Residential Magazine

Uncertainty reigns regarding mortgage performance quality

By Neil Pierson

One of the chief concerns for the mortgage industry as the U.S. attempts to recover from the coronavirus outbreak is forecasting how many loans will slide into delinquent or default status, and how many homes will wind up in foreclosure. These questions are not easy to answer and will require mortgage lenders, originators and others to sift through mountains of data. It may be many months before the industry gets a clear picture on the damage done.

“Trying to predict the ultimate impact of COVID-19 on mortgage performance is equally an art and a science right now as there is no true historical point of comparison for analysts to model against,” says Andy Walden, director of market research at Black Knight. “That said, there are some historical clues from the Great Recession that can provide some degree of insight.”

Trying to predict the ultimate impact of COVID-19 on mortgage performance is equally an art and a science right now.

Andy Walden, Director of market research, Black Knight

The unemployment rate is likely to have a significant impact on mortgage performance, and there are signs early in the outbreak that joblessness is rising to historic levels. The U.S. Bureau of Labor Statistics reported that, between February and March of this year, the national unemployment rate jumped 90 basis points to 4.4%. 

Many forecasts, of course, are predicting a much more dire scenario. This past March, Goldman Sachs estimated a jobless rate of 15% by mid-year, while the Federal Reserve Bank of St. Louis anticipated unemployment to top 32% as up to 47 million Americans may be laid off in the second quarter alone. The latter scenario would exceed the 24.9% jobless rate at the height of the Great Depression, the New York Post reported.

Black Knight’s February 2020 Mortgage Monitor report showed that mortgage delinquencies during the Great Recession peaked at 7.9 million, or 14.3% of all U.S. mortgages. Depending on how severe the unemployment crisis gets, the share of nonperforming loans during the coronavirus outbreak could spike at anywhere between 7.5% and 18.8%. The good news, Black Knight reported, is that the market was historically strong prior to the outbreak, with delinquency and foreclosure rates near record lows early this year.

Another fear, according to some analysts, is declining home values. A first-quarter 2020 report from Fitch Ratings said that national home prices were overvalued by 1.5%. Shelter-in-place orders were causing homebuying activity to drop and shrinking demand was expected to lead to slower home-price growth. The report also noted that nearly one in five U.S. metros were at least 10% overvalued, with half of these areas in the states of California, Florida, Texas and Washington. San Antonio, Las Vegas and Austin were reportedly the most overvalued of the country’s top 50 most-populous metros.

Some areas of the country may be more susceptible to increased defaults and foreclosures. These include cities and states that rely heavily on industries such as employment services, transportation, tourism and oil. A report this past March from The Brookings Institution showed large shares of so-called “high-risk” jobs in places like Las Vegas; Orlando; Atlantic City, N.J.; Myrtle Beach, S.C.; and the Texas cities of Midland, Odessa and Laredo.“

Certainly, nondiversified local economies may be at greater risk in general, and especially so if the nature of the majority of the employment in the area is considered nonessential,” says Suzanne Mistretta, senior director of Fitch Ratings’ residential mortgage-backed securities (RMBS) group.

“Hourly workers who are furloughed or laid off are most likely to be affected in almost every industry since only essential workers are permitted by most municipalities,” Mistretta says. “Self-employed borrowers are also vulnerable if deemed unessential or [if] they cannot work remotely.” 

There are factors that could mitigate the level of nonperforming mortgages. RMBS pools are better positioned to weather a downturn, Mistretta says, due to risk-analysis measures such as ability-to-pay regulations, income-verification standards, lower loan-to-value ratios and the reporting of second-lien mortgages.

“Borrrowers’ reserves are also evaluated in underwriting, which helps during temporary disruptions,” she says. “Appraisal standards have been markedly improved and are much more uniform across all [mortgage] products.”

Walden indicates that some homeowners may be able to lower their default risk by utilizing more traditional loan products such as a refinance or a home equity line of credit. He also noted that 30-year mortgage rates were “extremely volatile” earlier this spring and those fluctuations may continue for some time as the market adjusts to the implications of COVID-19. Black Knight reported that the population of borrowers with an incentive to refinance reached a record high of 14.3 million early this past March, but rising rates caused that number to plummet by 75% or more within two weeks.

More localized crises, such as hurricanes and wildfires, provide a blue-print of sorts for what the mortgage industry can expect in terms of post-disaster delinquencies and foreclosures. Mistretta says that, in areas affected by Hurricane Maria in 2017, “delinquencies jumped by 20% but returned to pre-disaster levels several months later.”

Walden believes “it’s definitely too early to say” what the complete impact of the COVID-19 crisis will be. He notes that forbearance programs have been “broadly effective” following hurricanes and may have a large role to play in the current environment. 

“This does provide some hope that a large number of those entering the [forbearance] programs can avoid downstream foreclosure,” he says. “Of course, their effectiveness in mitigating long-term financial stress is less known.“


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