TheMReport

44 | TH E M R EP O RT SERVICING THE LATEST O R I G I NAT I O N S E R V I C I N G DATA G O V E R N M E N T S E C O N DA R Y M A R K E T We've Seen This Before A new report raises the question of subprime making a comeback—and the risk of default inherent in today's loans. M ortgage risk set a new series high in July, rising 0.5 points from the same period last year, accord- ing to the American Enterprise Institute's (AEI's) National Mort- gage Risk Index (NMRI) for July 2018. While the FHA index set a new high at 28 percent, higher cash-out refinances during the period also saw the refinance NMRI rising to an all-time high. "Higher NMRI indicates agencies continue to increase leverage to maintain levels of mortgage activity and in furtherance of their 'afford- able housing' mission," said Edward Pinto, Codirector of AEI's Center on Housing Markets and Finance. The NMRI monitor's the hous- ing market's stability through real-time tracking of leverage and is a standardized quantitative in- dex for mortgage risks. The index places loans in risk buckets and assesses default risk based on the performance of 2007 vintage loans with similar characteristics, pro- viding a nearly complete census of government-guaranteed loans and purchase-mortgage trends. In July, the data from the NMRI indicated a considerable spread of default rates across risk buckets, with the composite index for purchase loans being led by FHA loans that set a new series high. The AEI said that unless household income accelerated, "future support for the housing market will likely involve further increases in leverage from an already high level." A massive increase in cash- out risk, which has more than doubled from July 2013, was a vital driver of the rise in risks, along with a shift towards higher debt-to-income (DTI) after the government-sponsored enterprises (GSEs) increased DTI limit to 50 without compensating factors. "The increase in the cash-out refinance risk index has been nothing but breathtaking," said Tobias Peter, Senior Research Analyst at AEI's Center on Housing Markets and Finance. "With mortgage rates rising over the last two years, combined with declining volumes of rate-and- term refinances and flat purchase volume, nonbank lenders continue to ease credit standards for cash- outs, propelled in large measure by steering borrowers to FHA and VA, which have a much wider credit box." The data also indicated that subprime loans could be mak- ing a comeback. According to the NMRI, while growth in purchase lending volume did not pause equally across the risk spectrum, the volume of subprime loans is seeing "a robust increase while prime and near-prime contracted." Looking at how the general housing trends were impacting mortgage risk, AEI said that the supply-demand imbalance was driving up home prices. "The implications of leverage during a long-lasting seller's market, now in its 73rd month, are higher house prices concentrated at the lower end of the market and in lower-income neighborhoods where leverage has been increas- ing the most," Pinto said. "On the national level, there has been a long period with few metros experiencing negative home- price growth, which is allowing market excesses to build. Moving forward, there will be even more risk as borrowers, especially first- time buyers, are forced to take on more leverage to buy." MSR and the Rising Rate Environment A recent webinar sought to answer servicers' hot-topic questions on where the market is headed. A re advances on a loan and the losses associat- ed with them a part of the asset they've been taken against or are they separate entities? And while it is easy for mortgage servicers to think about revenue realization for more ex- treme delinquency levels, how can they account for those in the early levels of default? A recent webinar on mortgage servicing rights (MSR) performance by Mountain- view Financial gave insights into these questions and how mortgage servicers can forecast their impact more accurately. Presented by Mark Garland, Managing Director, Business Analytics; Mike Riley, Managing Director, Analytics; and Matt Maurer, Managing Director Business Development, the webinar also took a closer look at how the rising inter- est-rate environment was impacting the performance of MSR assets. "Bonds have been selling off hard and very fast as rates are going higher," said Riley. "We saw a largely parallel shift in rates for MSRs on a month-over-month basis in September and despite the rising rates, there was no re- ally large movement in mortgage spreads or volatility." Looking at prepayment activity, Riley said that there was almost no rate term refinancing activity across most of the outstanding loan population. Speaking about advances, losses and their relationship to mortgage servicing, Garland gave insights into whether advances should be counted as a part of the asset or as a separate entity in a financial state- ment. "At Mountainview, we believe that the cost of the advance is very much a part of the asset," Garland said. Explaining the implications of fair values on advances, Garland said that often with ABS products, when rates fell, the value would go up because the cost of advance would go down. "Some people see the cost of advances as a reduc- tion in custodial flow. The premise is that even though they don't necessarily get everything together, some of these funds are fungible, and they're ultimately sitting with custodial balances, so really the ad- vances theoretically are a reduction in float opportunity," he said. Regarding revenue realization, Garland said that while it was easy to think about the revenue realization model for extreme delinquency levels, many servicers found it challenging to forecast the model for early-stage delinquencies. "When the consumer doesn't pay, the servicer doesn't get paid, and it's very easy when we think of revenue realization when you go to the most extreme part of the default cycle like 90+ or 120+ delinquencies, but there's not enough attention paid to the 30- and 60-day product," he said, while recommending that servicers must understand patterns in what percentages are collected versus anticipated, especially on varying delinquency levels. Some of the other factors that made it difficult for servicers to forecast these models were issues where a lender paid mortgage insurance and partial payments or even events like hurricanes which can cause a good deal of disruption in the forecast.

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