve release, equity as % of total housing value was 52.7% at 1Q07.
The calculated equity cushion represented below with the blue line however uses the Fed data which is for all homes, including those home-owning households that do not have a mortgage. Similar to our above adjustments for the debt servicing ratios using data from HUD’s biannual American Housing Survey, we adjusted the equity ratio to include only households with a mortgage. .... The red line in the following chart shows that using these assumptions, by 1Q07 equity as % of house value for homeowners with mortgages dropped to 35.6% from 1985’s level of 52.8%. This demonstrates that households with mortgages are borrowing a greater proportion of the house’s value, leaving less equity remaining in the house.
Here's his chart. Once again, click on it for a larger image.
Posted at June 29, 2007 03:00 AM
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