Monday, June 08, 2009

Re-default Rate For Modified Resi Mortgages

JP Morgan put together a helpful overview of re-default (or "recidivism" as many insiders prefer to call it) rates by modification type. Not surprisingly, given the way most Americans manage their finances (month to month), the most effective form of modification is to reduce monthly payments. Loan forgiveness (basically reducing the outstanding balance on the mortgage) is the second most effective method.

In every scenario, a huge portion of modified mortgages re-default, generally within the first six months of the mod.

One of the points not mentioned, but which I think is worth noting, is that loan mods really only began in earnest last summer and, as such, the dataset is still very young. Certain kinds of loan mods (like loan forgiveness) are even newer efforts, at least in scale. So all of the recidivism rates are likely to keep rising simply as a result of time passing allowing for more re-defaults.

This is based on data that JP Morgan pulled together from the Loan Performance database on the Loan Performance database.

Here's what the JP Morgan analyst said about the analysis:

Moving on to the subject of re-default, we note that the overall re-default rate stands at 40%. Breaking that number out by modification methods, we observe that capitalization has the highest re-default rate of 54%, and rate reduction the lowest of 24%. Also, the more severe the starting delinquency status before modification, the higher the re-default rate (Table 7). Despite rate reductions seemingly being more effective than principal forgiveness in terms of re-defaults, we note that lowering the balance of a mortgage through a modification by 20% or more results in a re-default rate of 32%, compared to 43% when the balance is increased (mainly due to capitalization)—i.e., balance modifications impact redefault rates.

There also seems to be a strong correlation between monthly payment amounts and re-defaults (Table 6), reaching from 26% of modified borrowers re-defaulting when their payment drops by 30% or more, to 59% redefaulting when the payment increases. Given the mechanics of capitalization (delinquent amount is added to the loan balance and the loan is re-amortized resulting in higher payments) and the high re-default rates with an increase in monthly payment, it is obvious that the payment increase is the main driver for high re-default rates when capitalization is applied. Therefore the combination of capitalization and rate reduction, which results in an unchanged or decreased monthly payment 94% of the time and a re-default rate of 41%, is much more effective than just capitalization with a 54% redefault rate. Additionally, 66% of re-defaults happen within six months after modification. We think a 40% re-default rate for modified loans is reasonable going forward.
Re Default Rate