By the Numbers

FHA loans begin to show signs of credit stress

Brian Landy, CFA | October 14, 2022

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. This material does not constitute research.

A canary is starting to chirp somewhere in the mortgage credit coal mine. The share of FHA loans at least 60 days delinquent now tops the tally at the start of the year. And except for the first phase of pandemic and the 2017 hurricanes, the pace of new 60-day delinquencies has reached the highest level of the last nine years, FHA borrowers typically make small down payments and have less disposable income than other borrowers, making them a good early indicator of stress. Growing delinquencies could make it less likely that the FHA will lower insurance premiums. And this could be an early warning sign that credit stress could increase in other sectors of the mortgage market.

More FHA loans in Ginnie Mae pools are delinquent than there were at the start of the year (Exhibit 1). The number of loans at least 60-days delinquent fell from fall 2020 through July 2022. Many borrowers cured their delinquencies while other loans were bought out of Ginnie Mae pools by servicers. But the share of delinquent FHA loans has been growing since July. In contrast, VA loan delinquencies bottomed out at the same time but have held steady since. VA borrowers typically are much stronger than VA.

Exhibit 1: More FHA loans are ≥60 days delinquent than at the start of the year

Delinquency rates for FHA loans in Ginnie Mae pools.
Source: Ginnie Mae, Amherst Pierpont Securities.

FHA delinquencies follow a seasonal pattern, falling in the spring and then ramping up throughout the year, so some increase is expected. However, the October level is typically lower than the January level (Exhibit 2). The only exception in nine years was due to the Covid-19 pandemic that started in 2020

Exhibit 2: FHA delinquencies are typically lower in October than January

Source: Ginnie Mae, Amherst Pierpont Securities.

The rate of new 60-day delinquencies is at the highest level in the nine years Ginnie Mae has been publishing loan-level data, with two exceptions (Exhibit 2). The first exception came with the 2017 hurricane season, which affected many FHA borrowers in Puerto Rico, among other locations. The second exception was at the start of the pandemic in 2020. Notably, VA loans are not showing a similar uptick in new delinquencies; the pace is a little lower than before the pandemic.

Exhibit 3: The pace of new FHA delinquencies is the highest in nine years

May and June 2020 are excluded to show more detail in other months. The percent of loans each month that move from 30-days to 60-days delinquent.
Source: Ginnie Mae, Amherst Pierpont Securities.

Servicer buyouts of delinquent loans and delinquent loan cures also contribute to the total number of delinquent loans in pools. The buyout rate has fallen this year in response to higher interest rates, which also contributes to the increase in delinquent loans. However, that was largely offset by a higher cure rate.

The FHA releases its annual review of its insurance fund in November using data from the end of September. Policymakers might turn cautious about lowering mortgage insurance premiums if the pace of defaults is shifting higher. And slower home price appreciation should also weigh on the health of the insurance fund. Lower insurance premiums would not hurt most Ginnie Mae MBS, most of which are trading well below part. But pools created in 2022 with higher coupons would be negatively affected by lower premiums, so this may prove to be a positive sign for those investors. Owners of interest-only bonds also benefit if insurance premiums are not lowered.

The pickup in new defaults is occurring for borrowers across the spectrum of credit scores (Exhibit 4). The largest pickup occurs for borrowers with credit scores between 650 and 700, but even borrowers with scores over 800 are defaulting faster than before the pandemic. One reason might be due to credit score inflation during the pandemic. Many pandemic relief policies suspended delinquency reporting to credit bureaus, which caused many borrowers’ credit scores to increase. Therefore, the score might not represent the true risk of those borrowers.

Exhibit 4: Borrowers with different credit scores are defaulting faster this year

Source: Ginnie Mae, Amherst Pierpont Securities.

Borrowers with higher loan-to-value ratios also tended to default faster compared to before the pandemic (Exhibit 5). Only borrowers with extremely low or high LTVs had similar default rates compared to times before the pandemic. Most borrowers with high mark-to-market LTVs have new loans and haven’t had as much time to get into financial difficulties.

Exhibit 5: Default rates increased more for borrowers with higher LTVs.

Source: Ginnie Mae, Amherst Pierpont Securities.

Brian Landy, CFA
brian.landy@santander.us
1 (646) 776-7795

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