More write-downs ahead for banks

March 4, 2010

Be afraid. Be very afraid.

I know this is getting tedious but, I can’t help it.

Today’s Wall Street Journal included a story about how home mortgage refinancing volumes aren’t as high as expected, even though interest rates are low and being kept low by the Federal Reserve.  The premise of the story is:  there’s money being left on the table by borrowers who aren’t refinancing.

But buried in the article is a reason to continue to be very concerned about bank balance sheets and the write-offs yet to come.

John Albright, a retired Navy officer in Manassas, Va., hasn’t been able to refinance because the value of his home has plunged. He figures its market value is now around $275,000, but he and his wife still owe more than $500,000 on their mortgage.

Their refinance application was turned down last year because they lacked equity in the home. He says his lender told him he could refinance only if he could come up with about $200,000 to pay down his mortgage. So they are stuck with an interest rate of about 6.5% at a time when his wife’s income has declined. “We’re going from paycheck to paycheck, but what can you do?” Mr. Albright says.

Here we have a couple who appears to be still paying on their mortgage, but has no hope of refinancing into a lower rate because the amount they owe exceeds the market value of their home by a huge amount.  The Albrights are stuck in this house until and unless one of two things happen:  either home prices skyrocket or they convince their bank to reduce the principal balance of the mortgages to something closer to the current market price, and they might only do this in a “short sale” if  the Albrights want to move.

This is obviously bad news for the Albrights, but it’s equally bad for their lender.  This mortgage is likely still being shown on the banks books as “current” since the Albrights appear based on the article to be making payments.  But if you were to mark this loan today, you’d have to say that there’s an embedded loss for the lender of $225,000–the difference between the current mortgage and the market value.  I’m feel safe in saying that whoever holds this paper hasn’t recognized this loss yet simply because the loan is still paying.

All of which is a long way of saying that the problems in residential real estate are starting to feel “perpetual” (even though they won’t be, it just feels like it), and there are more losses buried on banks’ balance sheets (as if we need to be reminded of that!).

Mortgage Mess

December 16, 2009

Sadly, the mortgage mess is going to be with us for a long time.  The big thing that I think is likely to prevent a resolution any time soon is complicated, but worth thinking about.  It’s really much more complicated than I depict here, too, but for simplicity I’ve stripped it down to one issue and the essentials at that.

As you think about why more mortgages aren’t being renegotiated so that foreclosures can be avoided, consider this:

The holder of the first mortgage is quite often different from the holder of the second mortgage or HELOC.  If both mortgages were written at the same time, the chances are that the first was sold off and likely securitized, while the second was either held by the lender or sold in a separate securitization.  That second lien loan is, in many cases, worthless because of declines in market values of homes beyond the point where the homeowner has any equity (as discussed in this WSJ article).

For example, if the home was worth $250,000 and the owner got an 90% first mortgage and a 10% second at the outset ($225k and $25k, respectively), but that home is now worth only $190k (a drop of 24%–not unheard of these days to be sure), the second lien holder is S.O.L.

The reason that this is important and the reason that the crisis is going to be around for a long time is that those separate holders of the mortgages have different motivations and different exposures to be managed.  If the holder of the second lien is the originating bank and that bank acts as the servicer for both loans, there is a potential incentive for that servicer to not renegotiate the first mortgage to avoid having to realize the worthlessness of the second.  Setting aside the fact that the servicer can potentially make more money keeping a struggling homeowner barely alive than they can with a fully renegotiated loan, the holder of the second lien has no incentive to realize the true value of its position, so they don’t.

The government is pressing lenders to restructure mortgages to avoid foreclosures–but those are first liens that they’re thinking about.  If the first mortgage is restructured to the point that principal is forgiven and the balance reduced, the servicer/second lienholder must recognize that its loan is wiped out and write it down to zero if it’s still unsecuritized.  (If the second is securitized, the situation is potentially much more complicated.)  It’s not at all clear that this process of clearing bank balance sheets of “toxic waste” has occurred, despite the massive losses recognized during 2008.

To say nothing of the commercial real estate exposures that are lingering in a semi-dead state to be dealt with at some point in the future, hopefully after banks can earn enough money to replace the capital they’re about to deplete with big CRE write-downs.

More to come on this topic.

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