A whole new ballgame: much of the industry's attention throughout the refinance boom was on the origination side. Lenders sought endless ways to maximize loan closings for as many borrowers as they could in as little time as possible. Now, conditions have changed and servicers are looking at the default potential of all those new loans in the portfolio.

Author:Williams, Dean

WHILE MORTGAGE ORIGINATORS NOW ARE FOCUSED on managing the decline in production, the servicing sector is bracing for potential "default fallout" from the explosion of loans written in the last three years. [??] Yet in spite of the new awareness that more defaults are likely to be on the horizon, there are opportunities today for servicers (and investors) to increase profitability and stabilize and secure their market position. [??] As a result of an effective national campaign promoting widespread homeownership and the exponential popularity of new and old kinds of nonconforming mortgage loans, homeownership levels are currently at an all-time high. One byproduct of the drive to qualify more homeowners, however, has been that some of those new homeowners were not fully financially prepared to be homeowners when they signed their loan. Others, due to an uncertain economy, may find themselves unemployed--or earning less now than when they bought their home. [??] Homeownership is not the answer for everyone. Nonetheless, when technology improves efficiencies in origination processes, a national homeownership campaign proves effective. And when the market experiences the lowest residential mortgage interest rates in decades, origination volumes are bound to remain high. But with those increased originations comes the inevitable byproduct--increased numbers of distressed properties, real estate-owned (REO) disposition loans, defaults and, eventually, foreclosures.

A look at the mortgage delinquency data will help to illustrate the picture better. A natural seasoning effect has been evident for a long time in the servicing business. Mortgages tend to reach peak delinquencies after seasoning for roughly three to four years in a portfolio. The massive volume of originations during the refi boom of the last few years will start to hit its default-prone years in the next few years. This alone will produce an uptick in delinquencies.

While overall national delinquency rates have been declining across the board since the third quarter of 2001 (with a few minor blips in the second quarters of 2002, 2003 and 2004), the string of good numbers may be about to hit some bumps in the road. A small signal that some rougher times may lie ahead for delinquencies appeared in the data for subprime loans in the third quarter of 2004.

The Mortgage Bankers Association's (MBA's) third-quarter 2004 National Delinquency Survey (NDS) released on Dec. 9, 2004, showed a modest decline in the national mortgage loan delinquency rate to 4.41 percent versus 4.49 percent in the third quarter of 2003.

The third quarter of 2004 also saw no increase in the rate of foreclosures started in the quarter compared with the rate in the second quarter of 2004. The rate of new foreclosures in 2004's third quarter (0.39 percent) was down slightly from the rate in the year earlier period (0.44 percent).

Both of these sets of numbers suggest that all is well on the default front. But when the survey results are examined at a more detailed level, specifically reviewing subprime and Federal Housing Administration (FHA) loan activity, the implications for the servicing industry are far less optimistic. Admittedly, one set of quarterly numbers does not define a trend. Yet, the numbers are worth examining.


The NDS delinquency rate for subprime loans has been bouncing around a bit over the last few quarters (see Figure 1). Over the last four reported quarters it has gone from a high of 11.53 percent (fourth quarter 2003) to a low of 10.04 percent (second quarter 2004). But significantly, the numbers had been declining for eight straight quarters until the third quarter 2004, when they kicked back up by 35 basis points.

The numbers on new subprime foreclosures started also staged a modest rise in the third quarter 2004 NDS report. After hitting a new low for the subprime delinquency series in the second quarter of 2004, they jumped by 18 basis points in the third quarter last year.

What the NDS reveals, in my view, is that the backlash of high loan volumes is beginning to take effect. Investors and servicers are now faced with the challenge of how best to prepare for...

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