Challenges Continue For a Recovery of Virginias Mortgage Market


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Challenges ContinueFor a Recovery ofVirginias
Mortgage Market

• June 2009

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Virginias mortgage debtproblem remains
substantial and will take time to unwind
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Loan performance continues to deteriorate at a
significant rate
Source Mortgage Bankers Association (MBA)
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Credit quality has weakenedover a prolonged
period of time

• When long-term mortgages were mainly funded with
  short-term bank deposits lenders maintained
  tight credit standards to off-set their interest
  rate risk.
• Starting in the late1970s the sale of loans on
  the secondary market grew substantially
• Securitization reduced interest rate risk and
  created latitude for lenders to progressively
  liberalize lending standards.
• Following the Tax Act of 1986 the rapid growth
  of home equity borrowing to support consumer
  spending added another element of credit risk.

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Household mortgage debt has risen much faster
than national GDP
Source Bureau of Economic Analysis (BEA) and
Federal Reserve
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A long-term rise in household debt was masked by
rising home prices

• During the housing boom steep rises in home
  prices allowed distressed borrowers to easily
  refinance their debts.
• This led to a falling rate of serious mortgage
  delinquency despite an ongoing decline in credit
  quality and growing levels of household debt.
• The reversal of home price appreciation
  eliminated refinancing as an exit door and
  left distressed borrowers more prone to
  foreclosure.

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A long-term decline in credit quality was masked
by rising home prices
Source Federal Housing Finance Authority (FFHA)
and Mortgage Bankers Association (MBA)
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Virginias foreclosure problem first took holdin
Northern Virginia
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The onset of falling prices in NoVA was a trigger
for rising foreclosures

• In 2007 foreclosures became a problem in NoVA
  following the onset of widespread price declines.
• The first wave of foreclosures was mainly
  adjustable rate subprime loansa large share of
  which had their first payment reset between mid
  2007 and late 2008.
• Prince William Manassas and other submarkets
  with high concentrations of subprime loans were
  impacted first and hardest.

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A drop in home prices lags well behind declining
home sales

• Declining home sales bring an end to price
  appreciation.
• However most sellers will wait a long time
  before they are willing to significantly cut
  their asking price.
• Not until there is a large inventory of unsold
  homes will competition lead to a meaningful
  reduction in prices.
• Even then it takes large numbers of distressed
  sales to push prices significantly lower.
• In the current market the lag time between the
  initial downturn in sales and beginning of a
  meaningful drop in prices has been two full years.

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The Prince William area illustrates the pattern
seen in Virginia markets
Source MRIS
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At the start of 2008 foreclosureswere heavily
concentrated in NoVA
Source ReatyTrac
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Now downstate markets are beginning to see
significant increases in foreclosures
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In 2009 foreclosures are impactinga widening
number of local markets
Source RealtyTrac
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The housing decline in downstate markets is
trailing NoVA by a full year
Source Virginia Association of Realtors
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Late 2008 marked the onset of price declines in
many downstate markets

• Until recently most downstate areas with high
  concentrations of subprime loans experienced
  fewer foreclosures than NoVA because their home
  prices remained relatively stable.
• Since late 2008 downstate housing markets have
  seen a steep up-tick in foreclosure activity as
  price declines have become prevalent.
• Rising foreclosure rates reinforce declining home
  prices creating a reinforcing cycleConsequently
  foreclosures will likely continue to rise until
  home prices stabilize

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Virginias foreclosure problem isnow becoming
more broad-based

• While subprime loans remain a serious problem a
  second wave of payment resets is now causing
  option payment ARMs and alt-A loan
  foreclosures to rise.
• In addition the impact of the recession is
  beginning to increase default levels among
  borrowers with traditional fixed-rate mortgage
  loans.
• Consequently foreclosures are no longer mainly
  NoVA or subprime problems.
• They are now a broad-based issue impacting a wide
  array of communities and borrowers.

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Virginias Northern Tieris seeing a return
tomarket fundamentals
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Lower-end pricesinflated by relaxed
underwritinghave returned to norms
Note Tiered price breakpoints are as of March
2009
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Prices appear to be stabilizing having fallen to
pre-boom levels
Source MRIS
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In NoVA falling prices have spurred a rebound in
existing home sales
Source MRIS
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Rising home sales are reducing unsold housing
inventory
Source MRIS
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A big factor in NoVAs salesrebound is increased
affordability

• In 2000 affordability was a problem mainly
  inside the Beltway
• At the peak of the boom affordability pressures
  were severe even in the outer suburbs
• Today affordability in the outer suburbs has
  returned to pre-boom levels

Historic affordability threshold
Source MRIS and Census Bureau
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What does the future hold for Virginias
foreclosure problem
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Problem loans and unemploymentwill keep defaults
high for some time

• The huge wave of defaults due to payment resets
  on subprime loans is now waning.
• However a second wave of payment resets on
  option payment ARMs and alt-A loans will
  begin in late 2009 and extend through 2011.
• This second wave of potential defaults will
  coincide with the likely impact of rising
  unemployment on borrowers ability to repay.

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The wave of subprime resets is ending but other
loan types are now at risk
Source Credit Suisse IMF Global Financial
Stability Report September 2007
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Foreclosures are stabilizing in areas hard-hit by
subprime defaults in 2008 but are increasing in
other markets
Source RealtyTrac
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Now foreclosures are rising in areas with
concentrations of alt-A loans
Source RealtyTrac
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Fixed-rate loan defaults are also rising due to
unemployment and falling equity
Source Mortgage Bankers Association (MBA)
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Unemployment has increased substantially
throughout Virginia
Source Virginia Employment Commission
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Historically rising unemployment leads to
increased loan defaults

• Unemployment is strongly correlated with rising
  mortgage defaults.
• Usually there is a lag between the initial rise
  in unemployment and an increase in default rates
  because borrowers first exhaust public benefits
  and savings before they miss payments.
• There is often a longer lag between the peak in
  default rates and the peak in unemployment
  because at the highest levels of unemployment
  people are out of work for an extended time.

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Default rates may continue to riseeven past the
peak in unemployment
Source Bureau of Labor Statistics (BLS) and
Mortgage Bankers Association (MBA)
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Prices have not yet fully correctedin some
downstate market areas

• Despite recent declines home prices remain high
  relative to incomes in some downstate areas
• During 2009 historically low interest rates will
  provide temporary price support to offset
  otherwise weak demand
• Nevertheless downward price pressure should
  continue to be feltespecially in the Hampton
  Roads and Charlottesville market areas

Historic affordability threshold
Source VAR and Census Bureau
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The downstate share of foreclosure auctions is
rising but there continues to be a
lesserbuild-up of foreclosed homes than in NoVA
Source RealtyTrac
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Foreclosed homes remain a major drag on NoVAs
market recovery

• In 2008 NoVAs inventory of foreclosed homes
  increased rapidly and dominated sales activity.
• The inventory has dropped since December but is
  still extremely high.

Source MRIS and RealtryTrac
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Rising foreclosures are slowingthe decline in
lender-owned homes
Source RealtyTrac
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The impact of foreclosed homes on local
communities is expected to be concentrated in the
Northern Tier
Eligibility based on foreclosures reflects
several risk factors as well as actual current
foreclosed home inventories. _____________________
__________________________________________________
_
Source U.S. Department of Housing and Urban
Development (HUD)
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The following factors will contributeto how
quickly markets rebound

• An upturn in sales marks the bottom of the
  market As unsold inventory declines prices
  will stabilize.
• In NoVA steep price cuts have contributed to a
  rebound in sales activity declining inventory
  and a bottoming-out of prices.
• However most downstate markets are still
  experiencing declining home sales and prices.
• Price stability will ease foreclosures but high
  default rates are likely to continue until the
  second wave of loan resets is past and
  unemployment levels begin to fall.
• Increased sales will not significantly reduce the
  inventory of foreclosed homes until the default
  rate declines
• Therefore continued high inventories of
  foreclosed homes remain the primary obstacle to
  market recovery

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What further risks lie ahead

• The length and severity of the recession remains
  an unknown. A layering of unemployment on top of
  current default factors will compound defaults.
• A continued build-up of lender-owned homes will
  reinforce current price declines destabilize
  neighborhoods and inhibit market recovery.
• There is the ongoing risk of further trauma in
  the credit markets that would significantly
  reduce the availability of affordable home
  financing. It is essential that an adequate
  supply of affordable mortgage funds remain
  available to enable increased sales.