Market Focuses on Still High Strategic Defaults
Strategic default rates have turned into an important mortgage market performance indicator.
It matters that the absolute number of strategic defaults for the first half of 2009 declined in successive quarters last year suggesting the trend may continue in 2010.
That hope is based on findings from a recent Experian-Oliver Wyman survey showing strategic defaults are moving away from their peak of the fourth quarter 2008. Given the spread of price declines and home equity losses, strategic default is a hard-to-predict risk banks have to deal with in addition to unavoidable delinquencies and foreclosures.
The industry is fine-tuning customer behavior predictive policies and tools that help avoid defaults and redefaults.
Fannie Mae has proposed policy changes that aim to discourage individuals who may consider strategic default to circumvent the system. These policies "do make sense," says VP of operations for Capital Markets Assessment Corp., Sylvia Alayon.
Whether that goal is feasible only time will tell.
Fannie's communication on strategic default seems to be a significant change in the way the GSE has been dealing with homeowners, which in the past few years focused on softening the blow to struggling homeowners, president of Chicago-based Fay Servicing, Wade Comeaux told this publication. Since studies show one in five defaults are strategic, Fannie has to reconsider its position.
"This new policy may push some homeowners to fight longer and harder to stay in their home," he said, but many of them "are concerned about today, rather than several years down the road."
Both delinquency and strategic default continue at high levels. Starting in 2Q09 there is "evidence of a break" in a quarter-to-quarter "upward trend," said Peter Carroll a partner at Oliver Wyman, New York, a decline that continues.
The incidence of cash-flow managers-or temporarily distressed borrowers whose payment behavior is similar to strategic defaulters but continue to make occasional mortgage payments-increased from 20% in 2008 to 26% in the first half of 2009.
According to Charles Chung, general manager of Decision Sciences at Experian Information Solutions Inc., Costa Mesa, Calif., "cash-flow managers" would be better candidates for loan modification programs than strategic defaulters. "They are likely to be in temporary distress and may also have financial resources which allow them to continue to pay their nonmortgage obligations," which demonstrates their willingness to pay. So a modified, more affordable mortgage can be very effective.
As expected the incidence of such defaults continues to be higher in areas with more pronounced home price declines, according to the second-ever Experian-Oliver Wyman Market Intelligence Report on strategic defaults. Compared to 2005, the number of strategic defaults in California was 80 times higher and in Florida 53 times higher by the second quarter of 2009.
The new data show that up to 19% of those delinquent for six months or more by the second quarter of 2009 were strategic defaulters. The trend continued all year and may have peaked or is close to peaking this year.
During that quarter 28% of super-prime delinquent borrowers with VantageScore between 901 and 990 went into a strategic default at a 50% higher rate than the overall delinquent population, the report said.
Investors responsible for multiple first mortgages are showing a higher incidence of strategic defaults. Curiously, borrowers with higher mortgage origination balances "are more likely to be strategic defaulters," despite geography, number of first mortgages and VantageScore.
Those who have home equity lines of credit on the other hand "are more likely to stay current on those lines prior to mortgage default." Up to 50% went delinquent on their HELOC before defaulting on their mortgage, compared to 70% of those who did not have a HELOC.
These findings indicate there certainly is a need to find ways to predict and possibly curb strategic default rates. New Fannie and Freddie policy requirements may, however, be hard to implement and counterproductive on servicers.
Alayon recognizes that such policies add servicer challenges by requiring they come up with a reporting mechanism that would separate the individuals who are making an effort to pay and work with the lender from those who can afford it. "It will definitely be another data reporting challenge for lenders and servicers. They have to come up with yet another tool to segregate these strategic defaults."
Given all the reporting requirements placed upon them, lenders and servicers have to also create new tools that will help them comply with customer behavior prediction requirements. "Technology is key, these lenders are going to have to invest millions of dollars in order to keep up with these reporting requirements."
While homeowners who intentionally plan "a strategic default" tend to attract more public attention, according to the National Foundation for Credit Counseling, Silver Spring, Md., the majority would pay their mortgage first, even when "underwater."
The NFCC 2010 Financial Literacy Survey found that only 23% of respondents consider it justifiable to default on a mortgage and go into foreclosure if the property is worth less than what is owed on the mortgage. Another 15% of the 2,028 participants consider it unjustifiable under any circumstance "to strategically default" on a mortgage.
Up to 91% of respondents—including consumers in financial distress—said they would pay their mortgage first. Asked whether they would be more likely to keep current their mortgage or their credit cards in times when they were unable to meet all of their financial obligations, they called their mortgage a priority.