When the U.S. housing boom went bust, defaults surged to unprecedented levels in securitizations minted from 2005 to 2007, earning those bonds worldwide notoriety. But their performance looks better than it once did thanks to home price recovery.
"Securities are performing better if you measure by delinquency rates," says Frank Pallotta, the managing partner at Loan Value Group. The degree of improvement varies depending on other factors including geography, borrower credit, fraud or misrepresentation with the original loan, and individual servicers' strategies, he says.
Home prices rose 10% to 40% in roughly 80% of key U.S. metropolitan markets from the fourth quarter of 2011 to last year’s third quarter, according to a recent report from Fitch based on data from Case-Shiller and LoanPerformance. Private-label residential mortgage-backed securities’ performance also showed related improvement during that time, the report shows.
Fitch studied delinquency roll rates—the percentage of borrowers who were current a year ago but are now delinquent—to measure how home price changes influence borrower behavior over time. These rates improved by as much as 48% in areas with the highest levels of home price recovery (about 40%), according to Fitch analysts Grant Bailey and Sean Nelson, the report's authors. Roll rates in areas without any home price appreciation improved only 6%, while an area with 10% home price appreciation saw a 17% improvement.
Taking advantage of boom-era securities' improved performance have been investors like the Dutch State Treasury, which is in the process of profitably selling off the last of the private-label mortgage bonds it acquired at a discount when it bailed out ING during the worst of the U.S. downturn.
A wide range of influential buyers from international institutions like ING to U.S. corporate credit unions were initially forced to record massive losses on their books. The paper losses brought down several major companies or led to government bailouts and forced regulators to rethink financial institutions' required capital cushions.
But investors that had the wherewithal to hold onto the bonds through the housing recovery have ended up doing better than they at one point thought they would.
A recent court approval of a closely watched $8.5 billion private-label residential mortgage-backed securities settlement "likely reflected, in part, the fact that litigants had dropped objections given improving [securities] performance over the last two years as the housing market has begun to recover," Fitch analysts said in a report early last week. (American International Group and some of the other investors involved in the case subsequently asked for a delay in the entry of the court decision. AIG is another example of an institution forced into a government bailout during the downturn. The rescue left the U.S. with massive RMBS holdings that the government was later able to sell at a profit.)
The window of opportunity for selling these legacy RMBS assets for higher prices may be closing, although this varies by region, says Dave Hurt, a vice president at CoreLogic.
"The dollar price of those has gone up but there is a point of diminishing return," he says.
Home prices have, on average, wavered in the past month, which may signal to investors there is limited upside in unsecuritized and securitized loan portfolios, Hurt and Pallotta say.
Preliminary indications for January are that home prices overall dipped 0.8% from December, according to CoreLogic. They are still higher year-over-year.
There also remains a contingent of RMBS loans in some areas that home prices have failed to rise high enough to help because the mortgages are still substantially underwater, Pallotta says.
Home price improvement may do little to help performance if it fails to bring a loan below the 120% loan-to-value mark, after which incentives to walk away from the home decline significantly, says Pallotta, whose company specializes in loan conversion incentives for underwater borrowers and others.
Several million borrowers still have significant negative equity above the 120% LTV mark and many of those are concentrated in agency and private-label RMBS from the boom years, he notes. Nearly 6.4 million homes, or 13% of residential properties with a mortgage, still had negative equity at the end of the third quarter of 2013, according to CoreLogic.