Most people in the default-servicing industry don’t foresee a U.S. economic recession or housing downturn in 2020. Two-thirds of respondents to a recent Auction.com survey, however, expect their company to see greater inflows of foreclosure and bank-owned properties this year.
Conducted in December 2019, the survey was sent to Auction.com clients, who collectively accounted for 87% of the servicing volume among the nation’s top 100 mortgage servicers in the third quarter of last year. Fifty-nine percent of respondents said they don’t expect a recession in 2020, while 54% said they don’t expect a housing downturn this year.
Somewhat counterintuitively, however, a solid majority of 66% expect their organization’s foreclosure and real estate-owned (REO) inflows to increase compared to 2019. Sixty percent said they expect inflows to increase slightly, while 6% said they expect substantial increases. This implies that many servicing professionals believe an uptick in defaults and foreclosures could occur even without an economic recession or housing downturn.
This, of course, begs the question: Where will the additional foreclosure inflow come from if it’s not triggered by lost jobs or decreasing home values? A deeper dive into the Auction.com survey results shows that default servicers are expecting most of the increased inflow in 2020 to come from government-insured loans — those backed by the Federal Housing Administration (FHA), U.S. Department of Veterans Affairs and U.S. Department of Agriculture. Eighty-nine percent of respondents said they expect a rising inflow of government-backed loans, far and away the largest share among all loan categories.
The strong expectation for a rise in foreclosure and REO inflow from government-insured loans corresponds to the increasing risk profile of FHA-backed loans originated in recent years. FHA’s annual report to Congress for fiscal year 2019 revealed that the average debt-to-income ratio for FHA-insured mortgages originated from October 2018 through September 2019 was 43.7% — an all-time high — while the average credit score was 666, the lowest figure since 2008.
The rising risk profile for FHA loans is beginning to translate into rising foreclosure starts. The October 2019 single-family loan-performance trends report published by the FHA, for instance, shows 10,405 foreclosure starts on FHA-insured mortgages during the month, up 0.6% year over year to a nine-month high.
There is precedent for increased supply in the distressed-housing market absent more widespread stress in the economic and real estate markets. Auction.com analyzed historical delinquency data from the Mortgage Bankers Association (MBA) and foreclosure-sales data from Attom Data Solutions to arrive at this conclusion.
The MBA data shows that the seasonally adjusted delinquency rate for all mortgages hit a 29-year high of 6.07% in first-quarter 1985 — more than two years after the previous recession ended and more than five years before the start of the next recession. This spike was likely tied to the savings and loan crisis that featured what was considered unsound real estate lending.
Another path to foreclosure increases without a recession is home-price corrections within local markets. This is evident through an Attom Data Solutions analysis of sold foreclosure properties in the Los Angeles metro area. The number of foreclosures sold in the Greater L.A. area — including those purchased at auctions or as REO properties from banks — increased to a more than 20-year high of 7,837 in second-quarter 1997. This surge in L.A. foreclosures occurred between the 1990 and 2001 U.S. recessions.
These examples provide at least two paths to an expanding inflow of distressed properties for servicers in 2020. Based on the Auction.com survey responses, the most likely path to a potential increase this year will come from risky lending that comes home to roost, namely from government-insured loans originated in recent years.