For many credit unions, real estate loans represent the largest percentage of their total loan balance. In these uncertain times, understanding the risk of loss due to default on your existing real estate loan portfolio is important. The impact of a loss to your financial performance has two factors, the probability that a borrower stops paying (Probability of Default) and how much you’ll lose in the event of default (Loss Given Default). Loss Given Default is derived from comparing the principal balance to the collateral value, less cost to sell. So what is the state of the real estate market in the COVID-19 reality and where are real estate property values going? What does delinquency look like currently?
Home prices are driven by the law of supply and demand. If demand goes up and/or supply declines, real estate prices will increase. If there are less buyers in the market with an increasing number of homes for sale, prices go down.
Since July 2019, the real estate market has seen a decline in inventory. COVID-19 made things even worse as sellers took their homes off the market.
In addition, COVID-19 brought new home construction to a standstill which had seen an increase at the end of 2019 in response to a health economy and low inventory, pushing demand for new home construction.
With stay at home orders enacted due to COVID-19, demand dropped. Buyers were not able to visit homes for sale and were reluctant to make purchases sight unseen. But as the country reopens, we are seeing a rebound in demand. Redfin is reporting demand during the first week of June is 25% higher than pre-pandemic levels. This may have been pent up demand after the stay at home orders had been lifted and was short lived. Mortgage applications fell by 5.1% for the week ending July 31st for the second week in a row.
Typically a reduction in supply and an increase in demand would result in higher real estate values. And we are seeing that to a degree. According to Zillow, median home prices in the U.S. have increased 4.1% year over year to $248,857. But they predict this increase to be short lived and that home values will decrease around 1.5% within the next year.
While low interest rates have made mortgages more affordable, the costs of buying a home may still be too large for some Americans. The average increase in home prices year over year is 4.5% as compared to 0.6% for wages. And with tightening of credit, many Americans may not have the down payment required to make a home purchase.
So now that we see that real estate values will remain relatively stable, what is the likelihood existing loans will default? The picture may not be so clear.
The Mortgage Bankers Association is reporting that as of May 31, 2020, 4.3 million homeowners are now in forbearance plans. As staggering as this number is, requests for forbearance have been on a downward trend for over eight weeks.
As states reopen, sending Americans back to work, more homeowners will be able to exit their forbearance plans. Black Knight is reporting that a higher share of mortgage payments has been made in June as compared to the same time in May, proving this trend.
Real Estate markets are very regionalized as is the economic impact of the pandemic. Those states and metropolitan areas that were hit hardest by the virus or rely heavily on the service industry for employment will be affected more than others. For instance, Florida whose main employment sector is tourism and has been hit hard with COVID-19 cases has over 11% of mortgage accounts in hardship as compared to 7.4% for all states.
While we have seen real estate values remaining relatively stable, factors may cause this to change. Unemployment rates have improved since the start of the COVID-19 pandemic but are still higher than Great Recession rates. As of June 2020, the unemployment rate was 11.1%. Many health experts predict a significant rise in cases of the virus coming this fall which may bring back stay at home orders and thus increase unemployment. How will unemployed homeowners continue to pay their mortgage?
The CARES Act provides relief and protection for homeowners impacted by the coronavirus, including a moratorium on evictions. This moratorium was extended through August 31. But what happens after that? Will there be another extension? If not, the market could experience an eviction crisis driving real estate values down.
While uncertainties still exist in the real estate market, one thing is certain, monitoring your members who are in forbearance and knowing the value of the real estate backing those loans is essential. In fact, the NCUA is requiring that credit unions monitor the performance of these loan modifications, including credit quality, delinquency and charge offs.
At 2020 Analytics, we can help provide the monitoring the NCUA is looking for by identify those members who are in forbearance and help track their risk as economic conditions fluctuate. We update your real estate values, including superior mortgages on junior liens. In addition, we stress test your portfolio for decreases in real estate values specific to your region. We also have implemented stress scenarios in response to COVID-19 based on your metro areas unemployment. Contact us today to learn how we can help you.