Clayton Homes has announced a payment protection plan to assist new buyers with up to three months of payments when home owners lose their jobs.  The plan will cover a homeowner’s mortgage, insurance, and property tax payments for all homes purchased before June 30, 2009.

I previously wrote about Clayton’s admirable track record during the past decade’s real estate boom and bust.  Is the announcement of the payment protection plan a sign that the company is continuing the prior record of responsible lending or a red flag that shareholders of Berkshire Hathaway, Clayton’s parent company, should be concerned about?  This is of particular interest given Berkshire Hathaway’s recent issuance of notes to fund Clayton’s portfolio of mortgages since Berkshire appears to be facing somewhat higher financing costs.  It appears that the payment protection plan will also apply to homeowners who have used financing options other than Clayton’s mortgage subsidiary.

Terms of the Payment Protection Plan

The payment protection plan contains the following key provisions:

• Home must be purchased prior to June 30, 2009.
• Payment protection plan is in force for two years following the sale of the home.
• The program only applies to owner occupied residences.
• The homeowner must be current on the mortgage at the time the payment protection assistance is requested.
• The homeowner must  have been employed on a full time basis for at least six months prior to requesting assistance and can only request assistance thirty days after an involuntary termination of employment that is not “for cause”.  In other words, this applies only to layoff or reduction in force scenarios.

Designed to Help Responsible Borrowers

It seems fairly clear to me that the protection plan is designed to assist borrowers who have a history of employment and have been responsible with payments up to the time they became unemployed.  Requiring that the borrower must be current on the mortgage will filter out individuals who were already in default prior to losing their jobs and probably had other financial difficulties other than unemployment.  The assumption is that individuals who qualify for the program are only at risk of potential default due to the change in employment status rather than a pattern of irresponsible behavior in the past.

Given the demographics of Clayton’s typical customer, one would expect to see higher than average default and foreclosure rates, but this simply has not been the case as Warren Buffett noted in his latest shareholder letter.  Default rates have been well below industry averages and presumably remain at satisfactory levels today.  Clayton homeowners typically consider their home to be a place to live rather than a potential jackpot and are less likely than others to “walk away” from a home simply because the outstanding mortgage balance  exceeds the value of the home.  Foreclosures typically occur because a homeowner is out of work and lacks an emergency fund sufficient to make mortgage payments.

Sign of Strength

Although we do not have updated statistics for Clayton Homes for the first quarter, it is likely that default and foreclosure rates may have crept up somewhat compared to the data released in Berkshire Hathaway’s 2008 annual report.  Unemployment is at multi-year highs and Clayton homeowners are certain to have been impacted by the economic turmoil of the first quarter.

By announcing a payment protection plan that provides a modest amount of aid, Clayton Homes will likely reduce the level of defaults and ultimate foreclosures by giving the homeowners time to locate alternative employment.  These homeowners have shown the capability to make payments when they have a source of income.  If a homeowner is still unable to make payments after the three month period expires, foreclosure proceedings may still occur.  However, if foreclosure can be avoided in even a small percentage of these cases, the investment is likely to pay off given the very high costs of foreclosure proceedings and the vastly diminished value of homes that have been through the process.  This can only be more true for modular and manufactured units given the perception of the quality of these homes compared to the existing inventory of site built houses that are also in foreclosure.

An Aside on Perceptions of Modular and Manufactured Housing

As an aside, I believe that the perception of inferior quality is largely unjustified  and the result of stereotypes of both the homes and the homeowners.  Modular homes are in many ways more structurally sound than site built homes because they benefit from consistency and quality controls available in a factory but typically not present on a work site.  In many cases, one cannot distinguish between a site built and modular home from the appearance of the home after construction/installation.  Manufactured housing has also improved significantly in recent years.  Berkshire Hathaway shareholders will have an opportunity to inspect a Clayton Home exhibit at the upcoming annual meeting of shareholders in Omaha.