The Daily Show recently offered this commentary on the current profitability of large banks:

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
Hoarders
www.thedailyshow.com
Daily Show Full Episodes Political Humor Tea Party

The gist of the Daily Show’s segment is that 4 banks profited every trading day during the last quarter basically by borrowing short term from the Federal Reserve at almost zero interest and lending the same money back to the government at 3.5% by purchasing 10 year Treasury bonds. They are the profit taking middlemen in a washing machine to fund large deficits to stimulate the economy. Note that the Federal Reserve and Treasury are aiding the banks in this arrangement. The public animosity towards the bank profiteers no doubt played a part in passing more vigorous reforms to financial regulations.

While on the one hand bank earnings in 2010 have been more than 4 times the earnings of the S&P 500, banks also have about $1 trillion in second liens on their books, with more than $400 billion on the books of the 4 largest banks. On the financial blog Rortybomb, Mike Konczal reports that the Bank Stress Test adverse scenario documents expected losses of 13-14% on these second liens (so banks value the second lien assets at 86% of their face value). He asserts that the current housing market might see real losses of 40-60%, considering that most of the second liens are worthless after the fall in home prices. There are 11 million plus underwater homeowners, almost 25% of all homeowners with bank loans. Konczal thinks the difference in the real losses to the big banks might be as much as $150 billion, which would require them to raise large amounts of additional capital. One analyst has predicted that the big banks will need to set aside an extra $33.2 billion starting this year because of home equity loan losses, enough to wipe out most of their estimated profits for the year. Home equity loans are a particular problem because long after the homeowner stops making payments, the banks continue to count the loan as current by adding the interest not paid to the loan balance. Second lien holders are balancing delaying the loan modification or short sale process and urging the homeowner to continue paying with action to avoid foreclosure, where the second lien holder will probably receive nothing.

Our anecdotal experience has been that most distressed homeowners have second liens. In most cases second lien holder banks have been unresponsive in releasing liens to allow short sales.  As an example, we can document a short sale that took us 13 months to complete, and we have others where the seller (and of course the buyer) has been waiting more than 5 months for a response from the second lien holder. Literally hundreds of other agents in the Certified Distressed Property Agent network are reporting the same thing. Millions of distressed homeowners are being punished by the unnecessary delay in resolving second liens. With financial reform at our doorstep, it would seem that the government could trade some of the good will that is helping the banks to profit for their cooperation in helping homeowners more quickly sell their homes.

As we approach the end of January, some of the economic optimism of late 2009 has faded, and Americans are reassessing their outlook for this year.  The stock market has fallen more than 500 points, but the market that in many ways continues to be the most central concern is real estate. Calculated Risk blog published an article about the Special Inspector General's quarterly report on the Troubled Asset Relief Program (TARP), which asserts:

"...the Federal Government's concerted efforts to support home prices risk re-inflating that bubble in light of the Government's effective takeover of the housing market through purchases and guarantees, either direct or implicit, of nearly all of the residential mortgage market."

The Calculated Risk article also published this graphic from the report, showing the different ways that the government is currently supporting residential real estate and lending in our markets. The report also outlines why "too big to fail" institutions benefitted from the TARP while contributing to the problem, and that these institutions have grown larger and more problematic as a result.

As portions of government support for home prices wind down and withdraw price support as our economy recovers, the article speculates that home prices will continue to fall. Interest rates will rise and demand for housing will fall.  Our own opinion is that we'll see a greater adjustment in higher priced homes than at the low end of the market since loans are more difficult to obtain and an increasing number of owners of higher priced homes will be subject to defaults and foreclosures.

While the wave of subprime adjustable rate mortgage payment resets has passed, a new wave of resets, most prominently option-ARM mortgage payment resets, is about to begin. Many of the Option ARM loans went to purchase more expensive homes, so we expect more defaults in higher priced homes this year. See this graphic published by the IMF posted in an older article on the Calculated Risk Blog.

Also, unemployment continues to force defaults even among conventional borrowers, who now make up the largest group of defaults and foreclosures by loan type. See this graph, again from Calculated Risk, "Statistical Recovery and Human Recession," showing how unemployment in this recession compares with other recessions since World War II.

While this discussion at the national level will have an impact on our local market, it is important to distinguish that not all markets will be effected in the same way. For instance, Kitsap County has only 7.5% unemployment, while the national rate is 10%. Fewer defaults occur in Kitsap County as a result of unemployment.

The Washington Center for Real Estate Research provides local affordability calculations that we can use to check on housing affordability using current median prices and interest rates. Note that unlike the discussion above these calculations only compare the affordability of standard conventional loans, not the different types of loan products that have been offered. We assume that a buyer making the median family income puts 20% down on the median priced home and obtains a 30 year fixed rate mortgage. We assume that a first time buyer making 70% of the median income puts 20% down on a house priced at 80% of the median and obtains a 30 year fixed rate mortgage. We assume that both buyers can afford to spend a maximum of 25% of their monthly income on the principal plus interest of the loan. Using the annual averages of median price, median income, and average annual 30 year fixed interest rate since 2003, we plot an affordability index equal to the maximum affordable payment divided by the actual payment. When the index is greater than 1, the loan is affordable to the typical buyer. When it is less than 1 some buyers cannot afford to purchase. Our numbers for 2009 are estimates using the latest monthly data for median prices and interest rates (2008 has been updated with average annual values), and an estimated median family income for 2008 and 2009. With interest rates rising from 5.34% in December to 5.13% in January for a typical 30 year fixed rate conforming loan and the median price falling in January to $239,950, affordability is improved slightly and remains very good. The outlook for rates is that they will continue to rise in the coming year, with some experts predicting they'll reach 6% by the end of 2010. Keeping in mind how median prices can be deceptive, you should be aware that the bulk of sales are concentrated below $400,000, with considerably fewer than normal in the higher price ranges. The affordability index improved to 1.29 in December from 1.27 in November. First time buyer affordability improved to 1.13 from 1.11 last month. Below is a  graph of the year-to-year changes in affordability and a second graph showing month-to-month affordability progress over the past year.

Year	2003	2004	2005	2006	2007	2008	2009
Annual Average interest rate	5.83	5.84	5.87	6.41	6.34	5.80	5.13
Median Income	$53,160	$53,923	$54,582	$58,304	$60,719	$65,000	$65,000
Median Price	$184000	$206900	$250000	$275000	$290343	$265000	$239950
Monthly payment	$867	$975	$1182.43	$1378	$1443	$1244	$1046
Affordable payment	$1,108	$1,123	$1,137	$1,215	$1,265	$1,354	$1,354
Affordability Index	1.28	1.15	0.96	0.88	0.88	1.09	1.29
1st time buyer payment	$693	$780	$946	$1102	$1155	$995	$837
1st time buyer affordable payment	$775	$786	$796	$850	$885	$948	$948
1st time buyer affordability index	1.12	1.01	0.84	0.77	0.77	.953	1.13

January's APR is 5.191% on a 30-Year and 4.573% on a 15-Year, both conforming. December's rates were 5.444% on a 30-Year and 4.952% on a 15-Year, both conforming. After rates rose somewhat in December, they are again back at very attractive levels. If you qualify for FHA, VA, or USDA loans , these programs have are attractive for low downpayment buyers. Limits for FHA and conventional conforming loans went up with the stimulus bill. The FHA maximum is $475,000, and the conventional conforming limit has returned to $475,000. Lending programs for jumbo loans have improved considerably, with the larger banks starting to come back to this market. A typical 30 year fixed jumbo APR (with total costs of the loan, not just the rate factored in) is 5.895% on one major bank web site - unchanged from last month. Local credit unions and savings and loans may be able to beat this rate for some jumbo loans. To check the daily rate you can contact your lender or preview web sites such as this one - http://bankrate.com/.

Hugh Nelson and Taylor Brown Earn Prestigious Designation to Help Homeowners in Danger of Foreclosure

Poulsbo, WA – 8/18/2009 – Hugh Nelson and Taylor Brown of Prowse and Company Real Estate in Poulsbo have earned the prestigious Certified Distressed Property Expert® (CDPE) designation, having completed extensive training in foreclosure avoidance and short sales. At a time when millions of homeowners are struggling with the possibility of foreclosure, the skills and education accumulated by both Nelson and Brown will help benefit Poulsbo-area communities.

Short sales allow the distressed homeowner to repay the mortgage at the price that the home sells for, even if it is lower than what is owed on the property. With plummeting property values, this can save many people from foreclosure and even bankruptcy. More and more lenders are willing to consider short sales because they are much less costly than foreclosures.

In the Poulsbo-area, more than 60 homes are in some stage of foreclosure, and as many as 13% of all mortgages may be in default. It is happening across all price ranges, and the fastest-growing category of homes entering foreclosure is luxury homes in excess of $1 million.

"The CDPE designation has been invaluable as I work with homeowners and lenders on complicated short sales," said Brown. “It is so rewarding to be able to help families save their homes from foreclosure.”

Alex Charfen, co-founder and CEO of the Distressed Property Institute in Austin, Texas, said that agents such as Hugh Nelson and Taylor Brown with the CDPE Designation have valuable training in short sales that can offer the homeowner much better alternatives to foreclosure, which can virtually destroy a credit rating. "These experts also better understand market conditions and can help sellers through the emotional experience,
he said.

The Distressed Property Institute provides live and online courses to train real estate professionals how to help homeowners in distress, with a particular emphasis on handling short sales. “Our goal is to help as many homeowners as possible, by educating as many real eWA professionals as possible,” Charfen said. 'Hugh Nelson and Taylor Brown have demonstrated a commitment to the struggling homeowners in Poulsbo, and will provide much-needed assistance in stabilizing the community."

For more information about CDPE Designation, visit http://www.cdpe.com.

This recent post on Calculated Risk pointed out a Bloomberg News article stating that the Financial Accounting Standards Board (FASB) was considering a massive new initiative to  require banks to record all assets at fair value every quarter. Bank fears about mark-to-market accounting drove changes to the rules in April 2009, allowing banks to value mortgage backed securities at higher than the fire sale prices in the current market. The standards by which bank assets are valued are important in determining the net worth on the bank’s balance sheet - so this is a life or death matter for banks. I was thinking this mark-to-market rule tightening might somehow force banks to deal more quickly with distressed homeowners. We have seen a seller wait 5 months for a response from Bank of America on a short sale offer, so we can sympathize with all the homeowners and Realtors who are completely frustrated by the system.  After taking a harder look at the problem - sigh - it’s a hard problem.

First - the Realtor's perspective - here are a couple internet posts by real estate agents impugning short sale delays.

• Dishonesty in Foreclosures and Short Sales
• Why banks preferred to let short sales turn into foreclosures

Neither article explains how the banking system works and why there is such difficulty in getting short sales approved. There is a clear distinction between trying to do a short sale where the loan was sold and later securitized and trying to do short sale where the loan (typically construction or development) is held on the bank’s books as an asset. A recent article by Arthur Delaney in Huffington Post better explains the situation for short sales where the loan has been securitized. Some important points from this piece:

• A study determined that damaged bank-owned property brings down the value of the neighbors properties by 21%
• 77% of short sales fail due to sluggishness on part of the lender
• According to one study, bank losses from short sale are 19% while bank losses from foreclosure are 40%
• With as many as 40% of real estate transactions being distressed property sales, banks and loan servicers just aren’t set up to handle the volume.
• In the case where the loan has been resold and then securitized (a large pool of loans is bundled into a security, which is then sliced into pieces (tranches) of various risk levels and sold to various investors), the bank wishing to approve the short sale has to obtain concurrence of all the various investors in the security. Investors in the lower tranches have little incentive to agree to short sale, since they must then write down their immediate loss.
• Congressional proposals to allow bankruptcy judges to modify mortgage loan terms were aimed at short circuiting the impasse between the mortgage backed security investors and the homeowner who cannot get swift response from the bank or servicer on short sale offers.

Here’s another article that tells the story of “Why do banks take so long to approve short sales” more from the bank’s perspective.

Many articles seem to confuse how banks account for losses on non-performing assets such as loans where the homeowner is in default. If the bank owns the loan, it must be marked to market. In a falling market the collateral is written down as well. Typically the bank will write down the asset value based on a quarterly revaluation and the estimated costs of sale. If the loan has been resold and securitized, the April changes to FASB accounting standards let the holders of mortgage backed securities value them at their value in a normal market. Note also that the idea of changing bankruptcy procedures as a panacea to undo all the bad loans neglects that every distressed homeowner would now have to go to court to get relief - probably not much more efficient than the current process.

Still, there may be better opportunities for short sales in disposing of non performing assets of community banks. These assets are more often than not construction loans for commercial or residential real estate. San Francisco Fed President Janet Yellen recently noted that the community banks under greatest financial stress are those with high real estate concentrations in construction and land development lending. As prices fall and developers default, these banks are having to write down the losses. As we’ve noted before, Washington State banks are more prone to this problem than our relatively good economy would seem to  indicate.

In the end, people losing their homes are being forced to endure hardships that cannot be quickly or easily resolved. A marked feature of all the financial wizardry and technical talent used in financing the housing boom is that no simple mechanism exists to resolve mortgage defaults. A new state law (SB 5810) effective July 26th provides 60 days for tenants (but not home owners) to vacate after foreclosure and requires that trustees not issue notice of default until 30 days after they have made initial contact with the borrower. Trustees in their letters must advise homeowners about how to contact DFI HUD approved housing counselors and about the new Washington State Bar Association free legal services to homeowners facing foreclosure.

One aspect of the government's financial stabilization program has been a program to improve home affordability. A program goal was to create a comprehensive stability initiative that would reduce monthly payments for 3 to 4 million homeowners to help keep them in their homes in spite of falling home prices and negative equity. Last week the Treasury Department prodded large banks to devote more resources to the program. The Washington Post article notes that loan modifications have been offered to about 270,000 homeowners, and it is unclear how many loans have actually been modified. While the program seeks to reduce payments, it does little to reduce the principal owing, thus little to alleviate the homeowner's problem of owning more than the house is worth.  The Federal Reserve Bank of Boston recently released a study titled, "Why Don't Lenders Renegotiate More Home Mortgages? Redefaults, Self-Cures, and Securitization." It indicates that about 30% of the time, homeowners who are more than 60 days behind on their payments cure their own default. It also indicates that homeowners of only about 3% of loans 60 days delinquent receive a concessionary modification to the loan, and only about 8.5% of homeowners receive any kind of modification at all. It also indicates that among modified loans, the overall re-default rate is 40-50%. The paper makes the case that the lender's costs to modify the loan would be wasted 30% of the time because owners cure the problem, and would be wasted in another 40-50% of the cases because the owners of modified loans would eventually default. Thus programs to keep people in their homes face an uphill battle.

One the other hand, a recent New York Times article, citing a Valparaiso University Study, identified that lenders were losing about 60% of the original loan balance in foreclosure sales. Since the numbers don't seem to work out for loan modifications, we once again wonder why lenders aren't ramping up the process for short sales to help improve their margins.

As May draws to an end, we want to keep a watchful eye on distressed homeowners, short sales, and foreclosures. In a short sale the seller negotiates a price with the buyer and the transaction is submitted to the bank for approval since the seller won’t realize sufficient funds to pay off his loan. In a foreclosure the seller is evicted and the bank’s representative auctions the house to the highest bidder. If the bank bids highest in the foreclosure auction, then the property becomes bank owned and is sold in the real estate market, usually after some months off market following the foreclosure auction. Homeowners owe more than the house is worth in roughly a third of our current transactions - not a scientific estimate - so this process of sellers dealing with a shortfall in paying off their loans is very much part of our current Kitsap County Market, not just some hypothetical situation.

On May 15th National Public Radio’s This American Life featured a report by Chris Arnold about loan modifications entitled, “The Mod Squad,” which highlights some current issues with distressed property sales. This report stated that 15- 20% of American households are now under water (owe more than the house can be sold for). Nationwide, more than 342,038 homes received a foreclosure filing last month, a 32% increase from April 2008. Arnold’s report estimates that about half of the 6 million foreclosures over the next 3 years don’t need to occur, that currently only 5-10% of the people who need help are enabled to stay in the home, that 46% of the people whose loans are modified fall back into default, that only 16% of loan modifications actually reduce the principal owed. The report states that large banks lack the technology to model the costs of short sale vs foreclosure. It said that the rules for banks to account for foreclosure allow them to delay posting the loss, whereas in a short sale, the bank must post the loss when it occurs. Thus it may appear best for the bank to delay sale, even though it continues to lose money every day that the property is not sold. The report said that the existence of 2nd liens often prevents modification of the primary loan to keep the homeowner in the house.

Hundreds of billions of dollars in legislation and Treasury initiatives have had little effect to speed loan modifications or speed the sale of troubled assets so that bank balance sheets can be repaired. From our perspective, property market values in short sales should not be any different than values in foreclosure, though desperate sellers may agree to short sale prices that banks are currently unwilling to accept. While banks ponder how to improve their loss mitigation software to predict the costs of sale, we wonder why they don’t just hire a Realtor. Perhaps legal procedures could be modified to level the accounting rules and allow sellers to authorize the bank to act directly for the seller in short sales in lieu of foreclosure, with provisions for certain guarantees such as allowing the seller sufficient time to vacate the premises following sale, etc. Realtors already can estimate sale price and costs of sale, do the legwork to effect necessary repairs, and otherwise fill in the decision making gaps currently lacking in the banking industry. The bank’s decision process would be simplified to whether the bank would lose less by restructuring the loan or by selling the house. We don’t know all the legalities that drive the current system - only that the end result is a system that isn’t working. With unemployment continuing to rise and with pressure on interest rates to rise, we expect that the number of home owners underwater will continue to increase and that prices will continue to fall until the excess inventory of homes is worked off.

Here's the Executive Summary of the Administration's Homeowner Affordability and Stability Plan - posted to the Washington Wire blog page at the Wall St Journal. Also here is a link to the examples illustrating how the plan would work.

Fannie Mae and Freddie Mac have suspending foreclosures until March 6th in anticipation of the rollout of a new government program to assist homeowners in preventing foreclosure. This follows the recent announcements by JP Morgan, Bank of America, and Citigroup that they have suspended foreclosures for the next few weeks. Today's Wall St Journal indicates that the President will announce a new homeowner assistance program next Wednesday. The program is expected to provide a subsidy to the homeowner, either in the form of an interest rate cut or principal reduction, to cut payments to as low as 31% of the homeowner's gross income. The new program is also supposed to include people current in their payments in addition to those who are more than 90 days behind in payment. This program won't necessarily help a person who has lost a job. Another expected benefit of the new program will be a standardized method for applying for the subsidy. Any improvement in communicating with the banks will help.