According to figures released the Bureau of Labor Statistics released on March 4, the unemployment rate dropped slightly in February, but is still at a record-high 8.9%. In addition, a recent report indicates strategic defaults are on the rise as they become more widely accepted.
These two economic factors are causing mortgage investors to be more focused on achieving greater transparency into the collateral health of nonagency mortgage-backed securities. While investors now have access to more detailed research related to payment and default hierarchy, a new approach to analyzing borrower behavior may provide even greater clarity.
Default distance (the number of months between the default of a revolving debt and the first occurrence of foreclosure) is a metric that provides more strategic insight into default timing.
In an evaluation of default distance, a positive number indicates that a borrower defaulted on a revolving debt first while a negative number shows that the borrower defaulted on his mortgage loan first.
Analysis by Equifax Capital Markets has found that revolving account defaults tend to occur before first mortgage loan defaults, with the time span between the two decreasing over time.
The most significant decrease in default distance was on high-loan-to-value-ratio mortgages, like option adjustable-rate mortgages, most likely driven by a rise in strategic defaults.
To analyze the significance of default distance and payment hierarchy, Equifax examined anonymous borrower credit information (linking it to CoreLogic loan-level, mortgage-backed securities data) to measure default distance at every point in the life of all nonagency securitized loans. The study analyzed Federal Housing Finance Agency home price data on mortgages for borrowers with only one mortgage outstanding and revolving debt such as credit card and home equity line of credit loans.
An in-depth look at this analysis by geography, market segment and credit score shows that geography plays a significant role in default distance. According to the analysis, default distance has shrunk in most states, especially states like Florida, California and Michigan that have been hard hit by poor economic conditions. All three states had an average default distances in January 2010 of less than five months. Texas and South Dakota had the longest default distances during the same period — an average distance of more than 15 months.
With default distance increasing over time for prime loans, this segment has started to stabilize, however slightly. On the other hand, default distance for subprime loans has plateaued at 10 months. In addition, option ARM loans have leveled off at five months.
Analysis shows that high credit scores do not necessarily result in long default distances. According to Equifax' study, in late 2008 and early 2009, borrowers with a high VantageScore had the lowest average distance between revolving and mortgage defaults. In fact, the default distance for those in the 800-900 score band was approximately five months.
Why? Because although borrowers in the highest score bands typically pay their credit obligation on time, when they do default, it's on multiple accounts. As a result, the default distance is shorter.
Payment hierarchy has changed since the credit crisis, but mortgage loan defaults still follow a pattern of occurrence after revolving debt defaults. However, since 2005 the default distance between revolving debt and foreclosed mortgages has decreased. The most substantial decrease in default distance can be seen among loans with high current combined loan-to-value ratios.
