Defaults Go Up and Prices Go Down

Second-quarter data show that defaults on nonprime mortgages are up, house prices are falling and things are going to get worse before they get better.

The default rate on subprime mortgage loans hit a record 13.44% in June, up 100 basis points in just 30 days, and nearly double the rate in June 2006, according to a Friedman Billings Ramsey report.

Despite the spike in June, FBR managing director Michael Youngblood expects defaults to increase gradually for the rest of this year and into next spring. He is hoping it won't exceed 14.5% by May 2008. The national housing index released by Standard & Poor's/Case-Shiller last week showed house prices declined at a 3.2% annual rate in the second quarter. The S&P/Case-Shiller index went into negative territory in January and prices fell at a 1.4% annual rate in the first quarter.

"The pullback in the U.S. residential real estate market is showing no signs of slowing down," said Robert Shiller, chief economist at MacroMarkets LLC.

National Association of Home Builders chief economist David Seiders noted there has been a "major turnaround in house prices" and he expects to see downward pressure on prices for at least a couple of more quarters.

"If it becomes too quick and too serious then it does affect credit quality and prospective losses on subprime would be made worse," he told reporters.

The foreclosure rate on subprime mortgages jumped to 5.44% in June and that topped the previous record of 5.19% set back in August 1997. The previous record for defaults (13.42%) also was set in August 1997.

The default rate on alt-A loans rose 31 basis points to 3% in June. "The default rates on alt-A and subprime loans deteriorated sharply in June from May, after six months of gradual erosion," Mr. Youngblood said. [The default rate includes loans 90 days or more past due, in foreclosure and real estate-owned.]

During 2006, underwriting standards on subprime loans deteriorated with each successive month, Mr. Youngblood said. He noted that debt-to-income ratios rose from 46% in May to 47% in June.

To mitigate the trend in foreclosures, the FBR researcher said servicers should heed the advice from legislators, regulators and others to restructure these loans. The NAHB chief economist considers the S&P/Case-Shiller index to be the "single best measure of house price movements" even though it is not seasonably adjusted or adjusted for inflation.

But that can be fixed. And according to Mr. Seiders, real house price appreciation declined by a 7.4% seasonally adjusted annual rate in the second quarter, which is a good distance from the record 9.2% negative rate set in the second quarter of 1991.

Back in the early 1990s, inflation was much higher than it is today and the economy was in a recession. But Mr. Seiders is worried that current problems in the mortgage market, coupled with huge inventories of unsold homes, could prolong the housing slowdown.

"I don't expect to see systemic price appreciation resurfacing until 2009," he said. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com/