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When fortunes fall flat.

When Fortunes Fall Flat

Ballooning personal bankruptcies have caused many once-bouyant housing dreams to deflate.

Quick, which would you choose, a mortgage world of increasing foreclosures or one with declining originations and less housing affordability?

The answer is that mortgage bankers may be hurling toward the worst of both, despite herculean efforts to help consumers forestall foreclosures and afford decent housing.

To understand what is frightening many mortgage bankers, take a look at the following:

* Foreclosures and

delinquencies--Both are setting modern records

and both are headed in the wrong

direction--up. The national

foreclosure rate is at nearly 1 percent; the

latter at 5.28 percent, the highest

levels since 1986, according to the

Mortgage Bankers Association of

America's (MBA) National

Delinquency and Foreclosure Survey for

the second quarter of 1991. * Bankruptcies--Chapter 13 filings,

the last gambit some buyers use to

save their homes from foreclosure,

are also setting records and heading

in the wrong direction. According to

the American Bankruptcy Institute

(ABI), personal bankruptcies have

been steadily increasing. The 45

degree angle portrayed in Chart 1

shows a low for the decade between

250 and 300 cases in 1984 that more

than doubled by year-end 1990. In

June 1991, personal bankruptcies

numbered close to one million. As it

is now, the chances of an individual

or couple filing for Chapter 13

during their lifetime are about one in

twelve, according to ABI. * More liberal bankruptcy laws--As

more and more citizens file for

bankruptcy, federal circuit courts

are becoming increasingly lenient,

giving persons in bankruptcy more

rights than ever before. What

particularly alarms mortgage bankers

is a development known as a

bankruptcy "cramdown."

Historically, a mortgage banker's loan has

been secured by the value of

property. The concept of value is

changing. Three federal circuit courts

have ruled that when a decline

occurs in the value of a residential

property tied up in a personal

bankruptcy, the lender has a

secured claim only for the present

value of the home, as opposed to its

value when the loan was originated.

This limit on the lender's secured

claim, then, is called a cramdown,

and it has caused a queasy feeling by

lenders and investors, because what

was thought to be a secure

investment may not be so secure after all.

Experts say the bad economic news prompting graphs of delinquencies, bankruptcies and foreclosures to soar sharply toward the ceiling will continue. Richard Peach, MBA deputy chief economist, expects foreclosure and delinquency rates to peak in late 1991 or early 1992, with a falling off in the 30-day-late category coming later in the year. But he says the 60- and 90-day delinquent loan rates may continue rising.

The 30-day delinquent rate, he explains, constitutes the greatest share of delinquent loans. For instance, in the second quarter 1991, which marked a 5.28 percent delinquency rate, 3.45 percent were 30-days delinquent, with the balance, 1.8 percent, evenly split between 60 and 90 days. Loans falling in these latter two categories of seriously late mortgage payment may follow the painful route from bankruptcy to foreclosure.

How many will actually end up in foreclosure will depend in part upon how the overall economy performs. Peach says he expects it to grow sluggishly in 1992. But with or without a sluggish economy, Sam Gerdano, ABI's executive director, says that if personal bankruptcy filings stay at the present rate of increase, they will be close to two million in another six years.


Behind the gloomy outlook are other nasty socioeconomic factors. Experts such as ABI's Gerdano and Richard Deleo, Pasadena-based Countrywide Mortgage Corporation's executive vice president, say that there are three main catalysts propelling the adverse trends: overextension of credit, divorce and the recession--in that order. Other factors such as disabilities and family additions together make up a "fourth" factor.

"It's important to understand," says ABI's Gerdano, "that the recession isn't the primary factor. The increase in filings began during the period when the economy was robust. To say the recession is the cause doesn't explain the upward trend."

What does help explain the trend, he says, is the growth in the amount of debt as a percentage of personal income. It has been rising since 1983 at almost the same 45 degree angle posted by bankruptcy cases. According to Federal Reserve statistics published by ABI, in 1983, debt as a percentage of personal income was just below 63 percent, and it rose dramatically to around 84 percent in 1990. (See Chart 2.)

Deleo and others say one primary culprit behind credit overextension is credit cards that have been too easy to obtain. Bankcard Holders of America, a consumer group in Herndon, Virginia, says the typical American carries nine credit cards, and despite high interest charges, owes more than $2,000 on them, for a total of approximately $226 billion in high-interest, revolving credit debt. Gerri Detweiller, an education coordinator for Bankcard Holders, says the "heydays of the 1980s are over" and credit card issuers are tightening application standards. Consumers charged $563 billion on credit cards in 1990, up $34 billion from 1989, according to the consumer group.

Then there's divorce. Though there has been a 10 percent decline in the divorce rate during the past decade, roughly one marriage in two breaks up. Most breakups occur, says Andrew J. Cherlin, professor of sociology at Johns Hopkins University, within 10 years of marriage. When husband and wife split, the mortgage is either late or doesn't get paid.

Then there's the recession. The unemployment rate in 1991 hovered near 7 percent, and predictions of an end to the recession have been found wanting. "It's a great irony. Economists are talking about how we need more spending to pull us out of a recession. If that is what it takes, an increase may be good for recovery, but down the road we will have increases in bankruptcies," Gerdano says.

Bankruptcy relief

There's also the changing public perceptions about bankruptcy laws. "There is just not the same stigma there used to be about going into bankruptcy," says Karin Pickard, vice president of the mortgage loan servicing group for First Union Mortgage Corporation, Charlotte, North Carolina. "We even have a cartoon in the office with a husband saying to the wife, |if the rich and famous can file for bankruptcy, why can't we?'" In other words, says Pickard, for many individuals, bankruptcy is no big deal.

Another change that has taken place with the public during the past few years, she says, is greater sophistication on the borrower's part. "They know what a loan workout is now, before they didn't. And now you have to call up their accountant to find out where the mortgage payment is," she says.

Advertising and the media have helped to convince the public that bankruptcy is a viable option to paying bills, as opposed to working with banks to develop solutions, says Bill Glasgow, executive vice president in charge of loan administration for BancBoston Mortgage Corporation, Jacksonville, Florida.

All these factors may add up to a foreboding future. ABI's Gerdano says that the soaring increase in bankruptcies means not only monetary losses, but loss of jobs, higher interest rates and loss of credit availability.

It may also mean higher standards for loan approvals, more costly mortgage loans and possibly fewer affordable homes. "If these conditions worsen, a person will have to walk on water to get a 95 [percent loan-to-value] loan," says Brian Chappelle, an MBA staff vice president. "We may have to look more closely at the stability of a person's employment and marriage," adds Countrywide's Deleo.

Still, says BancBoston's Glasgow, it's important to keep present day foreclosure rates in perspective. "Bankruptcies as a percentage of a mortgage banker's portfolio have remained fairly constant, usually less than 50 basis points, or less than 1 percent of the loans."

And First Union's Pickard says it is important to know how to read bankruptcy statistics. "Georgia is a quick foreclosure state--a bank can foreclose in two months. So there are a lot of bankruptcy filings to avoid foreclosure and extend the time [borrowers] have." Texas is also a quick foreclosure state, she says, while in Maine it can take a year, and in Florida, from eight to ten months. Often, she says, the filing of a Chapter 13 will give the homeowner time to get his or her economic act together and avoid foreclosure.

Cramdown threats

A major question looming on the horizon for lenders is how the cramdown factor will evolve. So far, cramdowns have been relatively few, but the potential destructiveness to mortgage servicing profits is apparent.

Thus far, three federal circuit courts of appeal (the Third, Ninth and Tenth) have ruled in favor of permitting residential mortgage cramdowns. But these decisions were reached before the mortgage lending industry could present contrary legal and public policy arguments to the contrary.

Freddie Mac currently has on appeal in the Second U.S. Circuit Court of Appeals a cramdown case from Connecticut, In Re: Jimmie and Cynthia Bellamy (No. 91-5045). And Fannie Mae is taking a cramdown case from Alaska to the Ninth Circuit, In Re: Cervantes (No. 35930), asking that court to reverse its own seminal cramdown opinion. If Fannie Mae and Freddie Mac are successful, then the route is open for a review of the cramdown issue by the Supreme Court. Such a review, if it comes, is not expected until late this year and probably not until 1992.

MBA, the National Association of Realtors (NAR), the American Bankers Association (ABA), the National Council of Savings Institutions (NCSI), and the U.S. League of Savings Institutions filed an amici curiae brief before the United States Court of Appeals for the Second Circuit supporting the Freddie Mac position opposing cramdowns and in the Ninth Circuit supporting Fannie Mae.

If the bankruptcy courts are upheld, the brief states, lenders will be "unable to realize the full value of their loans, and may be compelled to curtail investing in home mortgages or mortgage-backed securities because of anticipated losses."

That means, the brief maintains, that "without the availability of responsible financing and a plentiful supply of funds, there would be an inadequate supply of residential housing, residential real estate transactions would be curtailed dramatically, and the ability of Americans to own their own homes would be severely threatened."

There's also a possible legislative remedy, which is garnering similar support from industry groups. Legislation eliminating cramdowns has been introduced by Senator Howell Heflin (D-AL), chairman of the Senate Courts and Administrative Practice Subcommittee. Industry representatives hope for favorable passage in Congress sometime late in 1992 or early 1993.

(In a parallel move, the ABI is asking Congress to create a blue ribbon commission to study whether the Bankruptcy Code of 1978 is in need of reform to deal with the growing bankruptcy numbers. "There is a need for a systematic and thorough review," Gerdano says.)

Officials at various secondary market institutions generally view cramdowns as a future threat, but one that can be cured.

Freddie Mac's Dean Cooper, associate general counsel, says Freddie Mac has been involved in five cases thus far, and at the moment cramdowns are only a potential "theoretical" risk. He adds that most borrowers considering cramdowns decline to pursue them when informed by lawyers that their mortgage payments will remain the same or when they realize that their properties have slipped in value by only a few thousand dollars. In addition, Cooper says Freddie Mac has not had much of a problem because of its high purchasing standards and a relatively low, average loan-to-value (LTV) ratio on single-family residences of approximately 57 percent.

At Fannie Mae, Anita Champ, assistant director of loan servicing standards, says cramdowns are a very real threat to the future of the housing industry. "There are large and serious implications for mortgage financing," she says. Fannie Mae actively challenges each cramdown case, and supports legislative and court remedies. Fannie Mae has had 11 cramdown cases out of its 7.5 million mortgage portfolio.

At GNMA, a top housing official who asked not to be identified says he is very concerned about cramdowns, as FHA and VA insurance do not provide for cramdown protection. This official says he is hoping for a legislative resolution to the problem.

George Anderson, GNMA vice president for asset management, states that thus far, GNMA has had eight cramdowns in its GNMA-owned single-family and manufactured homes pool portfolio at a cost of $50,300 to GNMA. In late October, there were 178 pending cramdowns in its GNMA-owned portfolio with a potential loss of $962,000. However, Anderson says, many of these cramdowns will not occur because, under the cramdown terms, borrowers lose cramdown rights if they miss a payment. The mortgage then reverts to its original terms. Anderson expects many missed payments to occur. He also believes that if cramdowns become accepted practice, "there will be a very tough impact on the LTV ratio."

Without legislative or Supreme Court action against cramdowns, Howard Esaki, a senior analyst with Moody's Investors Service, expects the "floodgates to burst." If the current personal bankruptcy rate continues at the present pace, Esaki says, mortgage pools originated in 1991 may experience a cramdown rate of nearly 6 percent of original loan balances. This will be particularly true for high-LTV loans and for owners of expensive homes. These homeowners are more prone to protect these assets in Chapter 13 bankruptcy filings, Esaki says.

And Moody's isn't taking any chances by waiting around to see what Congress or the Supreme Court does. It has increased its guidelines for insurance protection against cramdowns, in some cases, 10 times as high as its past standards and, for the first time, issued a lower credit rating for a mortgage securities issue factoring in the potential for cramdown losses. Under normal circumstances, the real estate mortgage investment conduit (REMIC) offering by Fleet Mortgage Securities, Inc. of Columbia, South Carolina, would have been rated Aaa, but Moody's rated it Aa1 because it lacked the higher cramdown coverage now deemed necessary to get Moody's top rating.

Aside from moving on the legislative/legal front against cramdowns, mortgage bankers are beefing up collection staffs, installing sophisticated computer systems, tightening up application standards and developing creative default workout plans for borrowers in trouble.

For instance, First Union Mortgage is moving away from FHA and VA loans to conventional, where the delinquency rates tend to be lower, and in the past few years has doubled its collections staff. At Perth Amboy, New Jersey-based Margaretten & Company, Inc., Mary Donohue, second vice president and liquidations manager, says that though the number of bankruptcy actions have more than doubled, from 115 in 1987 to 360 today, a Hewlitt Packard 3000 computer system at the facilities in Iselin, New Jersey, has kept staff levels consistent. The computer system has the capability of tracking an individual's mortgage problems and the bankruptcy laws in the state where the property is located. Donohue and others involved in the mortgage banking business say they do everything possible to help those with serious economic problems get through tough times.

"The vast majority of the borrowers are in justifiable economic trouble, so we try to litigate less and help more," Donohue says, "and we monitor our cases closely."

"We try to tailor a default plan to the individual's circumstances," says Countrywide's Deleo, adding, "We have modified loans, and extended forbearance plans to help borrows find solutions."

"We still have the same old-fashioned problems of money mismanagement and borrowers not wanting to pay, but now we have lost jobs or new employment at less pay," says Robert Petrey, vice president of collections of Colonial Mortgage Company, Montgomery, Alabama.

Most national mortgage companies say that parts of the Oil Patch (Louisiana and Texas) and the New England states are of greatest concern today. "We had hoped for a dramatic turnaround as the Oil Patch problems eased up," says First Union's Pickard, "but it hasn't happened."

In some cases, the increased workloads on collection staffs have caused turnovers and burnout, while others seem to have weathered the deluge.

Countrywide's Deleo says that "burnout is a problem we all have to deal with." Colonial Mortgage's Petrey says burnout and stress have been factors for his small collections staff, which makes up to 1,000 calls a month. "It takes a certain type of personality to deal with the people we deal with," he says.

Khalidah Gore, a default specialist at First Union, must be that "certain type." She handles 20 to 50 calls day, and says the hard tales don't get her down. "Listening is part of the job, and I try to see where I can be helpful," she says.

The housing finance industry will need more Khalidah Gores if those bankruptcy lines keep moving in the same direction. And if the courts or Congress fail to act effectively against cramdowns, the worst is yet to come. [Chart 1 and 2 Omitted]

Joseph Dawson is a freelance writer based in Washington, D.C.
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Title Annotation:increased rate of bankruptcies
Author:Dawson, Joseph
Publication:Mortgage Banking
Date:Dec 1, 1991
Previous Article:Material differences.
Next Article:The new origination game.

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