Article in February 14, 2007 Wall Street Journal

Home Lenders Pare Risky Loans
More Defaults Prompt Cut
In 'Piggyback' Mortgages;
Housing Market May Suffer

By JAMES R. HAGERTY and RUTH SIMON
February 14, 2007

A rise in defaults is prompting some lenders to clamp down on the use of "piggyback" mortgages, a risky type of loan that helped prolong the housing boom by allowing borrowers to finance up to 100% of the purchase price.

Fremont General Corp., a major lender to people with weak credit records, has stopped providing these second mortgages, which are frequently used by financially stretched "subprime" borrowers who can't scrape together a down payment. A spokeswoman for Fremont, based in Santa Monica, Calif., confirmed the decision, which was first announced in emails to mortgage brokers earlier this week, but she declined to comment further.

Fremont's move comes amid a rapid tightening of credit standards by subprime lenders as they find investors no longer are eager to buy types of loans deemed particularly prone to default. The pullback by subprime lenders could put a further dent in demand for housing by preventing some potential buyers from getting loans at a reasonable cost.

Other lenders are likely at least to cut back on piggybacks this year because of the difficulty in selling them to investors, said Thomas Lawler, a housing economist in Vienna, Va., who refers to such loans as "oinkers" in light of their poor recent performance. This and other steps to tighten credit probably will prevent some people from buying homes this year, creating another "head wind" as the housing industry struggles to emerge from a sales slump, Mr. Lawler added.

Lenders are "getting back to the old-fashioned, makes-sense lending that prevailed before the last few years," said Daniel Jacobs, chief executive officer of 1st Metropolitan Mortgage, a nationwide mortgage brokerage firm based in Charlotte, N.C. Some are cutting back on piggybacks by making them more expensive and denying them to people with very weak credit records, Mr. Jacobs said. Mortgage brokers collect fees for signing borrowers up for loans.

Lenders also are tightening up in other ways, such as insisting borrowers provide pay stubs and other proof of their income or by making them put down at least a small down payment. "Across the board, everybody is ratcheting up" the minimum credit score at which they will make particular loans, said A.W. Pickel, a mortgage broker in Overland Park, Kan. Bob Moulton, president of Americana Mortgage Group, a broker based in Manhasset, N.Y., said he is still able to help most borrowers but that some requests for credit "are getting a little hairier."

Piggyback second mortgages typically cover as much as the final 20% of the home's cost, supplementing a first mortgage that covers 80%. Investors have grown increasingly wary of buying such loans from lenders amid a surge in defaults by recent subprime borrowers. The holder of the second-lien mortgage can hope to collect proceeds from the sale of collateral only if the holder of the first mortgage is fully repaid. In many foreclosure cases, second mortgages must be entirely or almost completely written off.

The subprime mortgage market has mushroomed in recent years as lenders found that investors both in the U.S. and abroad were eager to buy securities backed by such loans. Mr. Lawler, the economist, estimates that 17% to 18% of mortgage-financed home purchases in the U.S. last year involved subprime loans. About half of the subprime home-purchase loans included in mortgage securities last year were piggybacks, according to a recent report by Credit Suisse Group in New York. And about 43% of subprime loans packaged in securities in 2006 didn't require the borrowers to fully document their income or assets, a type of mortgage sometimes derided as a "liar's loan" because it can encourage borrowers to exaggerate their means to get a loan.

Borrowers have been rapidly falling behind on loans made in the past year or so. In November, payments were at least 60 days overdue on 12.9% of subprime loans packaged into mortgage securities, up from 8.1% a year earlier, according to First American Loan Performance, a research firm in San Francisco.

The Credit Suisse report said late payments and defaults have been particularly common on piggyback loans and those with less than full documentation. Borrowers who finance 100% of the home's cost have "no skin in the game" and so might be more inclined to walk away from the house when they begin to suspect they won't be able to afford it, the report said.

People who rent homes typically have to come up with a deposit to cover a couple months of rent, the report said. But "some homeowners who did not have enough savings to rent a home were able to actually buy a home," it said.

At a conference Monday, Goldman Sachs Group Inc. fixed-income strategist Michael Marschoun said 20% of the loans "cause more than half the losses" in the subprime market. "These are loans that have absolutely horrendous loss performance, and my prediction is these loans will simply not be originated going forward." These are "risk-layered" loans that have some combination of a low credit score, low down payment, low documentation and investment property.

Explaining the decision to stop providing such seconds, the Fremont email received by brokers said: "This is due to investors having no interest in second mortgage loans."

Fremont was the seventh-largest subprime mortgage lender last year, with $32 billion of such loans originated, for a market share of about 5%, according to Inside Mortgage Finance, a trade publication. About a quarter of Fremont's first mortgages originated last year came with a second mortgage, the publication estimates.

Borrowers who can no longer get piggyback loans may turn to mortgage insurance, often sold as a way to let borrowers obtain loans totaling more than 80% of the home's estimated value, but mortgage insurers draw the line on some risks. "We're comfortable...insuring borrowers who have lower credit scores, provided that there is full documentation," said Mike Zimmerman, vice president of investor relations for mortgage insurer MGIC Investment Corp. MGIC doesn't insure subprime second-lien loans based on the borrower's "stated," or undocumented, income. MGIC also doesn't insure subprime loans that total 100% of the estimated home value, he said.

Most subprime loans are sold to Wall Street firms and others institutions that package them into securities for sale to investors world-wide. The lower-rated portions of these securities -- those that absorb the first losses from defaults -- typically are sold to hedge funds and a variety of other investors in the U.S. and abroad.

Article in February 5, 2007 Wall Street Journal

Vacant Homes For Sale Cloud
Economic Hopes

Data Pointing to Glut Are Worst in Decades;
Impact of Speculators

By MICHAEL CORKERY
February 5, 2007

Amid brightening hopes that the U.S. housing market is stabilizing, some economists are zeroing in on a piece of data that could augur badly for the consensus view: the homeowner vacancy rate.

That figure, an often-overlooked measure of how many homes for sale in the country are empty, has climbed to its highest level since the Census Bureau began tracking it four decades ago. Last week, the bureau said that in the final three months of 2006 there were about 2.1 million vacant homes for sale.

That brought the national homeowner vacancy rate to 2.7%, up from 2.0% a year earlier. Before 2006, the number had never risen above 2.0%. Like the housing economy more broadly, the measure varies by region: The South had a homeowner vacancy rate of 3.0%, the Midwest had a rate of 2.9%, the West had a 2.4% rate and the Northeast had a rate of 2.0%.

The report, which usually gets little attention, sparked fresh concerns about the housing market. Goldman Sachs economist Jan Hatzius concluded in a report last Monday that rising vacancies signal that excess housing supply continues to grow -- and that new construction has to decline further this year, even after a 13% decline in new home starts in 2006.

Meantime, J.P. Morgan economist Haseeb Ahmed said the overhang of vacant housing stock could erode existing home values as sellers slash prices to move their vacant properties. Economists fear that many vacant homes are owned by speculators who are stuck with investment properties that they can't sell and may be under increasing pressure to drop their prices. "We are concerned that there could be downward pressure on prices for awhile," Mr. Ahmed says.

Such worries could cloud hopes for a swift housing rebound. Those hopes have been bolstered recently by signs that the market may be stabilizing. Sales, which fell sharply through much of last year, have leveled off in many metropolitan areas and mortgage applications have been rising.

Also upbeat was a report two weeks ago from the National Association of Realtors that the supply of existing homes for sale declined during the final two months of 2006. That was greeted as a positive sign for housing because a decrease in supply tends to lead to firmer prices. But the NAR figures count both vacant and owner-occupied homes for sale -- and inventory levels for owner-occupied homes can fall not just because the home is sold, but also if sellers remove the property from the market because they didn't receive desirable offers.

The homeowner vacancy-rate increase "does temper your outlook" for new construction, says David Seiders, chief economist at the National Association of Home Builders in Washington. Mr. Seiders is forecasting largely flat housing sales this year followed by a strong rebound in housing starts in 2008. "There clearly are uncertainties about how this is going to work its way out," says Mr. Seiders. "I keep preaching to builders it's not time to ramp up production."

Mr. Ahmed of J.P. Morgan says the homeowner vacancy rate calculates vacant homes that are residential year-round, and is supposed to exclude homes that are used occasionally as vacation homes, which have been growing in number in recent years. He says it's possible the vacancy rate may have captured some of these seasonal properties inadvertently. The high vacancy rate also may have been affected by the active 2005 hurricane season that forced residents to flee the Gulf Coast.

Another factor that may have contributed to the high vacancies, says Mr. Hatzius of Goldman: newly constructed homes that are finished and awaiting occupants, but haven't sold.

The vacancy indicator may help distinguish between the sellers who have casually listed their house on the market to see what price they can fetch, versus sellers who are under real pressure to sell. The owner of a vacant home -- who may be squeezed by mortgage payments for the vacant home as well as a current residence -- could be more willing to drop the price to minimize the cost, than a homeowner who lives in the home and doesn't have to sell.

Jon Estridge, 34 years old, owned a pair of investment homes in Virginia that sat empty for several months last year. When the market slowed, it was difficult not only to find buyers, but also to find tenants who would pay enough rent to cover his mortgages. "It eats you alive," said Mr. Estridge, who works for the federal government. "The market is going down, and you are paying a mortgage."

He eventually sold one home last spring, after dropping the price. He bought the property for $395,000 and sold for about $35,000 less. The other home sold for $260,000 in late August after he dropped the price by about $30,000.

To be sure, so far prices have fallen in relatively few markets. In fact, median home prices nationally were up 1.1% in 2006, according to the NAR. And last week, the Federal Reserve's Federal Open Market Committee said in a statement that "recent indicators have suggested somewhat firmer economic growth, and some tentative signs of stabilization have appeared in the housing market."

Many economists agree, however, that rising vacancies have likely been fueled by a group that is proving to be the wild card of this housing market: speculators. During the boom, they flooded the market and flipped homes for a profit. When sales slowed, speculators were stuck with vacant homes that have lingered on the market.

There's no doubt speculators had a major impact, but their numbers have been difficult to quantify. The recent vacancy data may be a useful measure of speculative activity and its fallout.

"I think a persuasive case can be made that the reason we are seeing such extraordinarily excessive vacancy is because of the heavy investor demand over the past few years," said Richard DeKaser, chief economist at National City Corp.

What's troubling is that speculators may not act like typical home sellers. When they sell their vacant home in a down market, they don't necessarily purchase another home. By contrast, people selling the homes they live in will most often buy another house -- thus fueling a healthy market of buying and selling.

Not surprisingly, buildings with five or more units -- which include condos that were magnets for speculators -- had the highest rate of vacancy. The vacancy rate among these units rose to 11% in the fourth quarter from 7% in the first quarter. For single-family homes, the vacancy rate rose to 2.3% in the fourth quarter from 1.8% in the first quarter.

Mr. Hatzius expects homeowner vacancies will slow, as builders cut back on production and owners convert their units to rentals to take advantage of rising rents. But then again, the housing market has been full of surprises.

"This whole thing has been new," says Mr. Seiders, the National Association of Home Builders' economist. "We've never seen this kind of investor activity and we've never seen this kind of [vacancy] resale. It's an extra complication moving forward."