Foreclosure auction inflow data points to a third wave of post-recession distress building in late 2019 and early 2020.
A total of 43,232 residential properties nationwide were referred to Auction.com in Q3 2019 for a potential future foreclosure auction, up from the previous quarter and a year ago to the highest level since Q1 2017.
The increase in inflow foreshadows an increase in completed foreclosures in the next six months, according to an analysis of historical inflow data. That analysis shows that more than half of foreclosure auction inflow eventually completes the foreclosure process—either through sale to a third-party buyer at the foreclosure auction or by reverting back to the foreclosing lender at the foreclosure auction. Of the inflow that eventually completes the foreclosure process, the vast majority (96%) does so within six months of the inflow date.
Post-Recession Distress Patterns
The characteristics of the increasing foreclosure auction inflow are distinct enough to label it a third wave of distress emerging in the wake of the Great Recession.
The first and largest wave comprised primarily risky loans originated during the 2004-2008 housing boom. A high percentage of these loans went bad in the subsequent housing bust. This first wave has largely subsided in the last few years, with loans originated between 2004 and 2008 accounting for 40% of all Auction.com inflow so far in 2019—the third consecutive year at less than half of all foreclosure inflow.
The second post-recession wave of distress emerged in 2018 as the result of a series of devastating natural disaster events—primarily hurricane-related—in 2016 and 2017 in Florida and Texas. Foreclosure moratoriums imposed immediately following these natural disasters eventually were lifted, resulting in surging foreclosure auction inflow in mid-2018. Although these inflow spikes were regionally focused in Texas and Florida, the impact was evident at a national level given the large size of combined housing inventory in those two states.
Default Undercurrents: Government-Insured and Privately Owned
The emerging third wave of post-recession distress is showing up in parts of Florida and Texas, but it is also showing up in markets far removed from Florida and Texas (see below for some more geographic details). That’s because this wave is less characterized by geographic concentrations of distress and more characterized by concentrations of distress based on loan type and lender type.
More to the point, the emerging third wave of distress is primarily driven by a rising undercurrent of defaults among government-insured loans and privately held loans.
The data shows a 1% increase in the overall inflow of government-insured loans, including those insured by the Federal Housing Administration (FHA), Veterans Administration (VA), and U.S. Department of Agriculture (USDA).
That increase, in and of itself, is nothing to write home about, but two sub-categories within the overall government-insured space stand out: VA-backed loans with a 31% increase and FHA-backed loans serviced by mid-market lenders—many of them so-called nonbank lenders and servicers—with a 17% increase. By contrast, FHA-backed loans serviced by national lenders, mostly traditional banks, posted a 12% decrease in foreclosure inflow in Q3 2019.
In its quarterly reports to Congress, the U.S. Department of Housing and Urban Development has been signaling an expected rise in defaults. In its most recent report, covering activity in the three months ending June 2019, it included the following statement:
“As the portfolio serious delinquency rate has reached historic lows and FHA credit profile shifts, FHA may see increases in SDQ rates going forward.
A close variation of the above statement has appeared in every quarterly FHA report starting in Q1 2017, likely prompted by record-high debt-to-income ratios, declining average credit scores, and a rising share of loans with down payment assistance in the post-recession housing recovery.
Foreclosure auction inflow of private portfolio loans—those not backed by government insurers or by the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac—also increased in the third quarter compared to a year ago. Inflow of private portfolio loans owned by national lenders increased 3% while inflow from private portfolio loans owned by mid-market lenders increased 139%.
The inflow trends by loan type reinforce findings from the September 2019 Mortgage Monitor Report from Black Knight, Inc.
The Black Knight report shows that the delinquency rate at six months after origination is trending higher for loans originated in 2018 and 2019, with a more extreme upward trend among Ginnie Mae-securitized loans—primarily comprising VA- and FHA-backed loans. The report shows that 3.3% of Ginnie Mae-securitized loans originated over the past 12 months were delinquent at six months, up from 3.1% for loans originated in 2018 to the highest level since 2009.
Among all loan originations, the delinquency rate six months after origination was 1% for loans originated in the first quarter of 2019, up from 0.9% for loans originated in 2018 to the highest level since 2010. The upward trend in early stage delinquencies also showed up for GSE-backed loans, albeit at a much lower level: 0.6% for loans originated in Q1 2019, up from 0.5% for loans originated in 2018 to the highest level since 2008.
Rock Star Real Estate Markets Not Immune
Among 2,410 counties with foreclosure auction inflow into Auction.com in Q3 2019, 870 counties (36%) posted a year-over-year increase in foreclosure auction inflow, including Maricopa County (Phoenix), Arizona; Miami-Dade County, Florida; Los Angeles County, California; and Bexar County (San Antonio), Texas.
Also posting year-over-year increases in foreclosure auction inflow in Q3 were all three counties in the Seattle metro area: King, Pierce, and Snohomish; and three counties in the Denver metro area: Denver, Arapahoe, and Adams.
“Some of the markets with the biggest inflow increases in the third quarter may be surprising given they have been rock stars of the real estate recovery of the last seven years,” said Jesse Roth, SVP of Strategic Partnerships and Business Development at Auction.com. “But those markets may now be victims of their own success, with an unsustainable run-up in home prices pushing the limits of affordability for many homebuyers in recent years. Those financially stretched borrowers now have less equity cushion to protect against foreclosure, particularly if they are in a government-insured loan that came with a low down payment and down payment assistance.”
The inflow geographic trends align with recent foreclosure start data released by ATTOM Data Solutions, which shows that U.S. foreclosure starts in the first nine months of 2019 increased in 14 states and 80 of 220 metropolitan statistical areas analyzed (36%)—counter to the national trend of declining foreclosure starts.
Among larger metro areas, those posting year-over-year increases in the first nine months of the year included Atlanta (up 23%), Orlando (up 24%), Jacksonville (up 7%), San Antonio (up 8%), Seattle (up 7%), and Denver (up 3%).
Downturn, Recession Would Strengthen Distress Wave
An analysis of delinquency and home price trends in the last three recessions (1990, 2001, and 2008) shows that on average delinquency rates spiked 253% from the pre-recession low to the peak during the recession. That average is skewed higher by the 2008 recession, when delinquency rates skyrocketed 671%. Removing that recession from the mix, the average increase in delinquency rates in the previous two recessions was 45%: 68% in the 1990 recession and 21% in the 2001 recession.
The same analysis shows that median home prices dropped 16% on average from the pre-recession high to the low during the recession. Again, the 2008 recession’s 36% drop skews the average. With that recession taken out, the average drop in median home price is 6%: home prices were down 12% in the 1990 recession and down just 1% in the 2001 recession.
Given no other shocks to the economy or housing market, this emerging wave of distress will likely be the smallest of the three that have materialized in the wake of the Great Recession. However, if dangerous rip currents develop in the housing market (think widespread and sustained home price depreciation) or in the larger economy (think recession), this distressed wave could pack a bigger punch.