Mortgage loan delinquency is rising quickly and is not expected to peak until this time next year, according to recent research.
Delinquency in the fourth quarter last year was 2.51%, up from 2.3 percent in the third quarter and from 2.0 in fourth quarter 2005, according to a report by CreditForecast.com, a combination of Moody's Economy and Equifax research.
The fourth quarter's delinquency rate was a couple basis points shy of the cyclical peak five years earlier, when the economy was struggling with recession from the 9/11 attacks, and is "still well below its recessionary high, but is rising quickly," analysts said in the report.
While the increase in delinquencies is not uniform across types of mortgage loans, as those on home equity lines-of-credit have nearly doubled from their cyclical low two years ago and those for home equity installment loans have barely budged, delinquencies are up sharply across loans 30, 60, 90 and 120 days late, and those in default.
And "all indications are that they will rise measurably higher in 2007," as the "mortgage delinquency rate is expected to rise to a peak of close to 3.5% at this time next year," the analysts added.
The weakening in credit quality is "all the more meaningful" given that it is occurring at a time mortgage debt outstanding posted another double-digit year-over-year gain in 2006, up a robust 13% to $8.2 trillion -- double the amount five years ago, according to the report.
The largest delinquency increases were reportedly in California, Florida, Michigan, New England and Nevada.
On a local basis, out of 250 markets analyzed, over 80 percent experienced higher delinquency over the past year, according to the report. Larger metro areas experiencing the most substantial weakening in quality include Riverside, Sacramento, San Diego and Los Angeles, Calif., and Las Vegas, Miami, Memphis, Detroit and Long Island.
The only large metro areas reportedly experiencing significantly lower delinquency rates include Salt Lake City, San Antonio and Albuquerque. Other areas include New Orleans, and Utah, parts of Texas, Oregon and North Carolina.
"Behind the weakening in quality has been heretofore extraordinarily aggressive mortgage lending," the analysts wrote. "Subprime lending to borrowers with poor credit histories has been particularly strong, as has interest-only and option-ARM lending."
According to the report, the national subprime share of purchase mortgage originations in 2005 was about 19 percent, but in California, "where credit problems are especially evident," the subprime share was 25 percent. IO and option-ARMs have accounted for over one-fourth of nonconforming loans in California and other problem states such as Nevada and Florida.
The analysts further noted that about $800 billion of mortgages outstanding, or approximately 10% of the total, face a first payment reset through the summer of 2008.
"Credit conditions are sure to weaken measurably over the coming year," the analyst said. "Heretofore aggressive underwriting, resetting ARMs and weaker house prices will continue to fuel increasing delinquency and default rates. Only expectations of a sturdy job market in most of the country will ensure that credit problems are not even more severe."
It is unlikely that "mortgage credit quality will deteriorate to the extent it threatens the ability of consumers to continue to increase their spending considering that "the banking system is very well-capitalized and profitable and most global investors are sophisticated institutions buying highly-rated mortgage securities," the analysts continued.
Given that on IO and option-ARM mortgages "are so new and that the securities based on them are even newer, however, the financial system, and thus the economy, may be more vulnerable than they appear," the analysts added. "Hence, the threat to the spending outlook is real."