How Many More Bad Loans Are There?

Casey Fleming

We’re done with getting rid of all the underwater home owners with bad loans, right?

Not by a long shot.  Today’s Mortgage Servicing News reports that non-performing loans are down significantly from the peak in 2010, but still three times higher than the pre-crisis level.  In other words, still quite high.

According to Jackie Stewart, a writer that covers the mortgage market, “The banking industry continues to sit on a mountain of problematic loans seven years after the onset of the financial crisis.”  Do we need to be concerned about this?  “…the continued existence of troubled assets could prove problematic should the banking industry face another economic downturn, industry observers warn,” he continued.  So, yes.

Why are banks still holding on to seriously delinquent loans?  As the financial crisis began to take hold I (and many analysts and industry vets who are smarter than me) argued that the fastest way to get through the crisis would be to re-negotiate terms and principal balances for those who had been sold toxic loan products.  Terms were re-negotiated, but principal balances almost never were.  This policy decision by large lenders incentivized many homeowners to walk away from their underwater homes, thus exacerbating the real estate market downturn, making matters worse and extending the recession.

Responsible home owners who decided to tough it out now make up the bulk of the bad loans that still remain on lenders’ books.

During the crisis lenders had to make a calculated decision: write down the principal balance and offer lower, fixed rates to help the homeowner stay, sell the loan (and thus the homeowner) to a hedge fund for a steep discount and make them deal with it, or hang on and hope the homeowner could recover.

So how big a problem is it?  “Noncurrent loans and other real estate owned totaled $162 billion at June 30, based on data from the Federal Deposit Insurance Corp. While the amount was a 63% decrease from mid-2010, it nearly tripled the $56 billion reported in mid-2006.”

Stewart goes on the discuss how individual banks arrive at their particular strategy for dealing with non-performing loans.  But he points out that rising interest rates and potential economic headwinds, particularly in the energy sector, could put to a test the strategy practiced by banks who hold the assets and try to work with long-delinquent home owners.

Time will tell, but we should all keep in mind we are not totally out of the woods yet.  Are you still underwater?  Do you have a bad loan?  If so, I’d like to hear your story.

Casey Fleming, Author The Loan Guide: How to Get the Best Possible Mortgage (On Amazon)
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