By the Numbers

FHA loans keep defaulting faster than others

| June 21, 2024

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.

Besides having direct implications for credit and prepayment risk in specific securities, mortgage delinquency rates also shed light on the strength of the consumer balance sheet. FHA and certain non-QM loans have become delinquent at a faster rate over the last few years, reflecting some of the strains on households with lower income, younger owners or more leveraged balance sheets. VA loans have shown their normal and steady delinquencies. And Fannie Mae and Freddie Mac conforming and jumbo loans have shown low and steady delinquencies, and little sign of stress.

FHA and non-QM loans stand out

The rates at which FHA and non-QM loans transition into delinquency have been increasing since the start of 2022 while VA and conventional loans have been relatively flat (Exhibit 1). The transition rate is the percentage of loans each month that becomes 60-days delinquent, and it is a strong predictor of eventual default.

Exhibit 1. FHA loans have the highest transition rates into delinquency…

Source: Fannie Mae, Freddie Mac, Ginnie Mae, Intex, Santander US Capital Markets.

FHA loans transitioned at roughly 0.8% per month in January 2022, roughly 1.05% per month in January 2023, and nearly 1.3% per month in January 2024.

Loans guaranteed by the Department of Veterans Affairs exhibit lower transition rates than FHA loans and have not trended higher over the last couple of years. VA borrowers typically have better credit than FHA borrowers. And conventional loans, whether below or above the conforming limit, have exhibited even lower transition rates than VA loans, only about 0.1% per year. Like VA, these loans have not been weakening over the last couple of years.

Implications for agency MBS and credit risk transfer securities

Investors in Fannie Mae and Freddie Mac MBS do not need to worry about credit losses, but transitions and defaults do influence prepayment speeds and the convexity of securities. Transitions and defaults can have a larger effect on credit risk transfer securities. Similarly, investors do not need to worry about credit losses on FHA and VA loans in Ginnie Mae MBS, whose guaranty is backed by the full faith and credit of the United States government. However, unlike the GSEs, Ginnie Mae servicers have an option to buyout delinquent loan from pools, so higher default rates can lower Ginnie Mae MBS convexity more than in in conventional MBS.

Implications for non-QM securities

Non-QM loan transitions have, like the FHA, been trending higher over the last couple of years. For example, transition rates rose to 0.6% per month in January 2024, compared to 0.3% per month in January 2022. However, performance has improved this year and may not experience the seasonal increase over the second half of the year that is likely in FHA loans. Investors in deals backed by non-QM loans need to be more conscious of credit performance than investors in conventional and Ginnie Mae MBS, since non-QM deals do not have a credit guaranty.

Credit performance has varied depending on the documentation status of the non-QM loan (Exhibit 2). The best performance has come from asset depletion loans, loans backed more by borrower assets than income, which have shown relatively stable transition rates over the last few years. These levels are comparable to conventional loans. The worst performance has come from loans with no documentation. But both of those categories are a small portion of the non-QM universe—each is roughly $2 billion outstanding and 2% of the non-QM universe. The bulk of non-QM loans are limited documentation or debt-service coverage ratio (DSCR) loans; the DSCR loans outperform the limited and full documentation loans.

Exhibit 2. Asset depletion loans have had the lowest transition rates.

Three-month moving average. Source: Fannie Mae, Freddie Mac, Ginnie Mae, Intex, Santander US Capital Markets.

Mortgage credit performance has not been a big issue for several years. Various assistance programs during the pandemic helped avoid what could have been a calamitous number of defaults. Credit performance for some of the weaker borrowers, primarily those that cannot make large down payments and use loans insured by the Federal Housing Administration, has been weakening as pandemic assistance programs have expired and inflation has caused other expenses to absorb a greater share of borrower income.

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

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles