Acceleration of Transition Rates from Delinquency to Foreclosure to put Additional Stress on Housing Market

Bank of America strategists  Chris Flanagan and James Nguyen report that mortgage servicers have accelerated processing delinquent mortgages after a relative hiatus related to fall 2010 "robo-signing" controversy.  That controversy  had led many lenders to voluntarily suspend foreclosure actions.  Bottom line: mortgage servicers appear to have gotten their act together and are working through the legal process to foreclose and ultimately liquidate the overhang of properties associated with the pandemic of delinquent mortgages.

The report's methodology is to apply a credit transition model  to the stock of existing and projected delinquent mortgages.  For example, the model may forecast that x% of 30 day delinquent mortgages will transition to 60 days delinquent in one month.  The following month, the model may project that y% will become 90 days delinquent and so forth until the property is foreclosed upon and eventually sold. 

                                             

The study's results are, for want of a better word, frightening.  The report forecasts that there will be 552,000 homes liquidated in the second half of this year, followed by 1,351,000 in 2012, peaking at 1,487,000 in 2013 and then 1,330,000 in 2014 and 960,000 in 2015.  In all, through 2015, 5.7mm homes will be sold/auctioned/liquidated as part of a foreclosure action (see table below).  Of this total, 63% or approximately 3.6mm mortgages  are held or guaranteed by a US agency.



We are talking about a lot of families.

The onset of this supply could not come at a worse time given the anemic growth in the US economy and the headwinds associated with the US employment picture.  Concerns about a global slowdown correlated with the European debt crisis and a deceleration of the Chinese economy further darken the picture.

Flanagan and Nguyen argue that urgent action is required NOW.  In particular, the authors cite the need to convert REO (real estate owned) properties to rental units.  Because the government effectively owns the risk on so many of these properties, it should be reasonably manageable to implement a government sponsored program, in alliance with private capital, to convert delinquent borrowers into current renters.  The goal should be to keep the borrower in the home and the home off the market.  

The US housing market risks continuing to be in a negative feedback loop from a weak economy and a housing market under duress.  A foreclosed property will in turn hurt neighboring real estate values which in turn compounds the problem.  Keeping that property out of foreclosure is a key component to any policy solution.