2004 and 2005 Mortgage Vintages: At Peril?
Following up on yesterday’s macro view on housing, I have decided today to bore down on key components of the mortgage equation. Besides we all know the standard Ministry of Truth ploy of just lumping everything together: Bullies and Brazil Americans, California and Kansas, toxic mortgages and AAA prime 30 year, and just calling “it all” rosy, with little consideration given to the segments. In fact we now learn that Pig Men just take a certain percentage of toxics and mix it in with the prime and call it all AAA, real chicanery.
Although papered over elsewhere, readers of this blog do know that the markets have began to get more than a bit concerned about 2006 vintage subprime credit conditions. In fact here is the latest chart that we’ve been following regularly on ABX 06-02 BBB credit insurance. This is an inverse chart, the lower the number the higher the cost for default insurance.
What the Riskloves haven’t quite looked at or even remotely addressed are late 2004 and 2005 vintage loans with a toxic demeanor. As mentioned the 2006 subprime market is large, and conditions in that vintage are worsening quickly. The next chart shows the amounts involved in the last three years with this genre. Subprime made up 25% of the total mortgage market in 2005 and 2006, and about 20% in 2004. Indeed 93% of all subprimes in 2005 were purchase originations (see second chart). That’s $665 billion worth, pretty much the whole blue block in the chart, and ditto for 2006. Poo poo it if you must, but there were about $1.9 trillion subprimes originated in 2004-2006. Add in a trillion in second mortgage HELOCs and lord knows how many midprime and/or Alt A pay options, and you have ground zero for a credit bust of biblical proportions.
I’m not even going to address much the myriad of additional wild man loans: interest only, Alt A, midprime ARMs, and neg am pay options out there, other than present this snapshot in the next chart. In fact I would suggest that the presence of these buyers with these exotic loans and at this magnitude was the causa promixa of the final push and peak in housing and blow off consumer credit expansion. And the fact that they were still around in 2006 with this credit type is the only reason housing prices didn’t severely correct this year.
And that’s why the discussion swirls in my posts and in the comments section about the enablers of these mortgages dropping like flies lately. Incidentially two more subprimers closed shop yesterday, and there are some rumors about #5 Fremont being next. And the subprimers are definitely tightening up on credit standards. Broker Outpost is an active industry chat site that has tipped off the Bubble watch community on blow ups and credit condition tightenings well ahead of the mainstream media. Witness (in real time) various posters discuss how Fremont is now out of the subprime 80/20 game. 80/20s are piggybacks: a primary mortgage, leveraged with a home equity credit line (HELOC). HELOCs of course are subordinate credits, and are the most vulnerable of all. They have been used aggressively by weak credits buying at the peak in the now weak Bubble markets (see next chart) . There are a trillion bucks of these out there, and an astonishing 40% of US mortgages have them. They constitute 10.5% of total mortgage debt.
What are some key aspects about the 2005 subprimes? First 50% of them are no or low doc mortgages. Secondly and this is crucial, 70% of them are two year ARMs and thus will reset in 2007. That’s $465 billion worth. Also keep in mind that about 17% ($55 billion) of the 2004 vintage used 3 year exploding ARMs, and those initial teaser rates were very low. So we are looking at about $520 billion in 2004 and 2005 subprime vintage resets in 2007.
Subprime mortgages are set to an index such as the Libor rate (now about 5 3/8%) plus a margin (about 4-5% typically, but sometimes higher). So a typical subprime homeowner is looking at about 10% as the new reset rate on his or her “exploding ARM”. The rate then usually adjusts every six months going forward. The initial first two year rate is often a steeply discounted or “teaser” rate. These run the gamut, but when I’ve looked at portfolio holdings of various toxic lenders, 5-7% turns up a lot. I would estimate that exploding ARMs will now deliver at least 50% higher payments to borrowers.
Alert readers will note that there were also about a half trillion in purchase subprimes in 2004, and yet the impact has been nominal, at least so far. The reason is two fold. First, as next chart shows, mortgage activity in 2004 was backloaded later in the year, with the first half less active. We may only be talking about $200 billion in first half, 2004 subprime originations. Credit conditions loosened as the year (and more subprimes) rolled out.
Click to enlarge:
Secondly buyers, at least the first half of 2004, still had appreciation in their homes when the resets came in early 2006. Some were churned into new teaser loans (at high prepayment fees pocketed by the financial sphere), or even into midprime loans. The refis enabled them to take out enough to sustain their new payments for awhile. Some may have even seen the handwriting on the wall and sold. Yet others are ripening, in trouble, and juggling other sources of debt as we speak. The problem with first half of 2006 refis though, is that as we will see from the next “Map of Misery”, housing prices in locales where these loans and the notorious pay option are popular are very soft now. Most of these borrowers are underwater. And those who were Ponzi converted into 2006 subprimes are in the vintage where delinquencies are quickly showing up.
click to enlarge:
The next chart shows top Metros with both interest only and neg am pay options:
Next look at the second half 2004 vintage. About 2/3 of them, and I would estimate about $200 billion, have had their rates reset in just the last several months. They are now scratching their heads on how to make payments. Late 2004 is when activity really picked up led by these loans, as did housing prices. Another glance at the Map of Misery will give you an inkling of where these aggressive toxic loans are situated: very concentrated in large, expensive Bubble markets. Places (metros) where the realtor feedback ratings are coming in with sub 2.0 (out of 5) demand ratings, such as ALL the cities on the last chart and the HELOC chart shown before. That would also apply to most of the state of Florida, California, and just about anything reddish on the Map of Misery.
In fact, I’ll submit that if you wish to focus on one indicator to track the emerging credit Bust in the US, just focus on reports and accounts from “the Map”. Ben Jones at Housing Bubble truly catches about all of them and in rapid succession. Henceforward a new Winterism (see primer on Winterisms in the side bar) will be “the Misery Map”, so be aware of what it means. Motivated sellers of housing henceforward will be referred to as Joe Ultra Light Sixpack (JULS).
I submit that late 2004 and 2005 buyers in most of the Misery Map have lost equity on their peak of market purchases. In fact, 14% of homebuyers in 2005 put zero money down, and had no equity to lose. That’s backing $215 billion in mortgages, and it doesn’t take too much intuition to figure out who they are: mostly subprimers on the Map of Misery. In fact faced with a 10% mortgage payment and negative equity snake eyes, JULS will either turn over the keys or be forced to do so, and sooner rather than later.
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