housing risk briefing_012714

1

Briefing on National Mortgage Risk Index and Other Risk Measures

Edward Pinto and Stephen OlinerAEI International Center on Housing Risk

HousingRisk.org

January 27, 2014

http://www.housingrisk.org/

2

Background

• Financial crisis largely stemmed from a failure to understand build-up of housing risk: – Mortgage risk – House-price (collateral) risk– Capital adequacy

• AEI’s International Center on Housing Risk (HousingRisk.org) is addressing this problem: – Will provide objective and transparent risk measures– National Mortgage Risk Index (NMRI) is now available– Indices of collateral risk and capital adequacy to be released later this year


3

The NMRI

• Principles behind the NMRI – Market stability depends on the preponderance of loans being low risk,

defined as good performance under stress – NMRI provides a stress test, similar to crash tests for cars and structural

stability ratings for buildings in hurricane zones

• Basics of index construction and coverage – Places loans in risk buckets and assesses default risk based on performance

of 2007 vintage loans with similar characteristics– Currently covers nearly all gov’t-guaranteed mortgages for home purchases

(about 75% of all purchase loans)– Coverage will be expanded later this year

4

NMRI for Home Purchase Loans

* Index changes measured from first month shown.Source: AEI International Center on Housing Risk, www.HousingRisk.org. Separate index not available for VA guaranteed loans. RHS is Rural Housing Service.

All indexes shown are high relative to prudent standards and have trended up.

Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-134%

8%

12%

16%

20%

24%

4%

8%

12%

16%

20%

24%

Fannie/Freddie: +0.9 ppt, from 4.9% to 5.8%*

Composite: +0.2 ppt, from 10.6% to 10.8%*

Stressed default rate

FHA/RHS: +1.3 ppt, from 22.2% to 23.5%*FHA/RHS accounts for 30% of all purchase loans and is the main factor behind high level of composite index.

Shifts in market share caused the composite index to decline from Nov. to Dec. even though the components were steady or edged up.


5

Calibrating Mortgage Safety

• Composite index substantially above 1990 level, but not approaching 2007 level when underwriting was exceptionally lax.

• Fannie/Freddie index somewhat above 1990 level and rising.

• FHA index extremely high and rising. Sharp contrast with safe underwriting during 1935-55.

NMRI - purchase loans Latest dateLatestValue

1935-1955 vintages (est.)

1990 vintage (est.)

2007 vintage (est.)

Composite index Dec. 10.8% NA 6% 19%

Fannie and Freddie Dec. 5.8% NA 4% 13%

FHA Dec. 24.1% 3% 15% 30%

A low-risk loan has an average default rate under stress of 3% and a maximum default rate of less than 6%. An index value of less than 6% is indicative of conditions conducive to a stable market.

6

Purchase Loan Origination Shares, by Risk Level

Source: AEI International Center on Housing Risk, www.HousingRisk.org.

Less than half of new purchase loans are low risk, and the share has edged lower on net since Aug. Likely would lead to market difficulties in event of recession.

Aug-13 Sep-13 Oct-13 Nov-13 Dec-1320%

25%

30%

35%

40%

45%

50%

20%

25%

30%

35%

40%

45%

50%

Low risk

High risk

Medium risk

Low risk defined as stressed default rate of less then 6%, medium risk is 6% to 12%, and high risk is 12% or higher.

7

GSE Low-Risk Origination Shares, Purchase Loans


Downward trend, especially for Fannie Mae.


62%

64%

66%

68%

70%

72%

74%

60%

62%

64%

66%

68%

70%

72%

74%

Freddie Mac

Fannie Mae

Combined

Note: FHA/RHS low-risk share (not shown) is about 2%.

8

Fannie Mae Share of GSE Purchase Loan Volume


Has increased since Q2, coinciding with greater riskiness of Fannie’s loan acquisitions.

2012:Q4 2013:Q1 2013:Q2 2013:Q3 2013:Q459%

60%

61%

62%

63%

64%

65%

66%

67%

68%

69%

9

Purchase Loans with DTI Greater Than 43%


Nearly one in four loans don’t meet DTI limit in QM – and likely won’t going forward because Federally guaranteed loans are exempt from limit.

Aug-13 Sep-13 Oct-13 Nov-13 Dec-1310%

20%

30%

40%

50%

10%

20%

30%

40%

50%

FHA/RHS

Composite

Fannie/Freddie

10

Purchase Loans with Down Payment of 5% or Less


Nearly half of all purchase loans and about a quarter of Fannie/Freddie purchase loans have a minimal down payment.


25%

30%

35%

40%

45%

50%

20%

25%

30%

35%

40%

45%

50%

Fannie/Freddie

Composite

All FHA/RHS purchase loans are assumed to have down payment of less than 5%.

11

NMRI Releases in 2014

• Final Monday of each month (with exceptions in italics below)• Always at 10 AM (ET)

Monday February 24

Monday March 31

Monday April 28

Tuesday May 27

Monday June 30

Monday July 28

Monday August 25

Monday September 29

Monday October 27

Monday November 24

Monday December 22

housing risk briefing_012714

Economy & Finance