The ugly pile of toxic mortgage securities closely linked to the financial crisis in the popular imagination looks much better now.

When the U.S. housing boom went bust, defaults surged to unprecedented levels in securitizations minted from 2005 to 2007. But their performance has vastly improved thanks to home price recovery. “Securities are performing better if you measure by delinquency rates,” said Frank Pallotta, the managing partner at Loan Value Group.

The degree of improvement varies depending on other factors such as geography, borrower credit, fraud or misrepresentation with the original loan, and individual servicers’ strategies, he said.

Home prices rose 10% to 40% in roughly 80% of key U.S. metropolitan markets from the fourth quarter of 2011 to last year’s third quarter, according to a recent report from Fitch Ratings based on data from Case-Shiller and LoanPerformance.

Many of the markets that suffered the steepest declines during the height of the crisis have bounced back dramatically. The rallying housing market has, in turn, fed into the performance of private-label residential mortgage-backed securities, the Fitch report shows.

To illustrate its point, Fitch studied delinquency roll rates—the percentage of borrowers who were current a year ago but are now delinquent. This served to measure how home price changes influence borrower behavior over time. Fitch found that, in general, the higher the rise in homes prices, the steeper the drop in the roll rate, which translates to improving deal performance.

For instance, the 12-month roll rate for the period ending in the third quarter of 2013 was 5.92% in regions averaging 40% home price increases from the fourth quarter of 2011 to the third quarter of 2013.
That represents a 47% drop from the 11.08% 12-month roll rate at the end of the fourth quarter of 2011 for this group of regions, according to Fitch analysts Grant Bailey and Sean Nelson, the report’s authors.
Regions averaging a 10% rise in home prices saw roll rates decline by a more modest 17%, while those with flat home prices had roll rates drop only 6%. 

Dutch Ditch Deals

Taking advantage of boom-era securities’ improved performance have been investors like the Dutch State Treasury, which  profitably sold off the last of the private-label mortgage bonds it acquired at a discount when it bailed out ING during the worst of the U.S. downturn.

There were three auctions beginning in December of last year and ending in mid-February. BlackRock Solutions was responsible for the execution and sales of the securities. The sale took place through a competitive auction process involving a number of selected broker dealers.

The $8.9 billion proceeds were used to pay off the guaranteed amount to ING in full. Proceeds in excess of the guaranteed amount, totaling approximately $1.9 billion, will be remitted to the Dutch State. This amount is higher than initially expected in November, when the decision to proceed with sales was announced.

A wide range of influential buyers from international institutions like ING to U.S. corporate credit unions were forced to record massive losses on their books. Actual losses in the billions and fears that they might soar even higher brought down several major companies and led to government bailouts. Among the grimmer milestones of the crisis was the U.S. government’s rescue of insurance behemoth American International Group, the collapse of Bear Stearns and its rushed sale to JP Morgan, and Bank of America’s purchase of a beleaguered Merrill Lynch. 

But investors that had the wherewithal to hold onto the bonds through the housing recovery — or purchase them at a fraction of par —have ended up doing better than they once thought they would.

A recent court approval of a closely watched $8.5 billion private-label residential mortgage-backed securities settlement “likely reflected, in part, the fact that litigants had dropped objections given improving [securities] performance over the last two years as the housing market has begun to recover,” Fitch analysts said in a report early last week.

AIG and some of the other investors involved in the case subsequently asked for a delay in the entry of the court decision. AIG’s is another example of an institution forced into a government bailout during the downturn. The rescue left the U.S. with massive RMBS holdings that the government was later able to sell at a profit.

Not-So Eminent Domain

And just as rising home prices might sap the desire of litigants to pursue these mortgage-related cases, they might also reduce incentives for local governments to use eminent domain to seizing underwater mortgages.
A case in point is Richmond, California, a cause célèbre of the eminent-domain movement. The economically-depressed city of a little over 100,000 has a proposal devised by Mortgage Resolution Partners (MRP) to seize 624 mortgages that it viewed as troubled.

But the city has yet to follow through. Structured-finance players believe that rising home values in the city will erode support for the plan. In a court filing against the loan seizure, investment banker Phillip R. Burnaman II, on behalf of Wells Fargo, argued that nearly 31% of the targeted mortgages have loan-to-value rations (LTVs) below 100 and 44% have LTVs above 120. He said that a good number of the underwater loans should be in positive equity terrain if home prices continue rising.

End of the Run?

But even with prices still expected to rise in place like Richmond, the pace may slow in some regions, and the window of opportunity for selling legacy RMBS assets for higher prices may be closing, says Dave Hurt, a vice president at CoreLogic.

“The dollar price of those has gone up but there is a point of diminishing return,” he says.

But even detoxifying an additional, small percentage of non-agency RMBS outstanding is likely to be a significant figure. Nearly $2.8 trillion of private label deals were issued in the three-year boom period of 2005-2007, according to date from Vector Securities, a CoreLogic platform.

Home prices have, on average, wavered in the past month, which may signal to investors there is limited upside in unsecuritized and securitized loan portfolios, Hurt and Pallotta say. Preliminary indications for January are that home prices overall dipped 0.8% from December, according to CoreLogic. They are still higher year-over-year, however.

Deeply Underwater

There also remains a contingent of RMBS loans in some areas in which home prices have failed to rise enough, leaving the mortgages substantially underwater, Pallotta says. Home price improvement may do little to help performance if it fails to bring a loan below the 120% loan-to-value mark, after which incentives to walk away from the home decline significantly, says Pallotta, whose company specializes in loan conversion incentives for underwater borrowers and others. 

Several million borrowers still have significant negative equity above the 120% LTV mark and many of those are concentrated in agency and private-label RMBS from the boom years, he notes. Nearly 6.4 million homes, or 13% of residential properties with a mortgage, still had negative equity at the end of the third quarter of 2013, according to CoreLogic.

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