Briefing on National Mortgage Risk Index and Other Risk Measures - PowerPoint PPT Presentation

Briefing on National Mortgage Risk Index and Other Risk Measures Edward Pinto and Stephen Oliner AEI International Center on Housing Risk HousingRisk.org August 25, 2014 1

Key Takeaways from Today’s Briefing • National Mortgage Risk Index (NMRI) for purchase loans – Using additional data, the NMRI has been revised to • Rate all loans in month of first loan payment rather than month of securitization • Extend composite, FHA, and RHS series back to Nov. 2012 from Aug. 2013 – 196,000 loans added in July, bringing total in NMRI to 3.66 million – NMRI at 11.41% in July, was down ¼ percentage point from June (revised) but up more than ¾ percentage point from July 2013 (new data) – Little discernible volume impact from QM regulation: over past 3 months, 20.9% of loans had total DTI > 43%, little changed from 2013:H2 – FHA not compensating for riskiness of high DTI loans; Fannie and Freddie compensating only to a limited extent – FHA’s NMRI, at 23.8%, was unchanged from June (revised). But it’s up 2½ percentage points from July 2013 (new data), a level that risks fueling home price volatility, particularly in lower income and minority areas – The softness in mortgage lending not due to tight standards but to reduced affordability, loan put back risk, and sluggish economic recovery 2

Key Takeaways from Today’s Briefing • State-level Mortgage Risk Indices (SMRIs) – Wide range across states (lowest: Hawaii and Washington, DC; highest: Mississippi) – Recent trend (May-July vs. February-April): o For FHA/RHS loans, SMRI continuing to rise in almost all states o For Fannie/Freddie loans, SMRI continuing to rise in most states • Metro-area Indices – Focusing on California – Mortgage risk highest in Central Valley and lowest in San Francisco Bay area – Housing risk in most California metros is at a high level and has risen substantially over the last year 3

Background • Financial crisis largely stemmed from a failure to understand build-up of housing risk: – Mortgage risk – House-price (collateral) risk – Capital adequacy • AEI’s International Center on Housing Risk ( HousingRisk.org) is addressing this problem: – Will provide objective and transparent risk measures – Mortgage risk indices published monthly – Monthly tracking of housing cycle risk for California metro areas and regions alongside mortgage risk indices – Indices of collateral risk and capital adequacy to be released later this year 4

Change to Timing Convention • Usual timeline: Loan origination  securitization  first payment • Loan origination date not known. Previously used month of securitization. • However, monthly securitization volume can be lumpy compared to loan originations (and associated first payment dates). Induced spurious volatility in monthly NMRI. • Switched to first payment date. Revised NMRI is less volatile month to month. Also, shifted a month or two later relative to previous series. Effect on Composite NMRI Stressed default rate 12.0% 12.0% Previous (securitization month) 11.5% 11.5% Revised (1 st payment month) 11.0% 11.0% 10.5% 10.5% 10.0% 10.0% Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 5

The NMRI • Principles behind the NMRI – Market stability depends on the preponderance of loans being low risk, defined as good performance under stress – NMRI provides a stress test, similar to crash tests for cars and structural stability ratings for buildings in hurricane zones Basics of index construction and coverage • – Places loans in risk buckets and assesses default risk based on performance of 2007 vintage loans with similar characteristics – Currently covers nearly all gov’t -guaranteed mortgages for home purchases (about 75% of all purchase loans) – Plan to expand coverage later this year to include the VA, non-agency loans, refinances, and second mortgages 6

Stressed Default Rates Risk Bucket FICO CLTV Total DTI Default Rate ≥ 770 ≤ 33% Very Low 61-70% 0.8% Low 720-769 76-80% 34-38% 4.2% Medium 690-719 81-85% 39-43% 9.3% High 660-689 91-95% 44-50% 22.7% Very High 620-639 > 95% > 50% 45.8% Note: Default rates represent cumulative defaults through year- end 2012 for Freddie Mac’s 2007 vintage of acquired loans. The loans included in the calculation are all primary owner- occupied, 30-year fixed-rate, fully amortizing, fully documented, home purchase loans. • Takeaway: Huge spread of default rates across risk buckets • All 320 risk buckets for home purchase loans are shown at Periodic Table on HousingRisk.org • Additional loan risk factors applied to ARMs, investor loans, second homes, 15 year terms, and 20 year terms 7

NMRI for Home Purchase Loans Composite fell ¼ percentage point, reflecting a decline at Freddie and a drop in the FHA/RHS share. RHS at a new series high, other 3 agencies at or near highs. Stressed default rate 24% 24% FHA/RHS: +2.5 ppt, from 20.6% to 23.1%* 20% 20% FHA/RHS share of purchase loans: Nov-12: 39.9%; Jun-14: 33.2%; Jul-14: 31.8% 16% 16% Composite: +0.2 ppt, from 11.2% to 11.4%* 12% 12% 8% 8% Fannie/Freddie: +1.1 ppt, from 4.9% to 6.0%* 4% 4% Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 * Change from November 2012 to July 2014. Source: AEI International Center on Housing Risk, www.HousingRisk.org. RHS is Rural Housing Service. VA guaranteed loans not included. 8

Calibrating Mortgage Safety NMRI – purchase loans Latest Latest 1935-1955 1990 vintage 2007 vintage date value vintages (est.) (est.) (est.) Composite index July 11.4% NA 6% 19% Fannie and Freddie July 6.0% NA 4% 13% FHA July 23.8% 3% 15% 30% An index value of less than 6 is indicative of conditions conducive to a stable market. • Composite index substantially above 1990 level, but not approaching 2007 level when underwriting was exceptionally lax • Fannie/Freddie index somewhat above 1990 level • FHA index is extremely high. Sharp contrast with safe underwriting during 1935-55. 9

Recent Headlines about Credit Availability • Large Lenders Loosen Credit Standards, Small Lenders Tighten Up — Fannie Mae survey (the MReport, July 25) • Mortgage Credit Loosens in July Index — MBA survey (the MReport, August 5) • Lenders Waiting for FHFA to Act Before Boosting Credit (National Mortgage News, August 7) • Banks Making Fewer Mortgages Because of New CFPB Rules, Fed Says (American Banker, August 4) • [Ability to Repay], QM Aren’t Majorly Impacting Prime Mortgage Market — Fed Senior Loan Officer Opinion Survey (the MReport, August 5) 10

Fed’s Senior Loan Officer Survey Net percentage of respondents tightening standards on residential mortgage loans 100 100 Subprime 80 80 Tightening 60 60 40 40 Prime 20 20 All residential mortgage loans 0 0 -20 -20 Loosening -40 -40 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Limitations of the survey: • Can be unreliable . Showed no net loosening of standards over 1996-2006. • Subjective . Responses are opinions of loan officers. Not based on hard data. • Imprecise definitions. Where do banks draw the line between prime and subprime? • Misses mix shifts . No information on share of lending that is subprime. • Small sample. Only a handful of banks report on subprime lending. In contrast, NMRI is objective, transparent, and based on millions of loans 11

Risk Shares for Home Purchase Loans Loan risk greater than level conducive to long-run market stability, with low-risk loans accounting for only about 42% of activity in July, down from 45% in 2013:H2. 50% 50% 45% 45% Low risk 40% 40% 35% 35% High risk 30% 30% Low risk defined as stressed default rate of less than 6%, medium risk is 6% to 12%, and high risk is 12% or higher. 25% 25% Medium risk 20% 20% 15% 15% Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Source: AEI International Center on Housing Risk, www.HousingRisk.org. 12

Renewed Pressure for Subprime Lending Succeeding • “[L]ender overlays are damaging the recovery by limiting access to creditworthy borrowers”. FHA Commissioner Carol Galante, March 2013 % of top 25 FHA purchase-loan issuers % of FHA purchase loans at top 25 with loans below credit-score cutoffs FHA issuers by credit score 35% 100% Below 640 All loans below 660 (July NMRI: 33%) 90% Top 25 issuers account for 30% about ¾ of total FHA volume. 80% 25% 70% 640-659 Below 620 20% 60% Below 600 50% 15% Range for July NMRI: 32% for 640-659 to 37% for <620 40% 10% 620-639 30% Below 580 5% 20% <620 10% 0% Nov-12 Mar-13 Jul-13 Nov-13 Mar-14 Jul-14 Nov-12 Mar-13 Jul-13 Nov-13 Mar-14 Jul-14 • “[Lender] credit overlays result in the rejection of many loans that would otherwise meet [GSE] credit standards”. FHFA Director Mel Watt, May 2014 • Calls to more fully utilize existing the FHA and GSE credit boxes risk fueling home price volatility, particularly in lower income and minority areas 13