During the final quarter of last year, residential delinquency rose, subprime delinquency soared and the percentage of borrowers starting the foreclosure process peaked.
Delinquency on one- to four-unit residential properties was 4.95 percent of all residential loans outstanding in the fourth quarter 2006, according to the Mortgage Bankers Association's latest National Delinquency Survey. The rate is up 28 basis points from the third quarter and 25 BPS above the level a year earlier.
"As we had expected, in the fourth quarter, delinquency rates again increased across the board. Increases in delinquency and foreclosure rates were noticeably larger for subprime loans," MBA Chief Economist Doug Duncan said in a written statement. "Subprime borrowers are more likely to be susceptible to the cumulative increases in interest rates that we have experienced and the resultant nationwide slowing of home price appreciation including outright declines in some markets."
"The significant increases in delinquency rates has in some cases led to unexpected increases in credit losses and the failures of some subprime specialist firms," Duncan continued. "Credit spreads on lower-rated tranches of subprime securities widened appreciably over the quarter as investors demanded a higher return for exposure to this credit risk. As we have noted before and as recent events have made clear, market discipline in this industry is swift, can be severe, and is more effective at changing lending practices than any potential changes in regulation."
The primary causes of delinquencies and foreclosures are an aging loan portfolio -- roughly half the loans are three years old and loans age through their third to fifth years of life, a higher share of adjustable-rate loans and of subprime loans, and a rise in interest rates, Duncan said in a conference call. Job loss, income declines and underlying economic factors in local economies contributed as well.
For every delinquency and foreclosure measure, subprime loans had higher rates than last quarter and last year, driven mostly by subprime adjustable-rate mortgage performance, Duncan noted in a conference call.
Subprime loan delinquency of 13.33 percent jumped 77 BPS from the linked quarter and 170 BPS from the year-ago fourth quarter. While the rate of serious delinquency, or loans past due more than 90 days, also increased for all loan types, it jumped the most for subprime loans -- 100 BPS from the linked quarter to 7.78%. Subprime ARM delinquency flew 122 BPS over the level in the third quarter to 14.44 percent.
Subprime ARM delinquency is climbing faster than for other loans in part due to the Fed raising interest rates on the short end of the yield curve for a substantial period of time. Combining borrowers who don't manage credit well and have adjustable terms on their mortgages, with the rise in underlying interest rates and payment increases lead to increased delinquencies, Duncan explained.
The economist also cited subprime lenders who have recently exited the business due to improperly underwriting loan risks, which lowers the hurdle rates for borrowers to be approved.
"With the reduction in spreads, some borrowers obviously made it through the doors that would not have been approved for credit in a period when profit margins were larger, when credit spreads and global markets were wider, and when underwriting standards were tighter," Duncan added. However, the performance of the 2006 cohort of loans in early payment defaults is "not outside of historical perspective," but is getting more attention due to a larger market. Further, "it should be noted that the volume of loans in 2006 is less than half as large as that of 2005," thereby early payment defaults are higher but on a smaller volume of loans.
In 2003, mortgage volume was $3.9 trillion, versus roughly $2.5 trillion in 2006, Duncan noted. Because investors have widened the risk premiums they require from businesses and has increased the cost of credit to lenders and ultimately for borrowers, MBA expects subprime loan production this year will decrease 30 percent from last year.
"The market is working, culling over-capacity from the industry, as price signals from the capital markets lead to changes in product mix from originators, and directly and immediately impact the rates that mortgage lenders can offer to borrowers," he added. "Far from being a problem, these clear and effective market signals and actions will help the market to more efficiently regain its equilibrium so that over capacity is being worked out as price signals from capital markets lead to changes in products.
Higher than the level of subprime delinquency, however, was FHA delinquency -- which at 13.46 percent surged 66 BPS from the third quarter and 28 BPS above the level a year earlier. The latest activity broke the previous record in the fourth quarter 2005.
The rate of delinquency for prime loans was 2.57 percent, up 13 BPS from the third quarter, and for Veterans Affairs loans was 6.82 percent, or 28 BPS worse than in the previous quarter, the report said.
The share of all outstanding mortgages in the foreclosure process was 1.19 percent, up 14 BPS from the prior three-month period and up 20 BPS from a year ago. The quarterly rise was due to a 67-BPS surge in subprime loan inventory to 4.53 percent and a slight increase in prime loans, as the inventory for FHA and VA loans decreased.
The rate of foreclosures started rose 8 BPS and 12 BPS from the respective linked quarter and year ago to 0.54 percent in the fourth quarter -- the highest in the 37-year history of the survey and since the level of 0.50 percent in the second quarter 2002 after the recession. While rate of new foreclosure starts increased for each loan type on a quarterly basis, it rose the most --- 18 BPS to 2.00 percent for subprime loans, and the second-largest upturn belonged to FHA loans, which rose 14 BPS to 0.93 percent.
Across all loan types, the states with the highest overall delinquency rates, on a non-seasonally adjusted basis, were Mississippi with 10.64 percent, Louisiana with 9.10 percent, and Michigan with 7.87 percent. But the largest quarterly increases belonged to West Virginia, Maine and Florida.
The foreclosure inventory leaders were Ohio, Indiana and Michigan, while the largest quarterly upturns were in Nevada, Mississippi and Massachusetts. Overall, 49 out of 51 states saw delinquency rate increases, while 44 states saw an increase in the foreclosure inventory rate.
For 2007, MBA expects economic growth will be slightly slower than in 2006, and combined with a slowly recovering housing market, "we would expect delinquency and foreclosure rates to level off as the housing market regains its footing towards the end of 2007," Duncan said. Home prices are likely to remain flat over the next couple of years. Delinquency and foreclosure rates are likely to increase over the next few quarters.
The fourth quarter survey reportedly covered 43.5 million loans -- or 88 percent of all outstanding loans, of which 33.3 million were prime, 6 million were subprime and 4 million government loans. Eight-eight percent of all loans covered.