By the Numbers
FHA loans keep defaulting faster than others
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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.
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