Mortgage Trends
With the issue of delayed bank foreclosures at the top of the evening news, I wanted to provide a different perspective on the issue and highlight what I think are some very important, yet often underestimated risks hidden within this issue. For many homeowners, the process of becoming delinquent and eventually going into default is actually a cash-flow positive experience. The process offers these borrowers temporary “free rent,” whereby a major previous monthly commitment is no longer a monthly obligation, freeing up cash for other purposes, including paying other bills. For those consumers who are managing cash flow issues each month, the lack of a mortgage commitment immediately allows them to meet other commitments more easily - making payments on credit cards and car loans that may have previously also become delinquent. From the perspective of a credit card or auto lender, the extended foreclosure process is a short-term positive – it allows a borrower who had previously struggled to remain current to now pay on time and in the short-run, contributes to portfolio health. Although these lenders will experience an improvement in delinquency rates, the reality is that the credit risk is simply dormant. At some point, the consumer’s mortgage will go into foreclosure, and which point the consumer will again be under pressure to continue meeting their obligations. The hidden and significant risk management issue is the misinterpretation of improved delinquency rates. Halting foreclosures means that an accumulating number of consumers are going to enter into this delayed stage of ‘free rent’, without any immediate prospect of having to make a rent or mortgage payment in the near future. In fact, according to Bank of America, “the average foreclosed borrower has not made a payment in 18 months”. This extended period of foreclosure delay will naturally result in a larger number of consumers being able to meet their non-mortgage obligations – but only while their free-rent status exists. A lender who has an interest in the “free rent” consumer is actually sitting on a time-bomb. When foreclosures stop or slow to a rate that is less than consumers entering it, that group will continue to grow in size - until foreclosures start again – at which point thousands of consumers will be processed and will have to start managing rent/housing payments again. Almost immediately, thousands of consumers who have had no problems meeting their obligations will have to start making decisions about which to pay and which not to pay. So, this buildup of rent-free mortgage holders presents a serious risk management issue to non-mortgage lenders that must be addressed. Lenders who have a relationship with a consumer who is delinquent on their mortgage may be easily fooled into thinking that they are not exposed to the same credit risk as mortgage lenders, but I think that these lenders will quickly find that consumers who have lived rent-free for over a year will have a very difficult time managing this transition, and if not diligent, credit card issuers and automotive lenders may find themselves in trouble. _____________________ http://cnews.canoe.ca/CNEWS/World/2010/10/08/15629836.html
With the news from the Federal Reserve that joblessness is not declining, and in fact is growing, a number of consumers are going to face newly difficult times and be further challenged to meet their credit obligations. Thinking about how this might impact the already struggling mortgage market, I’ve been considering what the impact of joblessness is on the incidence of strategic default and the resulting risk management issues for lenders. Using the definitions from our previous studies on strategic default, I think it’s quite clear that increased joblessness will definitely increase the number of ‘cash-flow managers’ and ‘distressed borrowers’, as newly jobless consumers face reduced income and struggle to pay their bills. But, will a loss of income also mean that people become more likely to strategically default? By definition, the answer is no – a strategic defaulter has the capacity to pay, but chooses not to, mostly due to their equity position in the home. But, I can’t help but consider a consumer who is 20% underwater, but making payments when employed, deciding that the same 20% that used to be acceptable to bear, is now illogical and will simply choose to stop payment? Although only a short-term fix, since they can use far less of their savings by simply ceasing to pay their mortgage, this would free up significant cash (or savings) for paying car loans, credit cards, college loans, etc; and yet, this practice would maintain the profile of a strategic defaulter. While it’s impossible to predict the true impact of joblessness, I would submit that beyond assessing credit risk, lenders need to consider that the definition of strategic default may contain a number of unique, and certainly evolving consumer risk segments. __________________________ http://money.cnn.com/2010/08/19/news/economy/initial_claims/index.htm
By: Staci Baker For the one-third of the U.S. population that rents, in the past, rental payment history has not been included in determining a credit score. With the acquisition of RentBureau by Experian, renters’ credit can now be affected by on-time payments or account delinquency, the same as an individual that owns a home. Why is it important to include rental payment history? Including rental payment history in credit score data strengthens the analytics used to compile credit scores by giving a more complete picture of an individual’s payment history. For consumers with no history on which to build a credit score, this allows them to create track record of continuous, on time, repayment. I believe the power this brings to multi-family owned units is the ability to quickly and easily determine who is either a low credit risk, or higher credit risk when leasing an apartment. As a property manager or resident screener, the risk that is taken on new tenants can be high. There are many unknown variables regarding a tenant’s credit worthiness, even once an application is completed – do they have a good history of making payments on time, did they fill out their application truthfully, will they be a good neighbor and many more. Now that the credit risk management of applicants includes rental payment history in the consumer credit file, it will identify better quality residents, reduce delinquency rates and lead to greater collections management.
By: Staci Baker With the increase in consumer behaviors such as ‘strategic default’, it has become increasingly difficult during the past few years for lenders to determine who the most creditworthy consumers are – defining consumers with the lowest credit risk. If you define risk as ‘the likelihood of [a consumer] becoming 90 days or more past due’, the findings are alarming. From June 2007 to June 2009, Super Prime consumers (those scoring 900 or higher) in the U.S. have gone from an average VantageScore* of 945 to 918, which increased their risk level from approx. 0.12% to 0.62% - an increase of 417% for this highly sought after population! Prime and near prime risk levels increased by 400% and 96% respectively. Whereas subprime consumers with few choices (stay subprime or improve their score), saw a slight decrease in risk, 8% - increasing their average VantageScore from 578 to 599. So how do lenders determine who to lend to, when the risk level for all credit tiers increases, or remain risky? In today’s dynamic economy, lenders need tools that will give them an edge, and allow them to identify consumer trends quickly. Incorporating analytic tools, like Premier Attributes, into lender’s origination models, will allow them to pinpoint specific consumer behavior, and provide segmentation through predefined attribute sets that are industry specific and target profitable accounts to improve acquisition strategies. As risk levels change, maintaining profitability becomes more difficult due to shrinking eligible consumer pools. By adding credit attributes, assessing credit risk both within an organization and for new accounts will be simplified and allow for more targeted prospects, thus maximizing prospecting strategies across the customer lifecycle and helping to increase profitability. * VantageScore®, LLC, May, 2010, “Finding Creditworthy Consumers in a Changing Economic Climate”
I recently attended a conference where Credit Union managers spoke of the many changes facing their industry in the wake of the real estate crisis and economic decline that has impacted the US economy over the past couple of years. As these managers weighed in on the issues facing their businesses today, several themes began to emerge – tighter lending standards & risk management practices, increased regulatory scrutiny, and increased competition resulting in tighter margins for their portfolios. Across these issues, another major development was discussed – increased Credit Union mergers and acquisitions. As I considered the challenges facing these lenders, and the increase in M&A activity, it occurred to me that these lenders might have a common bond with an unexpected group –American family farms. Overall, Credit Unions are facing the challenge of adding significant fixed costs (more sophisticated lending platforms & risk management processes) all the while dealing with increased competition from lenders like large banks and captive automotive lenders. This challenge is not unlike the challenges faced by the family farm over the past few decades – small volume operators having to absorb significant fixed costs from innovation & increased corporate competition, without the benefit of scale to spread these costs over to maintain healthy lending margins. Without the benefit of scale, the family farm basically disappeared as large commercial operators acquired less-efficient (and less profitable) operators. Are Credit Unions entering into a similar period of competitive disadvantage? It appears that the Credit Union model will have to adjust in the very near future to remain viable. With high infrastructure expectations, many credit unions will have to develop improved decisioning strategies, become more proficient in assessing credit risk –implementing risk-based pricing models, and executing more efficient operational processes in order to sustain themselves when the challenges of regulation and infrastructure favor economies of scale. Otherwise, they are facing an uphill challenge, just as the family farm did (and does); to compete and survive in a market that favors the high-volume lender.
By: Staci Baker As more people have become underwater on their mortgage, the decision to stay or not stay in their home has evolved to consider a number of influences that impact consumer credit decisions. Research is revealing that much of an individual’s decision to meet his credit obligations is based on his trust in the economy, moral obligation, and his attitude about delinquency and the effect it will have on his credit score. Recent findings suggest that moral obligation keeps the majority of homeowners from walking away from their homes. According to the 2009 Fannie Mae National Housing Survey (i) – “Nearly nine in ten Americans (88%), including seven in ten who are delinquent on their own mortgages, do not believe it is acceptable for people to stop making payments on an underwater mortgage, while 8% believe it is acceptable.” It appears that there is a sense of owning up to one’s responsibilities; having signed a contract and the presumed stigma of walking away from that obligation. Maintaining strong creditworthiness by continuing to make payments on an underwater mortgage is motivation to sustain mortgage payments. “Approximately 74% of homeowners believe it is very important to maintain good credit and this can be a factor in encouraging them not to walk away (ii).” Once a homeowner defaults on their mortgage, their credit score can drop 150 to 250 points (iii), and the cost of credit in the future becomes much higher via increased interest rates once credit scores trend down. Although consumers expect to keep investing in the housing market (70% said buying a home continues to be one of the safest investments available (iv)) they will surely continue optimizing decisions that consider both the moral and credit implications of their decisions. i December, 2009, Fannie Mae National Housing Survey ii 4/30/10, Financial Trust Index at 23% While Strategic Defaults Continue to Rise, The Chicago Booth/Kellogg School Financial Trust Index iii http://www.creditcards.com/credit-card-news/mortgage-default-credit-scores-1270.php iv December, 2009, Fannie Mae National Housing Survey
Since 2007, when the housing and credit crises started to unfold, we’ve seen unemployment rates continue to rise (9.7% in March 2010 *) with very few indicators that they will return to levels that indicate a healthy economy any time soon. I’ve also found myself reading about the hardship and challenge that people are facing in today’s economy, and the question of creditworthiness keeps coming into my mind, especially as it relates to employment, or the lack thereof, by a consumer. Specifically, I can’t help but sense that there is a segment of the unemployed that will soon possess a better risk profile than someone who has remained employed throughout this crisis. In times of consistent economic performance, the static state does not create the broad range of unique circumstances that comes when sharp growth or decline occurs. For instance, the occurrence of strategic default is one circumstance where the capacity to pay has not been harmed, but the borrower defaults on the commitment anyway. Strategic defaults are rare in a stable market. In contrast, many unemployed individuals who have encountered unfortunate circumstances and are now out of work may have repayment issues today, but do possess highly desirable character traits (willingness to pay) that enhance their long-term desirability as a borrower. Although the use of credit score trends, credit risk modeling and credit attributes are essential in assessing the risk within these different borrowers, I think new risk models and lending policies will need to adjust to account for the growing number of individuals who might be exceptions to current policies. Will character start to account for more than a steady job? Perhaps. This change in lending policy, may in turn, allow lenders to uncover new and untapped opportunities for growth in segments they wouldn’t traditionally serve. * Source: US Department of Labor. http://www.bls.gov/bls/unemployment.htm
In the past few days I’ve read several articles discussing how lenders are taking various actions to reduce their exposure to toxic mortgages – some, like Bank of America, are engaging new principal repayment programs.* Others, (including Bank of America) are using existing incentive programs to fast-track the approvals of short-sales to stunt their losses and acquire stronger lenders on existing real-estate assets. Given the range of options available to lenders, there are significant decisions to make regarding the creditworthiness of existing consumers and which treatment strategies are best for each borrower, these decisions important for assessing credit risk, loan origination strategies and loan pricing and profitability. Experian analysis has uncovered the attributes of borrowers with various borrowing behaviors: strategic defaulters, cash-flow managers, and distressed borrowers, each of whom require a unique treatment strategy. The value of credit attributes and predictive risk scores, like Experian Premier Attributes and VantageScore, has never been higher to lenders. Firms like Bank of America are relying on credit delinquency attributes to segment eligible borrowers for its programs, and should also consider that more extensive use of attributes can further sub-segment its clients based on the total consumer credit profile. Consumers who are late on mortgage payments, yet current on other loans, may be likely to re-default; whereas some consumers may merely need financial planning advice and enhanced money management skills. As lenders develop new methods to manage portfolio risk and deal with toxic assets on their portfolios, they should also continue to seek new and innovative analytics, including optimization, to make the best decisions for their customers, and their business. * LA Times, March 25, 2010, ‘Bank of America to reduce mortgage principal for some borrowers’
A recent January 29, 2010 article in the Wall Street Journal * discussing the repurchasing of loans by banks from Freddie Mae and Fannie Mac included a simple, yet compelling statement that I feel is worth further analysis. The article stated that \"while growth in subprime defaults is slowing, defaults on prime loans are accelerating.\" I think this statement might come as a surprise to some who feel that there is some amount of credit risk and economic immunity for prime and super-prime consumers – many of whom are highly sought-after in today’s credit market. To support this statement, I reference a few statistics from the Experian-Oliver Wyman Market Intelligence Reports: • From Q1 2007 to Q1 2008, 30+ DPD mortgage delinquency rates for VantageScore A and B consumers remained flat (actually down 2%); while near-prime, subprime, and deep-subprime consumers experienced an increase of over 36% in 30+ rates. • From Q4 2008 to Q4 2009, 30+ DPD mortgage delinquency rates for VantageScore A and B consumers increased by 42%; whereas consumers in the lower VantageScore tiers saw their 30+ DPD rate increase by only 23% in the same period Clearly, whether through economic or some other form of impact, repayment practices of prime and super-prime, consumers have been changing as of late, and this is translating to higher delinquency rates. The call-to-action for lenders, in their financial risk management and credit risk modeling efforts, is increased attentiveness in assessing credit risk beyond just a credit score...whether this be using a combination of scores, or adding Premier Attributes into lending models – in order to fully assess each consumer’s risk profile. * http://online.wsj.com/article/SB10001424052748704343104575033543886200942.html
A recent article in the Boston Globe talked about the lack of incentive for banks to perform wide-scale real estate loan modifications due to the lack of profitability for lenders in the current government-led program structure. The article cited a recent study by the Boston Federal Reserve that noted up to 45 percent of borrowers who receive loan modifications end up in arrears again afterwards. On the other hand, around 30 percent of borrowers cured without any external support from lenders - leading them to believe that the cost and effort required modifying delinquent loans is not a profitable or not required proposition. Adding to this, one of the study’s authors was quoted as saying “a lot of people you give assistance to would default either way or won’t default either way.” The problem that lenders face is that although they have the knowledge that certain borrowers are prone to re-default, or cure without much assistance – there has been little information available to distinguish these consumers from each other. Segmenting these customers is the key to creating a profitable process for loan modifications, since identification of the consumer in advance will allow lenders to treat each borrower in the most efficient and profitable manner. In considering possible solutions, the opportunity exists to leverage the power of credit data, and credit attributes to create models that can profile the behaviors that lenders need to isolate. Although the rapid changes in the economy have left many lenders without a precedent behavior in which to model, the recent trend of consumers that re-default is beginning to provide lenders with correlated credit attributes to include in their models. Credit attributes were used in a recent study on strategic defaulters by the Experian-Oliver Wyman Market Intelligence Reports, and these attributes created defined segments that can assist lenders with implementing profitable loan modification policies and decisioning strategies.
In my previous two blogs, I introduced the definition of strategic default and compared and contrasted the population to other types of consumers with mortgage delinquency. I also reviewed a few key characteristics that distinguish strategic defaulters as a distinct population. Although I’ve mentioned that segmenting this group is important, I would like to specifically discuss the value of segmentation as it applies to loan modification programs and the selection of candidates for modification. How should loan modification strategies be differentiated based on this population? By definition, strategic defaulters are more likely to take advantage of loan modification programs. They are committed to making the most personally-lucrative financial decisions, so the opportunity to have their loan modified - extending their ‘free’ occupancy – can be highly appealing. Given the adverse selection issue at play with these consumers, lenders need to design loan modification programs that limit abuse and essentially screen-out strategic defaulters from the population. The objective of lenders when creating loan modification programs should be to identify consumers who show the characteristics of cash-flow managers within our study. These consumers often show similar signs of distress as the strategic defaulters, but differentiate themselves by exhibiting a willingness to pay that the strategic defaulter, by definition, does not. So, how can a lender make this identification? Although these groups share similar characteristics at times, it is recommended that lenders reconsider their loan modification decisioning algorithms, and modify their loan modification offers to screen out strategic defaulters. In fact, they could even develop programs such as equity-sharing arrangements whereby the strategic defaulter could be persuaded to remain committed to the mortgage. In the end, strategic defaulters will not self-identify by showing lower credit score trends, by being a bank credit risk, or having previous bankruptcy scores, so lenders must create processes to identify them among their peers. For more detailed analyses, lenders could also extend the Experian-Oliver Wyman study further, and integrate additional attributes such as current LTV, product type, etc. to expand their segment and identify strategic defaulters within their individual portfolios.
In my last blog, I discussed the presence of strategic defaulters and outlined the definitions used to identify these consumers, as well as other pools of consumers within the mortgage population that are currently showing some measure of mortgage repayment distress. In this section, I will focus on the characteristics of strategic defaulters, drilling deeper into the details behind the population and learning how one might begin to recognize them within that population. What characteristics differentiate strategic defaulters? Early in the mortgage delinquency stage, mortgage defaulters and cash flow managers look quite similar – both are delinquent on their mortgage, but are not going bad on any other trades. Despite their similarities, it is important to segment these groups, since mortgage defaulters are far more likely to charge-off and far less likely to cure than cash flow managers. So, given the need to distinguish between these two segments, here are a few key measures that can be used to define each population. Origination VantageScore® • Despite lower overall default rates, prime and super-prime consumers are more likely to be strategic defaulters Origination Mortgage Balance • Consumers with higher mortgage balances at origination are more likely to be strategic defaulters, we conclude this is a result of being further underwater on their real estate property than lower-balance consumers Number of Mortgages • Consumers with multiple first mortgages show higher incidence of strategic default. This trend represents consumers with investment properties making strategic repayment decisions on investments (although the majority of defaults still occur on first mortgages where the consumer has only one first mortgage) Home Equity Line Performance • Strategic defaulters are more likely to remain current on Home Equity Lines until mortgage delinquency occurs, potentially a result of drawing down the HELOC line as much as possible before becoming delinquent on the mortgage Clearly, there are several attributes that identify strategic defaulters and can assist in differentiating them from cash flow managers. The ability to distinguish between these two populations is extremely valuable when considering its usefulness in the application of account management and collections management, improving collections, and loan modification, which is my next topic. Source: Experian-Oliver Wyman Market Intelligence Reports; Understanding strategic default in mortgage topical study/webinar, August 2009.
By: Kari Michel The U.S. government and mortgage lenders have developed various loan modification programs to help homeowners better manage their mortgage debt so that they can meet their monthly payment obligations. Given these new programs, what is the impact to the consumer’s score? Do consumer scores drop more if they work with their lenders to get their mortgage loan restructured or if they file for bankruptcy? The finding from a study conducted by VantageScore ® Solutions* reveals that a delinquency on a mortgage has a greater impact on the consumer’s score than a loan modification. Bankruptcy, short sale, and foreclosure have the greatest impact to a score. A bankruptcy or poor bankruptcy score can negatively impact a consumer for a minimum of seven years with a potential score decrease of 365 points. However, with a loan modification, consumers can rehabilitate their scores to an acceptable risk level within nine months. This depends on them bringing all their delinquent accounts to current status. Loan modifications have little impact on their consumer credit score and the influence on their score can range from a 20 point decrease to an increase of 30 points. Lenders should proactively seek out a mortgage loan modification before consumers experience severe delinquency in their credit files and credit score trends. The restructured mortgage should provide sufficient cash availability to remain with the consumer. This ensures that any other delinquent debts can be updated to current status. Whenever possible, bankruptcy should be avoided because it has the greatest consequences for the lender and the consumer. *For more detailed information on this study, Credit Scoring and Mortgage Modifications: What lenders need to know, please click on this link to access an archived file of a recent webinar: http://register.sourcemediaconferences.com/click/clickReg.cfm?URLID=5258
By: Tracy Bremmer There has been a lot of hype these days about people strategically defaulting on their mortgage loans. In other words, a consumer is underwater on their house and so he/she makes a strategic decision to walk away from it. In these instances, the consumer is current on all of their non-mortgage accounts, but because the value of their home is less than what they owe, they make the decision to default on their mortgage loan. Experian and Oliver Wyman teamed up to really dig into this population and determine these issues: • Does this population really exist? • If so, what are the characteristics of this population, such as assessing credit risk or bankruptcy scores? • How should loan modification strategies be differentiated based on this population? This blog will be one of a three-part series that addresses these questions. Let’s begin with the first question. 1. Does this population really exist? The quick answer is yes – this population does indeed exist. In fact, in 2008 strategic defaulters represented 18 percent of all mortgage defaults, up 500 percent from 2004. When we conducted our study we found there were varying populations that also existed when it came to mortgage defaults. In fact, we classified mortgage defaulters into five categories: strategic defaulter, cash flow manager, distressed defaulter, no non-real estate trades, and pay-downs. We defined these populations as follows: • Strategic defaulter - Borrowers who are delinquent on their mortgages, even when they can afford the payment, because their loan balance exceeds the value of their home, • Cash flow manager - Borrowers facing delinquency issues with their mortgage because of temporary distress, but continue to make payments on all credit obligations, • Distressed defaulter - Borrowers facing potential affordability issues that go delinquent on their mortgage along with other credit obligations, • No non-real estate trades – Borrowers who are delinquent on their mortgage, however they do not have any other non-mortgage trades to evaluate if they have strategically defaulted or are in distress, • Pay-downs – Borrowers who pay down their mortgage loan. In my next blog, I will address the characteristic differences in behavior between these populations. Specifically, I will evaluate what characteristics make strategic defaulters stand out from the rest and what is unique about the cash flow managers. Source: Experian-Oliver Wyman Market Intelligence Reports; Understanding Strategic Default in Mortgage topical study / webinar. August 2009.
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