Roll Rates Steadying?

Since the 1970s, the share of loans that are 30 days late during one quarter that roll into foreclosure during the following quarter has risen steadily — until recently, when roll rates began to skyrocket. But now they may be steadying.

Jay Brinkmann, chief economist at the Mortgage Bankers Association, said he is uncertain as to where roll rates are headed. The most recent quarterly data from the MBA showed a slight decline in the share of delinquent loans rolling into foreclosure, probably reflecting increased efforts among servicers to keep troubled borrowers in their homes.

Today, about 35% of loans that are 30 days past due during one quarter are subject to foreclosure proceedings in the following quarter. That’s up from about 5% in late 1979. And during the 1990s, the roll rate fell in a range of between 10% and 15%. In a conference call with reporters, Mr. Brinkmann said that high roll rates in California and Florida, as well as in Nevada and Arizona, are driving the dramatic increase. In recent quarters, roll rates in California and Florida have exceeded 60%.

In most areas of the country, including the economically struggling Upper Midwest, roll rates have risen but not as dramatically as in states that experienced a housing boom amid high volumes of nontraditional lending. “I don’t know if the rest of the country is going to follow more of a Michigan example or how much closer we are going to be to the California model,” Mr. Brinkmann said.

This recession is different from previous ones because the housing sector entered the recession already weakened, he said. In the past, housing usually entered a recession strong and suffered as a result of the recession.

On the bright side, Mr. Brinkmann said low mortgage rates should bolster origination activity. The MBA projects that the 30-year, fixed-rate mortgage contract rate will average 5.1% in 2009. The MBA predicts that lenders will originate $1.9 trillion of home loans this year, up from about $1.8 trillion in 2008.

For years, regulators have relied on the “Texas ratio” to get a quick read on the health of banks. But A.M. Best’s researchers say that in today’s economy, the Texas ratio may not be the best way to get a read on the pulse of a banking institution.

And deterioration in the housing and mortgage markets is one factor undermining the Texas ratio’s diagnostic accuracy.

The Texas ratio is nonperforming loans divided by the sum of total equity and loan loss reserves. Essentially, it weighs a bank’s bad loans against the bank’s cushion against losses.

But since earnings are a bank’s first line of defense against credit losses, A.M. Best says that earnings capacity provides an additional layer of support. Despite the weak economy, 81%, continue to post a positive return-on-assets.

But because neither housing markets nor the general economy appear poised to rebound in the next few quarters, Texas ratios and earnings are likely to remain under strain, A.M. Best said.

Analyst Khanh Vuong, co-author of an A.M. Best report on the subject, said that the Texas ratio was widely used by regulators during the last banking crisis in the late 1980s to decide when to focus on closing a troubled bank. But in today’s market, A.M. Best is not sure the Texas ratio is a good gauge, because it assumes all delinquent loans will end up as losses.“We believe there are a lot of implicit assumptions in the ratio which we think are not necessarily accurate,” he said.

Because consumer mortgages are at the heart of the current financial crisis, he said larger banks — super-regionals and international banks that invested heavily in MBS and derivative securities — in general have been hurt worse than community banks. However, smaller banks located in hard-hit areas like California, Florida, Arizona, Nevada or the industrial Midwest also have suffered, Mr. Vuong said.

So far, a “spiral effect” has compounded the mortgage sector problems, he said. The first round of mortgage defaults led to foreclosures, which reduced property values in many areas, which in turn exacerbated the industry crisis and sparked more foreclosures. So far, regulators and policymakers have not done anything to stabilize the housing markets and prevent the next wave of foreclosures from occurring, he said.

In 2008, ARM lending fell sharply as the initial payment savings disappeared, according to a survey by Freddie Mac.

“Our survey found that starting rates for conforming one-year ARMs averaged 1.76 percentage points above their fully indexed rate, the largest rate premium observed since Freddie Mac began collecting ARM data in 1984,” said Frank Nothaft, chief economist at Freddie Mac, in a news release.

In addition, with 30-year fixed mortgage rates falling to a 50-year low, consumers could find FRMs at rates in many cases lower than the initial rate on an ARM loan. It’s the first time in the history of Freddie Mac’s survey that FRMs were broadly available at lower initial interest rates than most ARM products.

In December, the ARM share of loan applications fell to 3%, the lowest ever recorded in Freddie Mac’s survey. During the peak of the housing boom, the ARM share was around 36%, Freddie Mac said. The initial rate on ARM loans did not decline as much as yields on one- or three-year Treasury securities during the fourth quarter.

With lower consumer demand for ARMs, fewer lenders are offering a wide array of ARM products, Mr. Nothaft said.