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 some encouraging findings. A recent Experian-Oliver Wyman survey shows strategic defaults are moving away from their peak of the fourth quarter of 2008.
Currently, given the spread and volatility 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 and encourage them to work with their servicers.
"We're taking these steps to highlight the importance of working with your servicer," said Terence Edwards, executive vice president for credit portfolio management. "Our approach is meant to deter the disturbing trend toward strategic defaulting."
Borrowers who could pay but instead walk away or do not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure. Those who work with their servicer could be eligible for a new mortgage loan in two to three years. Fannie will also take legal action to recoup the outstanding mortgage debt from strategic defaulters in jurisdictions that allow for deficiency judgments.
Policy changes were announced in April but Fannie said it will be instructing its servicers in the near future to monitor delinquent loans facing foreclosure and put forth recommendations for cases that warrant the pursuit of deficiency judgments.
These policies "do make sense," says Sylvia Alayon, VP of operations for Capital Markets Assessment Corp.
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, Wade Comeaux, president of Chicago-based Fay Servicing, told this publication. Since studies show one in five defaults are strategic, Fannie had 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."
Whether Fannie's goal is feasible only time will tell.
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. 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 Soultions Inc., Costa Mesa, Calif., "cash-flow mangers" 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 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.
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. Fannie's policy requirements may, however, be hard to implement and even counterproductive for some servicers.
Alayon says 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 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" and comply with customer behavior predictions and new reporting requirements. "Technology is key." Lenders who do not have a solid platform to which they can just add new tools "will have to invest millions of dollars in order to keep up."
It is worth mentioning that while homeowners who intentionally plan "a strategic default" attract public and industry 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, even before their credit card.