Slowing home purchases and refinancings have strained mortgage underwriters who rely on application fees as a major revenue source. Easing underwriting standards is lenders' time-honored fix for this problem, at least until the credit cycle peaks.
Such a strategy may be behind the recent growth in the number of mortgage pools backed by so-called "B" and "C" loans, which are almost solely adjustable-rate.
Although they now account for only about 10% of all adjustable-rate mortgages, that proportion is growing because of an increase in originations and because "B" and "C" borrowers tend to prepay at a slower rate than their higher-quality "A" counterparts.
As expected, the Moody's credit indexes for "B" and "C" mortgage-backed pools reveal risk levels that are generally much higher than for ARM pools that are not "B" and "C."
At the end of 1993, "B" and "C" delinquencies were running at roughly double the pace of ARMs in the higher category. Since then, delinquency rates had converged, but they now appear to be diverging again.
The apparent decline in "B" and "C" delinquency rates in fact stems from the practice of some servicers' removing delinquent loans from a pool rather than letting them proceed to foreclosure.
Moody's considers the long-term viability of this tactic when assessing the creditworthiness of these servicers' pools. This practice notwithstanding, as the effects of higher short-term rates take hold, we expect "B" and "C" delinquencies to rise.
Finally, "B" and "C" foreclosure rates mirror the improvement in delinquencies but remain far higher than for their higher-quality ARM counterparts - more than five times as great during 1992 and more than double at yearend 1994.
