Foreclosure Tsunami Continues in California

The foreclosure tsunami in California continues unabated. More foreclosures were started in California during the second quarter of 2007 than any comparable period in over ten years. We need to go all the way back to 1997 to see such record volume of foreclosures within the state. What has caused this tsumani? It has been caused by the "perfect storm" of depreciating home prices, anemic sales, re-setting adjustable rate loans, and the mortgage meltdown in the financing sector.

When we analyze the statistics, we can see that the vast majority of the loans that went sour were originated by lenders between the summers of 2005 and 2006. If you remember those halcyon days, real estate appreciation was still in double-digits and we were experiencing the tail-end of historically low interest rates. As a result, lenders liberalized their guidelines to maintain high loan volumes. But because interest rates had risen, lender utilized adjustable rates mortgages with artificially low "teaser rates" to qualify more borrowers. Property owners took advantage of those loosened guidelines and teaser rates to obtain loans in record numbers. Its those teaser rates, now adjusting up to higher market rates, that are causing the tsunami of foreclosures we are experiencing today.

Keep in mind, there are 8.4 million houses and condos in California. The vast majority of those properties are financed by mortgages that are current and continue to be current.

Nevertheless, the loans that did fall into default last quarter were mostly originated between July 2005 and August 2006, which was at the height of the mortgage frenzy. The median price paid for a California home purchased during that period was $460,000. In contrast, the median price paid for those properties where mortgages went into default last quarter was only $445,500. (This discrepancy is caused because there is a lower default rate with higher valued properties.)

The median mortgage for those properties is $342,000, and their mortgage payment is approximately $2,225 per month. Homeowners were five months behind on their payments (up from three months) when the lender started the default process. The borrowers owed a median $11,126 in unpaid mortgage payments. In other words, once the foreclosure starts, the borrower has the choice to either "reinstate" the loan by paying the $11,126 arrears, or "redeem" the loan (later in the foreclosure process) by paying the loan balance (i.e. $342,000) and the arrearage (i.e. $11,126). Obviously, reinstating is preferred to redeeming.

The median age of these defaulted loans is 16 months, which corresponds to the peak of loan originations in August of 2005. And, as we all know, the primary loan utilized for purchasing home during that period was the

1. Notices of Default.

The first step in the foreclosure process in California is the recording of a Notice of Default ("NOD"). There were 53,943 Notices of Default recorded in the second quarter of 2007 (April to June). That is a shocking number in itself, but even more devastatinging when you consider that it was 15.4% increase from the previous quarter, and up an earth-shattering 158% compared with the same quarter of 2006.

This was the highest levels we have seen in California since 1996, when foreclosures were at their worst. In 1996, for those of us that remember those dreadful days, 61,541 foreclosures were started. The lowest level recorded was in the third quarter of 2004, when only 12,417 NODs were filed.

Although 53,943 default notices were recorded in California last quarter, only 50,901 properties were affected. How is that possible? Many homes are financed using more than one loan, what are called "piggy-back" loans. Utilizing multiple loans on the same property helps homeowners avoid mortgage insurance. That is up 162.8% from the second quarter of 2006.

The default numbers reflect wide regional differences. The second-quarter numbers were a record in Riverside, San Bernardino, Contra Costa, Sacramento and most Central Valley counties. However, in Los Angeles County, the state's largest, it was still less than half the first-quarter 1996 peak. This reflects the depth of the recession in the mid-1990s, as well as the relative strength of today's housing market. At least so far...

On a loan-by-loan basis, mortgages were least likely to go into default in Marin, San Francisco and San Mateo counties. The likelihood was highest in San Joaquin, Merced and Riverside counties.

Overall, Southern California counties saw 30,828 notices of default recorded last quarter, a 151% increase over 2006! If you enjoy hanging out at county recorder's offices like me, you will quickly notice that Los Angeles County has the largest volume of defaults in the state. While the percentage, at 126% is still lower than other counties, the sheer volume (10,393 NODs) during the second quarter is its own mini-tsunami. The recorder's office had to open extra windows just to handle the onslaught.

The worse foreclosure county in California in terms of percentages continues to be Riverside where 6,648 NODs were filed this quarter, a 190% increase over 2006. It was just three years ago that Riverside County was the fastest growing county in the United States. Now it has the dubious distinction of having the highest percentage of foreclosures in the country. Not far behind is San Bernardino County, where 5,141 NODs were filed, a 179% increase compared to 2006.

Fortunately, 54% of California homeowners in default ultimately avoid losing their homes in foreclosure by either bringing their payments current, refinancing, or selling the home and paying off what they owe. But even that is becoming dramatically more difficult as the real estate market sinks. A year ago it was 92%. In other words, last year only 8% of the homeowners that fell into foreclosure, actually lost their properties. In contrast, today over 46% of the homeowners in foreclosure loss their homes at a trustee's sale! This dramatic increase reflects the continuing slowdown in the real estate market.

2. Trustee's Deeds.

Those homeowners that don't bring their loans current (or weren't able to refinance or sell their homes in time), ultimately loss them at trustee's sales on the courthouse steps. At that point, a Trustee's Deed Upon Sale ("Trustee Deed") is recorded in the county recorder's office, signifying the new owner. When we analyze Trustee's Deeds recorded in the second quarter of 2007, the statistics are disheartening. 17,408 homeowners lost their homes during the second quarter! That is the highest number ever recorded by the various companies that methodically keep these statistics. By way of comparison, the number of Trustee's Deeds was up 57% from the first quarter of 2007, and a mind-boggling 799% from the second quarter of 2006. The previous high watermark occurred in the third quarter of 1996, when 15,418 Trustees Deeds were recorded. For those of you keeping score, the lowest level was 637 in the second quarter of 2005, when the real estate market was still in full regalia.

In Southern California, where foreclosures are at their worse, the volumes of Trustee's Deeds stand in stark contrast to the boom years of 2000-2005. Of the 9,504 Trustee's Deeds recorded in Southern California counties during the second quarter of 2007, the highest volume was in Los Angeles County. 2,581 properties were lost in foreclosure in LA County, a 799% increase compared to the comparable time period in 2006. But that was not the worse county in California. By far, San Bernardino County holds that distinction with a 987% increase in 2007 compared to 2006.

What does all of this mean for the future? Well, so far (and it is a big "so far") foreclosures have not tugged down property values. However, if foreclosures continue to rise unabated in the final quarter of 2007, it will inevitably unleash more empty properties into the market place. That, coupled with continued turmoil in the mortgage markets, will inevitably lead to increase inventories of unsold homes, and certainly lower real estate values. Some of the worst-hit neighborhoods in the Empire and Central Valley markets are already experiencing an erosion of their property values. A harbinger of things to come.