Why do state laws affect borrower behavior and home prices?
The right direction: December LPS Mortgage Monitor takeaways (Part 3 of 4)
State foreclosure laws influence borrower behavior
Borrower behavior is heavily influenced by consumer protection laws, particularly at the state level. States that have judicial review of foreclosure activity tend to have higher delinquency rates and a bigger foreclosure shadow inventory. New York State is legendary for how long a borrower can live in his or her home without paying the mortgage. It can be several years. Judges push servicers (who don’t have any skin in the game) to keep modifying the underlying mortgage.
Seven of the top ten states for total non-current loans are judicial
Just under half of all states are judicial, but they’re concentrated at the top of the non-current leader board. Mississippi is the highest, with 15.5% of all mortgages non-current, with 13.3% in delinquency and 2.1% in foreclosure. Mississippi isn’t judicial, but the next five states—Florida, New Jersey, New York, Maine, and Louisiana—are. These states have high levels of shadow inventory. In fact, New York and New Jersey have incredibly high pipeline ratios.
Judicial states have had low home price appreciation
We’ve seen that home price appreciation varies widely by location. In the red-hot California markets, there’s tight supply, as the foreclosure pipeline has been worked through. In several California markets, you’re seeing 20%-plus annual home price appreciation. In the judicial states—particularly New York, New Jersey, and Connecticut—you’re seeing much lower home price appreciation. The shadow inventory remains huge, and buyers are reluctant to step up in the face of such supply.
Implications for mortgage REITs
Real estate prices are a bigger driver of non-agency REITs, such as CYS Investments (CYS), Newcastle (NCT), and Redwood Trust (RWT), than they are of agency REITs like Annaly (NLY) and American Capital (AGNC). When prices rise, delinquencies drop, which is important because non-agency REITs face credit risk. Even for agency REITs, which invest in government mortgages, rising real estate prices can drive prepayments, which negatively affects their returns. Rising real estate prices also help reduce stress on the financial system, which makes securitization easier and lowers the cost of borrowing. Finally, those REITs with large legacy portfolios of securities from the bubble years are able to stop taking mark-to-market write-downs and may revalue their securities upwards. Since REITs must pay out most of their earnings as dividends, higher earnings mean higher cash flows to the investor.
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