International
Big surge in US mortgage delinquencies - Wall Street Journal
By Finfacts Team
Dec 5, 2006, 15:44

Stamp duty reform is a cost-free bandwagon The Wall Street Journal reports today that Americans who have stretched themselves financially to buy a home or refinance a mortgage have been falling behind on their loan payments at an unexpectedly rapid pace.

The surge in mortgage delinquencies in the past few months is squeezing lenders and unsettling investors world-wide in the $10 trillion US mortgage market. The pain is most apparent in subprime mortgages, though there are signs it is spreading to other parts of the mortgage market.

Subprime mortgages are loans made to borrowers who are considered to be higher credit risks because of past payment problems, high debt relative to income or other factors. Lenders typically charge them higher interest rates -- as much as four percentage points more than more-credit-worthy borrowers pay -- one reason subprime mortgages are among the most profitable segments of the industry.

The Journal says that they have also have been among the fastest-growing segments. Subprime mortgage originations climbed to $625 billion in 2005 from $120 billion in 2001, according to Inside Mortgage Finance, a trade publication. Like other types of mortgages, subprime home loans are often packaged into securities and sold to investors, helping lenders limit their risks.

Until the past year or so, delinquency rates were low by historical standards, thanks to low interest rates and rising home prices, which made it easy for borrowers to refinance or sell their homes if they ran into trouble. But as the housing market peaked and loan volume leveled off, some lenders responded by relaxing their lending standards. Now, the downside of that strategy is becoming more apparent.

In a November conference call titled "How Bad is Subprime Collateral?" Tom Zimmerman, head of ABS research for UBS, and David Liu, head of mortgage credit, outlined how much higher loan delinquencies and foreclosures are for 2006 subprime loans compared with similar subprime loans from earlier years, a result of worsening underwriting quality from lenders combined with a slower housing market.

"I guess we are a bit surprised at how fast this has unraveled," said Zimmerman. While it's "not a secret that subprime collateral has performed pretty disastrously so far," he said, "I must say we were a bit surprised by the magnitude with which" the loans "deteriorated this year."

The rate of subprime loan delinquencies of 60 days or more, borrowers are that have fallen far behind in their payments, has risen to about 8 percent, up from about 4.5 percent a year ago.

These 60-day plus delinquencies have spiked in the past few months, to 3.63 percent for the 2006 loans in October, up from 2.95 percent in September and 1.62 percent in July, according to UBS research.

Comparing loans of similar age, 2006 loans are performing worse than 2005, which are worse than 2004. In fact, given where delinquencies are now, loans from 2006 are on track to be among the worst-performing ever, along with the 2000 to 2001 years, according to UBS research.

Liu said that not only have delinquencies risen more rapidly in 2006 than in earlier years, but 2006 loans have entered the foreclosure process faster. In October 2006, the foreclosure rate was about 2 percent, while a year earlier it was 1 percent.

Liu identified risk layering i.e. interest-only loans, without having to provide adequate documentation, as one contributing factor.

"The biggest picture is the risk layering is getting worse," Liu said. "That is a problem of underwriting quality." In the recent past, Liu said, subprime loans made to borrowers with full documentation and to those with low documentation had similar delinquency rates because the lower documentation borrowers had higher credit scores.

Now, the low-documentation subprime loans are showing a 3.57 percent 60-day-plus delinquency rate, while full documentation 2006 subprime loans are at 2.01 percent.

The Wall Street Journal says that fraud has also increased. Some borrowers who took out no- or low-documentation loans were coached by loan officers or mortgage brokers to inflate their incomes and couldn't afford even their first mortgage payment, says Theresa Ortiz, a foreclosure manager with Neighborhood Housing Services of New York City, a nonprofit that works with homeowners in financial trouble.

Even after the housing market started to cool in late 2005, lenders continued to offer credit on easy terms. Many didn't begin tightening up until a few months ago. Now, they are pulling back. Accredited Home Lenders Holding Co., for example, is doing fewer piggyback and stated-income loans -- or loans that don't require borrowers to fully document their income -- especially for people with lower credit scores. In retrospect, "the tightening process should have started a bit earlier," says James Konrath, Accredited's CEO.