By the Numbers
FHA transition rates continue to climb
Brian Landy, CFA | October 20, 2023
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 rising number of FHA loans in Ginnie Mae mortgage-backed securities are going delinquent each month. Servicers so far have successfully stepped up efforts to cure those loans without resorting to modifications that require the servicer to buy the loan out of the pool. Buyouts are prohibitively expensive for servicers when mortgage rates are higher than the note rate on the delinquent loan. This has led to a growing share of FHA loans that have partial claims, a subordinate lien that accrues no interest and does not require a monthly payment. This is likely contributing to slower housing turnover by FHA borrowers that are reluctant to move since that would require them to pay off the partial claim. Slower speeds should lift the value of interest-only bonds backed by FHA collateral, which benefit from slower prepayment speeds.
The transition rate of FHA loans to at least 60 days delinquent has recently risen above 1.0%, nearly the level achieved following hurricanes Irma and Maria in late 2017 (Exhibit 1). The chart shows the percentage of FHA and VA loans each month that become at least 60-days delinquent. Transitions into delinquency spiked following the economic shutdown in 2020 but recovered starting in June 2020 and eventually dropped back to pre-pandemic levels. The transition rate for FHA loans is higher than that for VA loans, since the former program caters to borrowers with lower credit scores and first-time homebuyers. However, after reaching a post-pandemic low in April 2021 the transition rate for FHA loans has risen to nearly 1.2%/month in September. The VA transition rate, however, held steady during this time.
Exhibit 1. FHA transition rates approach levels reached after 2017 hurricanes
Monthly transition rate of loans ≤30 days delinquent to ≥60 days delinquent. Values at the peak of the pandemic are omitted from the graph, to improve the scale for non-pandemic months. The omitted values are noted on the chart.
Source: Ginnie Mae, Santander US Capital Markets
Transition rates exhibit a seasonal pattern, often falling in the early part of the year after borrowers receive tax refunds, then rising throughout the remainder of the year. Natural disasters may play a role, as hurricanes are more likely after spring. Hurricanes Irma and Maria drove FHA and VA delinquencies higher in 2017. However, in 2023 there is no evidence of a spike in VA delinquencies, which suggests that natural disasters were likely not responsible for the pickup in FHA delinquencies.
FHA transition rates were generally higher for moderately seasoned loans, especially those with higher coupons (Exhibit 2). This shows the annualized transition rates for FHA loans in each cohort, averaged over the last 12 months. For example, the transition rate was 10.6% for 2.5%s 2021 and 18.4% for 3.5%s 2021. Higher coupons may be more likely to contain reperforming FHA loans, and loans that defaulted once may be more likely to default again.
Exhibit 2. High-coupon, moderately seasoned FHA loans show more defaults
Annualized average transition rate from October 2022 through September 2023 for FHA loans in 30-year Ginnie Mae securities, excluding RG custom pools. Cohorts must have at least $5.0 billion outstanding. Cohorts are pool coupon and loan origination year.
Source: Ginnie Mae, Santander US Capital Markets
The rate of loans that cure back to performing status also increased this year (Exhibit 3). This chart shows the monthly rate at which loans move from at least 60 days delinquent to less than 60 days delinquent as a percentage of outstanding unpaid balance. Ginnie Mae servicers have the option to buyout delinquent loans from pools at par but will not do so if the loans are trading at a discount to par. Lenders will also avoid loan modifications, which necessitate setting the borrower’s note rate at the current market rate. Those modifications are ineffective when mortgage rates are high and the modification would increase a borrower’s note rate and payment.
Exhibit 3. The FHA cure rate has reached the highest-level dating back to 2014.
Transition of loans ≥60 days delinquent to ≤30 days delinquent, as a percentage of all loans outstanding. Ginnie Mae’s loan-level disclosures started at the end of 2013.
Source: Ginnie Mae, Santander US Capital Markets
The most common approach to cure loans without a buyout is to use the FHA’s partial claim process, which uses the proceeds from a no-interest, no-payment 2nd lien to bring a loan current. Unfortunately, the partial claim process is cumbersome when rates are high since it can cure a delinquency but not make the loan payment more affordable. The FHA has proposed an alternative approach to using the partial claim funds to lower a borrower’s payment, but the details have not yet been finalized. Some borrowers probably cure on their own, without using a partial claim. High mortgage rates have pushed buyout rates below pre-pandemic levels, and the issuance of reperforming and modified loans has also fallen below pre-pandemic levels.
The share of FHA loans that are at least 60-days delinquent has held steady in 2023 (Exhibit 4). The transition rate into delinquency and the cure rate out of delinquency are roughly canceling each other. However, the delinquency rate in 2023 is holding at a level higher than pre-pandemic norms, for FHA and VA loans. FHA loans are slightly over 4% at least 60-days delinquent, while VA loans are roughly 2% delinquent.
Exhibit 4. The share of delinquent loans is higher than before the pandemic.
Source: Ginnie Mae, Santander US Capital Markets
The number of FHA loans with partial claims is nearly 10%, up from below 6% in March 2022 (Exhibit 5). This is a consequence of a higher rate of new delinquencies and an increase in the cure rare of those loans. In March 2022, Ginnie Mae began disclosing the number and balance of loans that have partial claims at the pool-level, so data is not available before then, but was likely much lower before the pandemic when loan modifications were used more frequently.
Exhibit 5. FHA loans with partial claims in Ginnie Mae MBS approach 10%.
Source: Ginnie Mae, Santander US Capital Markets
A borrower with a partial claim will be less likely to move than an otherwise identical borrower without one. The partial claim needs to be paid back if the borrower moves, if the borrower refinances into a non-FHA loan, or when the loan matures. The borrower does not make payments on the partial claim before then, and the partial claim accrues no interest. Therefore, most borrowers will be reluctant to voluntarily forfeit the attractive financing of a partial claim. This likely is contributing to slower FHA turnover than VA turnover; FHA loans were typically faster than VA before 2022 (read here for more details.)
The FHA loans in some cohorts are more likely to have partial claims (Exhibit 6).
For example, in the 2020 vintage there are more loans in the 3.5% and 4.0% coupons with partial claims; some of these loans may have been bought out from earlier vintages and re-pooled into Ginnie II multiple issuer pools before Ginnie Mae stopped that practice. The table excludes loans placed into the custom “RG” pools for reperforming loans that were previously bought out of a pool. On the other hand, lower coupons in the 2022 vintage have a greater share of partial claims attached.
Exhibit 6. Percentage of FHA loans with partial claims, by cohort.
Percentage of FHA loans in Ginnie Mae 30-year MBS, excluding RG pools, that have partial claims. Cohorts are pool coupon and issuance year.
Source: Ginnie Mae, Santander US Capital Markets
A higher partial claims rate that slows speeds should benefit investors in interest-only bonds backed by that collateral. These bonds benefit from extension since that keeps the interest payments larger for longer, and interest-only investors receive nothing when a loan prepays.