Turning Around the Negative Trends in the Mortgage Industry

In the last 18 months the mortgage market in the United States has experienced a dramatic increase in delinquency and foreclosure among various product types including fixed-rate mortgages, adjustable rate mortgages and home equity loans.

During the first quarter of 2008, delinquency on first mortgages reached a national average of 3.23 percent nationwide. Currently, this figure is projected to move above 4 percent by the end of 2008*. Put simply, these levels of delinquency cannot be sustained as they have a detrimental impact on the U.S. economy as well as resulting in a sharp decrease in liquidity in the secondary mortgage market, due to a lack of investor confidence in U.S. risk prediction methodologies. The resulting lack of liquidity acts as an impediment to the ability of the nation’s mortgage industry to fund new loans.

The press, along with leaders throughout government and financial institutions, have suggested many causes for the current mortgage crisis, some of which include:

• Limited consumer risk prediction at the origination level
• Regulatory emphasis on lending to under-served markets to comply with the Community Reinvestment Act
• Underwriting mortgage loan repayment at the initial payment rather than mid-term resets
• Lack of ability to predict risk on a geographic sub-market level so as to allow for the appropriate alignment of acquisition strategies
• Limited portfolio risk prediction capabilities, which has resulted in inaccurate tranche assignment at the securitization phase
• A failure by rating agencies to accurately assess risk in the tranches of CMOs
• A lack of tools for investors to utilize in determining the risk of delinquency and default in potential CMO acquisitions
• Limited tools for servicers to use in monitoring and predicting risk
  

The recent deterioration in mortgage loan performance has taught the industry that possibly more is needed in the traditional underwriting approach to meet the requirements of the secondary market in a volatile world economy. The weighted reliance on appraisals, debt service and the misapplication of credit scores, coupled with sub-market economic variables created somewhat of a perfect storm for the high levels of delinquency we are seeing today.

In the future it will be of paramount importance that the mortgage industry starts to utilize more sophisticated risk management tools in the assessment of potential risk. Thought should be given to models that will allow the mortgage originators to:

• Predict future consumer credit behavior at the individual level
• Accurately predict risk at least two years into the future at the sub-market level (state or preferably at the MSA level)
  

As can be seen above, the use of a robust model can accurately predict risk on a geographic basis, which can be a very valuable tool for the mortgage banking and capital markets industries. In the immediate example, the model was able to accurately forecast 90+ mortgage loan delinquency rates within the state of Illinois. This same type of model can be used to predict risk down to the MSA level.

In summary, the industry is facing a very difficult environment today, however in the future it is likely that the economy will tend to have various volatile geographic sectors, which will pose a continuing challenge for mortgage lenders and the secondary market. It is incumbent upon the prudent mortgage executive to not only consider current risk in their new originations, but also to accurately determine future risk predicated upon the sub-markets within which the borrowers are located.

* Source: TransUnion’s Trend Data

Keith Carson is a senior consultant in TransUnion’s financial services group.  More information on Trend Data can be found at www.transunion.com/business.