MARKET TRENDS

MARKET TRENDS | SELLER'S CONSIDERATIONS

Policy, programs and perspective

TARP, the “Toxic Asset Relief Program” was originally intended to purchase the toxic assets (under collateralized and non-performing mortgage loans) from banks that did not meet capital ratios and therefore were at risk of being deemed insolvent. Instead, these taxpayer dollars were used to acquire equity stakes in banks, restoring these banks’ reserve requirements. The toxic assets remain toxic and on the books of the banks.

Banks that received TARP funds took on an “implied” accountability to the Federal Government. Incentives were then put in place designed to encourage banks to seek alternatives to foreclosure. Modifying loans would keep the homeowner in the property and have a limiting influence on the amount of inventory on the market. Banks felt as if modifications were merely postponing the inevitable and they would find themselves foreclosing on these homes at a lower value than when the loan was modified. Modification activity has increased but it remains to be seen whether the intended benefit is lasting.

It is estimated that somewhere between 28% and 48% of homeowners nationally are “upside down” (owe more than their home is worth). To avoid

massive defaults, the government continues to implement programs designed to offer alternatives to foreclosure, keeping these homes from hitting the market and re-inflating inventory. Borrowers facing unemployment, divorce or other financial challenges now have more alternatives to default. Alternatives to foreclosure are critical to the continued stabilization of home values.

While effective in stabilizing participating banks, TARP left the toxic assets on the balance sheets of at risk banks. This treated the symptom, not the disease. Banks holding nonperforming loans are no longer required to price these assets at “fair market value;” unless an event occurs which diminishes the face value of the loan. Foreclosure and short sale transactions are two such events, thus requiring banks to record the actual loss. Loan modification keeps the borrower in the home and in most cases, will allow the bank to keep the asset on their books at face value.

Legislators expect “TARP banks” to place priority upon modifying loans rather than foreclosing. This expectation will have a limiting effect on inventory levels, support value restoration and improve the position of at risk homeowners and banks. Every dollar of home price appreciation is one less dollar of “toxic asset.”

Contingent risk

When the housing bubble burst, many blamed the resets of adjustable rate mortgages. As you can see in the graph to the right, we are now through the bulk of the sub-prime resets. What we are now facing is likely the most challenging reset; the Option Adjustable Arm.

These are loans that not only featured an adjustable rate, but allowed the borrower to select a minimum payment that was less than the interest payment, adding to the principal balance monthly. Many of these borrowers will soon see their minimum payment increase substantially and will not be eligible to refinance because they owe considerably more than their home is worth. Regardless of their qualifications, this is the segment of borrowers most likely to strategically default rather than make huge payments on an asset not worth what they owe.

Since TARP did not buy these mortgages, it will be up to the banks to deal with these assets. This is the segment where merely resetting an interest rate to a low fixed rate might not be enough to keep the borrower interested. These are the borrowers most likely to owe twice what their home is worth.

The good news: if we can navigate through these resets without having inventory levels spike, home values will remain stable and begin to appreciate modestly. Banks are happy to keep people in their homes so long as values are not declining. We will have cleared the bulk of the risk by 2012, resulting in a return to a housing market which can stand on it’s own.

Alternatives to Foreclosure or short sale

Loan Modification: Typically, banks are offered incentives to modify a loan to a fully amortizing, fixed rate program with a payment that does not exceed 31% of the gross household income. This can be accomplished by lowering the interest rate to as low as 2% and stretching repayment out to as long as forty years. Rarely have we seen banks reduce a principal balance, but this may become necessary in order to avoid catastrophe with Option Arm resets. There are currently no government programs that meaningfully subsidize principal write-down.

Deed For Lease: This is a relatively new program offered by Fannie Mae.
It requires that the borrower be behind on payments, have tried to obtain a loan modification but do not qualify, and are able to afford the “market rent” using less than 31% of the household gross income for rent. These borrowers would voluntarily deed their home to Fannie Mae and sign a lease on the property for one year. They may be able to continue with the lease on a month-to-month basis after the first year. Most believe that Freddie Mac will soon offer a similar program since they already do on an informal basis.

Forbearance: This is a temporary postponement of mortgage payments for a borrower that encounters a temporary situation where they are unable to make their payments. Typically, the lender will defer a specific number of payments, add them to the principal balance, create a short term repayment plan, or even create a second mortgage which will amortize with the first over the term of the loan.

Programs of this nature are an encouraging sign that banks see recovery or stabilization in the housing sector. If banks forecast further decline in values, they will accelerate their options toward foreclosure in an effort to seize the property and resell the asset before values decline further. When banks feel values are stable, their preference is to keep the home occupied, off the market and generating some level of revenue.

What remains to be seen is how banks manage their inventory going forward. If they find a way to work out the option arms, the worst is over. To do so, they will need to keep the homeowners interested

CENTURY 21 NEW MILLENNIUM | REAL ESTATE NEWS