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| A Goldman Sachs analyst blamed the recent surge in early payment defaults on relaxed underwriting guidelines by lenders eager to make up lost volume.In a letter to her clients, Goldman Equity Analyst Lori Appelbaum took a posture similar to other recent reports, comments from industry executives and others in calling the situation “bleak.”
“The outlook for subprime mortgage credit quality remains extremely challenging,” Appelbaum wrote in the report made available by Goldman. “This reflects very poor underwriting in late 2006 with the subprime mortgage market now hitting peak levels of early payment defaults and delinquencies in 2007 with peak losses to follow.” Appelbaum put the blame squarely on what she describes as lax underwriting standards by lenders chasing new business. “The fundamental issue is underwriting,” Appelbaum wrote, “as subprime underwriters lowered underwriting standards as volumes dropped with originators underwriting very high leveraged 90 percent to 100 percent [loan to values] to low FICO subprime borrowers. The weak underwriting, coupled with flat to declining home prices, contributed to the poor performance of the subprime market, Appelbaum said. “Subprime consumers received mortgages with little money down and little in income documentation,” she said. “Deterioration has been most evident where risk layering was the most pervasive. “The combination of low FICO scores underwriting (mid/upper 500s) and high leverage at 100% LTV is producing the greatest problems.” Other contributors were “low or no income verification … and other higher risk characteristics such as investor loans,” he said. Appelbaum said 10 percent of the subprime market, or 1.5 percent of the overall mortgage market “has very high risk given very weak underwriting.” “Consequently, 2006 underwritings are likely to be worse than that experienced in the last downturn,” she said. Underwriting has tightened this year “and the expectation is that 2006 underwritings will produce peak losses and delinquencies with improvements thereafter,” Appelbaum said. Prime mortgage credit quality “remains strong” but profitability “remains extremely challenging” for mortgage originators due to slowing volume growth and rising credit costs, she said. That is causing an industry shakeout — with mortgage originators scuttling operations and going out of business. “We count no fewer than 14 mortgage originators that have been sold, put themselves up for sale or have exited the business since last summer,” Appelbaum said. “To use a baseball (or cricket) analogy, we sense we are still in the ‘middle innings’.” |
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Patrick Crowley is a feature journalist and blogger for MortgageDaily.com. He is also a reporter, blogger and columnist for The Cincinnati Enquirer. |
