Investors and insurers have been frightened by rising mortgage delinquency rates. Yet late payments have increased only slightly from the 22-year lows reached at the end of last year and early this year.

Why the strong reaction to the mild increase?

Mark Zandi, chief economist for Regional Financial Associates, West Chester, Pa., says he believes the industry has been lulled by low delinquency rates in the past few years. Executives are also disturbed by high consumer debt rates, soft housing prices, and relatively high total household debt. These perceptions have made investors and insurers much more sensitive to mortgage delinquencies.

But Mr. Zandi and other observers say they believe that while the latest jump may mean little in itself, there is plenty of reason to worry about a continuing rise, if not a surge, in delinquencies as 1996 unfolds.

The immediate worry among many industry executives seems to be that debt is outpacing income, with consumers overextending themselves and paying bills later and later.

One of the more optimistic observers, consultant David Olson, takes a different view. He says the 14% growth in consumer debt in 1994, versus only a 5.8% increase in personal income, has little significance. From 1990 through 1992, consumer debt grew much more slowly than income, and for the five years through 1994, income growth has still outpaced debt expansion.

Mr. Zandi, however, says some of the details of debt and income flow may be more disturbing than the overall picture.

"For anyone making less than $50,000 a year, their debt is rising to 20%" of annual income, said Mr. Zandi. He predicts that number may rise as high as 25%.

Increasing debt in low-income segments, combined with negligible income growth in those areas, is leaving the United States poised for even higher delinquency rates in 1996, he says.

Nima Nattagh, an analyst with TRW Redi Property Data, Anaheim, Calif., agrees that the immediate worry about delinquency rates is based more on perception than reality. But he says the industry should keep a careful watch on delinquency rates next year as recently made loans go through their peak danger periods.

Mr. Nattagh and other observers point out that lenders, trying to scrape together business after the refinancing boom ended early in 1994, have been making loans that they might not have considered previously. This trend includes lending to people with blemished credit records, making mortgage loans with low down payments, and extending jumbo loans on investment properties.

Subprime lending is the new hot market for traditional lenders hoping to plump up volume. But lack of experience in the area has meant that the industry's procedures are not up to par in the new market, said Gordon Steinbach, executive vice president for Mortgage Guaranty Insurance Corp., Milwaukee.

"You've got to know what you're doing or it'll bite you," agreed one lender that has expanded into subprime loans.

A move into affordable housing can also mean increased delinquency rates. Countrywide Funding Corp., Pasadena, Calif., says the 30-day delinquency rate on its own portfolio increased to 3.01% in October, from 1.71% a year ago. It attributes the big jump to its House America affordable housing program.

Loan-to-value ratios are one key measure of quality that continues to deteriorate as lenders stretch their limits, especially where property values are soft. In California, the amount of loans with 90% or greater LTV increased to 42.4% of all originations in the third quarter of 1995, from 35.2% in all of 1994 and 33.9% in all of 1993.

Given the rise in loan-to-value ratios, the industry should be worried. According to Mortgage Guaranty, loans with a 90% LTV ratio have twice the rate of default as 80% LTV loans - while 95% LTV loans have twice that of 90% loans.

Investors are not amused.

"Looking at structures these days, I would be more critical than in the past of underlying collateral," said one trader of mortgage securities. Credit enhancement strategies have not changed at all, but quality has, he said.

"There is a tendency to mix A-minus and B and C paper into an A-quality pool," he said. "People buy a deal thinking they are buying all A-quality paper, but they're getting B and C loans as well." B and C paper has value at the right price, he said, but "you better know what you're buying."

"Investors should look closely at credit enhancement structures" for whole loans, said Dale Westhoff, senior managing director at Bear, Stearns & Co., New York. A slight rise in delinquency rates "is really not an issue," because usually deals that are not insured by Fannie Mae or Freddie Mac are overcollateralized, he added. "There is usually a lot of protection on these deals."

There may be some saving grace for 1996, according to Mr. Zandi. Appreciating housing prices, in combination with lenders tendency in the last few months to rein in credit standards, may provide some relief toward the end of 1996, he said.

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