Yesterday a lot of folks, including myself, were slightly incensed at the announcement by mortgage insurer PMI that it is launching a pilot program offering cash bonuses to borrowers who stay current on their mortgage payments.
I went on a tirade about how ridiculous it is to pay people to meet their legal, contractual obligations, how it enables bad behavior. Don't get me wrong, I still believe that.
Today, however, I learned something that made me understand a bit more why the mortgage insurers, and the lenders and investors participating in a similar bonus program, are running so scared:
Between 12 and 24 percent of always performing loans, depending on the asset type, exhibit LTVs (loan to value ratios) that are higher and have risen more steeply than those of defaulted loans, raising the specter of a renewed increase in strategic defaults should previous default trends hold true—Moody's ResiLandscape
Researchers at Moody's say that a loan's LTV is a "strong predictor of its propensity to default," and if history serves as a model, the higher the LTV, the more risk of default.
After the end of the home buyer tax credit, the average home price for always-performing loans originated since 2005 began falling again, according to Moody's, which consequently turned falling LTVs around, pushing them up as borrowers lost more equity in their homes.
Always-performing loans are concentrated in strong housing markets, like Washington DC, Los Angeles, New York and Chicago. Moody's notes that these rapidly rising LTVs are reminiscent of those of loans that have defaulted since 2009 (so we're not talking about the subprime crash here).
The fact that increasing LTVs have usually preceded default indicates that the defaults likely represent economic decisions to stop paying on mortgages where balances far exceed property valuations.
Rapid rates of LTV increases may themselves be a factor in a borrower's decision to strategically default, since they may quickly erode any remaining confidence in borrowers that they could ever restore positive equity in their property—Moody's ResiLandscape.
Every time I talk to bankers and banking analysts about strategic default, they all tell me it's a very small percentage of overall defaults and largely relegated to the hardest hit housing markets, which have lost the most value.
They also say it's mostly investors. That may have been true for a while, but clearly those same banks and others, like the mortgage insurers, are getting a bit nervous about how falling home values might alter the mindsets of the borrowers behind those always-performing loans.