Despite a rise in mortgage delinquencies, home foreclosures, and unemployment, many industry experts remain confident that the mortgage business can weather any credit storms on the horizon.
The anemic economy notwithstanding, the mortgage and housing markets are still on a relatively solid footing and should fare well for the balance of the year, several observers said.
"So far we have not seen any significant worsening in mortgage credit risk because the fundamentals are still strong," said Michael D. Youngblood, the managing director of real estate research at Banc of America Securities LLC. "I'm not saying that we are never going to see it, but right now everything is, 'So far, so good.' "
Yet some observers say that many new products, such as mortgages with loan-to-value ratios of 90% or more, cash-out refis, and risk models used by automated underwriting systems, have not been tested under tough economic conditions. If the economy continues to worsen, these observers say, portfolio lenders and mortgage bond investors may face problems as these loans hit choppy waters.
Delinquency and foreclosure rates ticked up slightly during the second quarter of 2001, according to a survey released Sept. 4 by the Mortgage Bankers Association.
Delinquencies among loans on one- to four-unit residential properties reached 4.63%, up 26 basis points from the first quarter, and the share of loans on which foreclosure has been started rose 5 basis points, to 0.36%. The percentage of loans in the foreclosure process at the end of the quarter rose 1 basis point, to 0.91%.
In addition, unemployment surged in August, to 4.9% from July's 4.5%, which could lead to more problems in existing mortgage loans.
Mr. Youngblood of the Bank of America unit said that the mortgage trade group's latest foreclosure data are not indicative of a widespread rise in credit problems but rather of an increase in the riskier VA and FHA-insured loans. "One has to read the MBA delinquency survey very carefully," he cautioned.
Subprime and newer types of loans will get into trouble faster because they are highly leveraged and are held by borrowers who are more vulnerable to swings in the economy, said Bert Ely, the principal of Ely & Co. Inc. in Alexandria, Va. "The weaker credits are the ones where problems start," he said. These borrowers "are not good at managing their finances to begin with."
"It's a reach to say we have a crisis here, even if we get a prolonged slowdown that could cause consumer credit problems," Mr. Ely said.
Richard Beidl, an independent mortgage technology analyst in Norwood, Mass., said that during the last significant recession, in the 1980s, many borrowers with 80%- to 85%-LTV loans simply left their homes as prices fell. In fact, he said, the losses turned so bad that Fannie Mae and Freddie Mac stopped underwriting the high-LTV products. (Today, both Fannie and Freddie buy up to 97%-LTV loans.) And things could get worse this time around, Mr. Beidl said.
Moreover, many other new loan products have appeared in the last few years, said Scott Cooley, the chief strategy officer of Ellie Mae Inc. in Pleasanton, Calif. These credits were underwritten with data culled from an economic boom period, he said. Ellie Mae is a private, business-to-business provider of Internet services for the residential mortgage brokerage industry and is not related to the government-sponsored enterprises.
"Average-LTVs have continued to increase, loan products have continued to get more aggressive, and lenders are more and more lenient on automated underwriting criteria," Mr. Cooley said. "When do you start turning that around? Does it take a recession to start making those changes? Maybe now is the right time to tighten standards."
It is difficult to obtain data from the last major recession, Mr. Beidl said, which leaves risk managers with data based on the last seven years. By basing their data sets on relatively recent statistics, he said, they miss the cyclical nature of the economy.
To be sure, the last housing recession, in the 1980s and early 1990s, was driven by downturns in several regional markets: the Southwest, the Northeast, and California, Mr. Ely said. Currently, he said, there are no indications that regional crises are brewing.
Further, some experts say, the mortgage industry today is better at managing credit risk and in developing models that predict which loans will have problems.
"Modeling in the mortgage risk and analytical areas has made a stellar jump from the mid-1990s to today," said Frank Raiter, managing director of the structured finance residential mortgages group at Standard & Poor's. The modeling systems, many of which have been tested against historical data from periods of economic distress, help companies act more quickly to address loan problems, Mr. Raiter said.
Executives at Fannie Mae and Freddie Mac, of course, expressed confidence in their abilities to guide lenders to underwrite safe loans and to service the loans when they become distressed. They also said their first line of defense, the automated underwriting systems, weed out risky loans.
"We are able to effectively look at every individual loan at a very granular level" when they come to Freddie, said Joseph E. Amato, a vice president for finance at Freddie Mac. "This is a significant change versus the early 1990s, when loans were underwritten manually, leading to much greater risk and uncertainty."
Executives at both companies said the loans they own or have securitized average an LTV of just over 60%, supplying an adequate cushion for whatever credit deterioration could occur in a recession.
Robert J. Engelstad, Fannie Mae's senior vice president for credit policy, said many products launched recently by the GSEs "are built off fundamental core products that we have been doing for many, many years." As a result, he said, Fannie has sufficient data for predicting loan health.
Both boasted that their credit losses during the second quarter had hit historic lows.
Mr. Engelstad said that Fannie's credit loss reached the 17-year low of $16 million, or a loss rate of half a basis point. Mr. Amato said that Freddie's credit loss was $14 million, or a rate of 0.6 basis point.
Moreover, Fannie and Freddie executives said both companies maintain systems for identifying problems during the life cycle of their loans to alert servicers of potential problems. However, Mr. Raiter said, it would be inappropriate to expect models to do everything in terms of managing risk.
Indeed, an industry observer, who requested anonymity, warned that there is no guarantee that mortgage companies are protected from a downturn.
"You can protect yourself against the things that you know best that have happened before," the observer said. "However, the greatest difficulty occurs when the nature of the problem is different from what you have experienced before, and the financial markets are wonderful for coming up with new ways to deal out trouble."