Transcript Traditional Underwriting

MORTGAGES, MARKETS AND
WHAT WE KNOW SO FAR
Detroit Chapter of the Institute of Internal
Auditors
Robert Van Order
University of Michigan
1
Basic Observation:
Big increase in foreclosures. Why?
All Foreclosures Started: U.S
y = 3E-05x - 0.7908
R² = 0.8313
0.90
0.80
0.70
Quarterly rate
0.60
0.50
0.40
0.30
0.20
0.10
0.00
2
Subprime ARM Defaults are Very Different
from Prime and Subprime FRM
Loans 90 days or more delinquent or in foreclosure (percent of
number)
16
Subprime
ARM
– Recession
14
12
10
Subprime
FRM
8
FHA & VA
6
4
2
Prime Conventional
Source: Mortgage Bankers Association
(Quarterly data not seasonally adjusted;1998Q1-2007Q3)
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
0
3
Stylized Facts and Gatherings from
Various Data Sources






Credit Risk: A Few Propositions
Recent History: Especially Large Early Payment
Defaults: Can it be rate adjustments?
Changing Loan Characteristics: Hard vs. Soft Data,
Technical Change and the Two Decades.
Economic Conditions
Market Structure: The rise of subprime
Securitization: The rise of non-agency securities
4
Cumulative REO Rates Are Showing Poor
Performance of Recent Origination Vintages
0.0%
0.0%
2002
2003
2004
0
2005
2006
45
1.0%
40
1.0%
35
2.0%
30
2.0%
25
3.0%
20
3.0%
15
4.0%
45
4.0%
40
5.0%
35
5.0%
30
6.0%
25
6.0%
20
7.0%
15
7.0%
10
8.0%
5
8.0%
10
Subprime
5
Alt-A
0
Cumulative REO Rate as a Share of Number of
Loans Originated
Could it have been ARMs?
2007
Age of Loan in Number of Months From Origination Date
Source: Loan Performance, a subsidiary of First American Real Estate Solutions
Note: the last twelve points on each origination year cohort contain fewer loans progressively
as loans issued at earlier dates always age faster. Data through December 2008.
5
Credit Risk

Underwriting models and history suggested
scorecards and diversification worked
6
Relative Default Probabilities
Note the “Nonlinearity” as you move Northeast
More sensitive to mistakes.
LTV <70
LTV 71-80
LTV 81-90
LTV 91-95
FICO <620
0.96
4.8
11.04
19.68
0.46
2.3
5.29
9.43
0.2
1
2.3
4.1
0.08
0.4
0.92
1.64
FICO 620-679
FICO 680-720
FICO >720
7
Price Performance Matters. So Does
(Did?) Diversification
Default Probability vs. House-Price Appreciation
State/Origination Year and National/Origination Year Cohorts (1985-1995)
80% Loan-to-Value, 30-Year Fixed-Rate Hom e-Purchase Mortgage
Cumulative Default Rate
25%
Individual States
AK 1986
National
20%
15%
CA 1990
AZ 1985
10%
CA 1989
NV 1985
5%
HI 1994
DC 1995
0%
-30%
-10%
10%
30%
50%
70%
90%
110%
130%
5-Year Cum ulative House-Price Appreciation
8



So looking back, you would have thought that
controlling FICO and LTV was a big deal, you
couldn’t have a credit problem without changes in
FICO-LTV distribution, and a diversified
portfolio would perform well.
But Performance Got Really Bad.
Especially in Early Months
9

Underwriting has changed over time, but not in
ways you might have thought.
10
High LTVs went up in 90s. Fell lately
LTV Trends
Average LTV
% LTV>90
19
73
19
76
19
79
19
82
19
85
19
88
19
91
19
94
19
97
20
00
20
03
90.0
80.0
70.0
60.0
50.0
40.0
30.0
20.0
10.0
0.0
11
Recent observables haven’t changed all
that much (Tales?)
Loan Characteristics at Origination for Different
Vintages: Alt-A and Subprime
Demyanyk, Yuliya and Otto Van Hemert, “Understanding the Subprime Mortgage Crisis”
(2007)
2001
Average Loan Size (*$1000)
151
2002
168
2003
2004
2005 2006
180
201
234
259
43:3
28:2
25:1
26:1
FRM (%)
41:4
39:9
ARM (%)
0:9
1:9
1:3
4:3
10:3
12:8

Hybrid (%)
52:2
55:9
54:7
67:3
62:0
46:2

Balloon (%)
5:5
2:2
0:8
0:2
2:6
14:9
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

Refinancing (cash out) (%)
52:1
51:2
51:6
47:9
45:7
44:8

FICO Score
620
630
641
645
653
654
79:3
79:4
79:2
79:3
78:5
78:3
39:1
39:8

Loan-to-Value Ratio (%)

Debt-to-Income Ratio (%)
37:8

Documentation Dummy (%)
68 :5
Initial Rate (%)
Margin for ARM and Hybrid (%)

38:1
38:2
38:5
63:4
59:8
57:2
51:8
44:7
9 :4
8:3
7:3
6:7
6:6
7:2
6:2
6:3
5:9
5:3
5:0
4.9
12
We Seem To Have Two
Explanations Left


Economic Conditions.
Structure and Moral Hazard
13
January 2000
April 2000
July 2000
October 2000
January 2001
April 2001
July 2001
October 2001
January 2002
April 2002
July 2002
October 2002
January 2003
April 2003
July 2003
October 2003
January 2004
April 2004
July 2004
October 2004
January 2005
April 2005
July 2005
October 2005
January 2006
April 2006
July 2006
October 2006
January 2007
April 2007
July 2007
October 2007
January 2008
April 2008
The Case-Shiller Index
House Prices: 2000-2008
250.00
200.00
150.00
National
100.00
Detroit
Phoenix
50.00
Dallas
0.00
Single-family Construction
1,900
1- to 4-Family Housing Starts (thousands of units, SAAR)
Forecast
Third Quarter 2005
record: 1.8 million units
– Recession
1,600
1,300
1,000
700
Fourth Quarter 2007:
0.9 million units
Sources: Bureau of Census, Freddie Mac
2007
2004
2001
1998
1995
1992
1989
1986
1983
1980
1977
1974
1971
400
Price Changes by State: Third
Quarter 2007
United States -2.2%
(3rd Quarter Annualized Growth)
Pacific
-5.8%
Mountain
0.4%
West North
Central
-0.8%
New England
East North
Middle
Atlantic
Central
-0.9%
-3.6%
-3.8%
DC
> 5% Quarterly Change
0 – 5% Quarterly Change
< 0% Quarterly Change
< -5% Quarterly Change
East South
Central
West South Central
4.9%
Source: Freddie Mac Purchase-Only Conventional Mortgage Home
Price
Index (Annualized Quarterly Rates for 3rd Quarter 2007)
-0.1%
South Atlantic -2.7%
How favorable were economic
conditions?
The UFA Default Risk Index
Constant-Quality Loan by Vintage
125
100
75
Year
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
50
1990
Index
1990-2000 Average=100
150
17
The structure of the Market Has
Changed


More Subprime and Alt-A
Non Agency Securitization
18
Subprime used to be about 10% of originations,
but it’s share increased a lot after 2003
Market shares
70
60
FHA/VA
50
40
Conforming
30
Subprime+
Alt-A
20
10
0
1
2
3
4
5
2001-2005
19
Securitization Changes
Note the nonagency share went up after the subprime
share went up and around the time the vintages got
worse.
Non Agency Share of MBS
60.00%
50.00%
40.00%
Non Agency Share of
MBS
30.00%
20.00%
10.00%
20
03
20
00
19
97
19
94
19
91
19
88
19
85
0.00%
20
SUBPRIME SECURITIZATION



Credit risk is more important than for Agency
securities. The risk has been handled (poorly) by
structuring.
So securitization could have been a big part of the
problem, because it is so susceptible of moral
hazard/asymmetric information.
Recall that to some extent the recent subprime
loans didn’t look that bad on paper. Hard vs. soft
information.
21
Subprime Foreclosures Started: 4-yr
Distributed Lag of Multipliers
Subprime Foreclosures Started: 4-yr Distributed Lag of Multipliers
1.25
Actual Defaults
1
Underwriting
Economic Conditions
0.75
0.5
0.25
-2E-15
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
-0.25
-0.5
22
-0.75
As an aside there have been spillovers
that don’t match with actual risk.
About half way through the eventual
increases in defaults
All Foreclosures Started: Forecast
4.00
3.50
Annual Rate (%)
3.00
2.50
2.00
1.50
© 2008 University Financial Associates LLC
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