Mortgage Delinquencies Still Rising

Freddie Mac (FRE) reported that the serious single family delinquency rate for mortgages in its portfolio rose to 3.87% in December from 3.72% in November, an increase of 15 basis points. Serious delinquencies are mortgages where the homeowner is more than 90 days behind on their payments, but have not yet been foreclosed on.

The serious delinquency rate rose in every month of 2009 (and every month in 2008, for that matter). A year ago the rate stood at 1.72%, at its low point in the first half of 2007, it was well below 50 basis points, so we have seen a nine-fold increase off the bottom and more than a doubling in the serious delinquency rate over the last year.

Any Silver Lining?

If there is any good news in this report, it is that there does seem to be a slight slowing in the rate of growth of the delinquency rate, with the 15 bp rise in December being less than the 18 bp rise in November, which was in turn less than the 21 bp rise in October. The key point, however, is that it is still rising.

If someone is 30 days behind on their mortgage, the odds are that they will correct the problem, but if they are more than 90 days behind, the odds are that they will never come up with the money to catch up. This is a very big pool of foreclosures just waiting to happen. Fannie Mae (FNM) has not released their delinquency rate data yet, but odds are that it will look very similar to the Freddie data.

However, given the number of people who are seriously underwater on their homes, perhaps the better question is why isn’t the delinquency rate higher than it is? If you have a loan out secured by an asset, and the value of the asset is well below the amount of the loan, it is economically irrational to pay off the loan, especially if there is no recourse.

The big boys certainly understand this. BlackRock (BLK - Snapshot Report) is not going to bring down the whole firm just because they made a bad investment in Stuyvesant Town in New York. No, they write off the small amount of equity they have in the deal and default on their mortgage. If homeowners were rational, they would do the same thing.

True, there are non-economic considerations in deciding if you should continue to pay your mortgage. After all, a house is a home, not just an asset. Still, the question remains, why are so many homeowners pushing themselves into poverty by paying their mortgages when the house just is not worth that much?

Taking in the Longer View

As far as the macro economy is concerned, we should be glad that they still are. The current level of serious delinquencies means that there will be another big wave of foreclosures coming. That distressed inventory will weigh on the housing market, and could abort the recent (slight) recovery in housing prices.

That, in turn, would force still more homeowners underwater, making it economically irrational for them to pay their mortgages. Lather, rinse, repeat. Such a process was at the heart of the financial crisis last year.

If these problems start up again, we will be in a very tough spot. The GSEs will not be the only firms to suffer. The major banks like Bank of America (BAC - Analyst Report) and Wells Fargo (WFC - Analyst Report) will also take a hit and the losses will depress bank capital, and hence even further undermining their ability and willingness to lend.  That could lead to another round of secondary offerings, further diluting existing shareholders.

Being underwater is not the only factor in people being seriously delinquent on their mortgages. Even if they have equity in their homes, if someone is out of work, they might not have the cash flow needed to service the mortgage. However in that case, they still have the option of selling the home and preserving their equity. More jobs would certainly help the situation.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market-beating Zacks Strategic Investor service.

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