Calculated Risk posted some highlights of the transcript from the Wachovia earnings call yesterday -- and in it are some interesting details about how new modeling efforts at the bank led it to write down so much of the value of some of its loans. Specifically, Wachovia has discovered the phenomena known as "ruthless defaults," where a troubled borrower faced with an insurmountable mountain of debt simply walks off into the night, never to be heard from again. From the call, and Wachovia's chief risk officer Don Truslow:
I don't know where the tipping point is, but somewhere when a borrower crosses the 100% loan to value, somewhere north of that ... their propensity to just default and stop paying their mortgage rises dramatically and I mean really accelerates up and it's almost regardless of how they scored, say, on FICO or other kinds of character, credit characteristics. It's difficult on the walk-away part of the question, that is going on, clearly and there's lots of evidence of that in the market ... And so we do our best to try to gauge but that portion of the defaults is just kind of hard to quantify. But that behavior is going on. We're seeing in our portfolio the most significant declines and defaults activity in California and of course it's the largest concentration for us in the pick a payment portfolio by far. What I don't know and I guess we're just learning over time is whether the same sort of behavioral trends and patterns will spread to other markets or be observed in other markets at the same pace that they have been in California.
In plain English, Wachovia is saying that prior models didn't account for what overextended, upside-down borrowers would do when faced with a mortgage on an asset worth less than they owe on it. The above should make anyone in the industry take pause, and think about what an extended downturn and recession could mean for millions more borrowers who have either extracted their equity cushion or never had one to begin with. We've all heard about the idea of borrowers walking away, but the above discussion from Wachovia should trickle down to every other bank out there with significant California exposure, in particular. In other words, if Wachovia has put new correlations in its model to cover behavioral trends once considered an outlier, and that modeling effort led the bank to write off a whole extra chunk of mortgage debt (or at least up reserves for future expected losses) -- every market participant should be asked what industry peers are doing around that same issue.