By the Numbers
Parsing the credit prospects of remaining delinquencies
Chris Helwig | June 4, 2021
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
After a healthy decline in delinquencies across most sectors of mortgage credit in April, the trend flattened in May, possibly signaling a tail of borrowers coming out of pandemic with persistent financial hardships. While conventional wisdom suggests better credits cure and weaker credits remain, that does not appear to be the case to date. Strong underwriting, robust housing and consumer fundamentals continue to support the remaining loans. Modification and extension look more likely than liquidation and loss.
Delinquency rates across most sectors of mortgage credit peaked last July and have broadly declined since (Exhibit 1). The drop in April was especially notable, coming a year after many forbearance programs began. A comparison of attributes of delinquent borrowers at the July peak to those in last month’s remittance cycle shows that, by and large, those attributes have remained fairly consistent. That suggests as the population of delinquent borrowers decreases, the decrease may not be driven by better borrowers re-performing and worse credits remaining delinquent or in forbearance. While the findings are not uniform, the trend seems to hold across major exposures to mortgage credit.
Exhibit 1: The decline in delinquencies loses momentum in May
Signs of strong underwriting and consumer and housing fundamentals seem to show up in multiple ways across mortgage credit. Across all forms of post-crisis mortgage credit exposure except RPLs, nominal delinquencies are falling faster than when measured as a percentage of UPB. Prepayment rates on pools continue to outpace cure rates, although this is most pronounced in the prime and non-QM sectors, which have experienced elevated prepayments even in the face of elevated delinquencies. This phenomenon is ultimately understating borrower recoveries in varying degrees when looking at delinquency rates on a percentage basis (Exhibit 2).
Exhibit 2: Comparing nominal and percentage delinquency cures across mortgage credit
Despite meaningful declines in delinquencies across all sectors, the differences credit metrics across populations of delinquent loans were generally small. Declines in average FICOs on May delinquencies versus those observed in July of last year were five to ten points across sectors while LTVs on delinquent loans remained fairly static. Loan WACs and borrowers’ debt-to-income were consistent as well. Some sectors saw a modest decline in the amount of delinquent non-owner occupied loans between July of last year and May.
In the prime jumbo sector one notable change is the amount of seasoning across the population of delinquent loans. Prime loans that were more than 60 days delinquent in July were on average 32 months seasoned. The remaining population of delinquent loans is now 54 months seasoned, suggesting that even after accounting for seasoning between July of last year and May that more recent vintage loans have re-performed while more seasoned ones have remained delinquent. This additional seasoning may actually be a positive for prime credits as loans with more seasoning will have accumulated larger amounts of home price appreciation, further de-leveraging a population of loans that were just a 72 combined LTV at origination. These large equity cushions should, at a minimum, insulate investors from losses if these loans ultimately liquidate but given these large stores of equity, it appears loan modifications may ultimately be the more likely resolution for these borrowers. Given the seasoning on these loans, they may represent a significant exposure in more seasoned trusts where the amount of loans has become relatively small and modifications may have somewhat of an outsized impact on the duration of the collateral pool.
Credit characteristics of loans still sitting in delinquency pipelines across expanded credit and RPL exposures remain robust as well. Nominal balances of seriously delinquent loans have fallen by nearly 70% in expanded prime and 65% in non-QM. And despite these steep reductions, there appears to be little to no adverse selection of better borrowers re-performing leaving worse credits to fall further into delinquency, potentially rolling towards foreclosure and subsequent liquidation. In the non-QM cohort, average FICOs have fallen by just seven points from 705 to 698 while original average combined LTVs on delinquent loans rose by just one point from 72 to 73 (Exhibit 3). Coupons and DTI ratios are roughly unchanged across the two observations but the amount of non-owner-occupied loans seriously delinquent fell slightly from 14% of total serious delinquencies in July to 10% last month. Deals backed by expanded prime collateral saw average LTVs rise by roughly two points but only to an original combined LTV of 70 while average FICOs on delinquent loans rose by just over ten points.
Exhibit 3: Comparing credit scores of seriously delinquent loans
Seasoned RPLs exhibited a similar trend as there are hardly any differences in the profile of the pipeline of delinquent loans within the cohort across the two observations. This may partly a function of the fact that the sector has not seen as large a decline in the nominal amount of delinquencies as other sectors, likely signaling that many of the same loans that were delinquent last summer may be still be in some form of payment forbearance. Despite a relatively modest decline in delinquencies relative to other sectors, there is likely not substantially more risk of losses associated with delinquencies rolling to liquidations than in other sectors. Significant amortization and mark-to-market deleveraging in RPL pools likely provide significant cushions for bondholders against losses associated with any liquidations. And if the legacy market can serve as a guidepost for potential losses associated with previously securitized forbearance securitized in RPL pools, recoveries have remained elevated throughout the past year and continue to increase underpinned by strong fundamental tailwinds.