We enjoyed spending time at the MBA Secondary last week – it was nice to see so many friends and make some new ones.

One of the highlights of the event was the breakout session on Rising Defaults (on Tuesday, 5/19).  The panelists, the moderator, and the audience did a great job covering a variety of relevant issues.  Here are a few select themes together with our initial thoughts.

Topic: While increased delinquencies are most apparent in FHA, all mortgage sectors have experienced higher credit risk.

MIAC Comment: We agree that the deterioration has been broad-based. The increase is much less noticeable in VA, GSE, Jumbo, and Non-QM because their base case delinquency rates have been so low in recent years.

Topic: When tracking credit, it makes sense to analyze age curves by vintage.

MIAC Comment: Given the importance of deal age, we agree that vintages should be compared on an age-adjusted basis. However, this should be viewed as a starting point for analysis. There is an important caveat when comparing age curves across sectors. In GSE, loans are removed from the MBS pool at D120+ by FNMA/FHLMC. In GNMA, loans often stay much longer than D120+ (depending upon buyouts). And in PLS, the removal from pools is governed by the applicable PSA. The key observation is that the ratio of D120+ to total UPB by age – a commonly cited metric – is NOT comparable across sectors or even across servicers/issuers within a sector.

Topic: Post-pandemic vintages (2022 and later) are performing the worst, as the pandemic vintages have better attributes (e.g., lower DTIs) and much more equity. However, the credit deterioration cannot be explained by traditional observable attributes like DTI, FICO, and LTV.

MIAC Comment: We fully agree that while DTIs have worsened, their rise cannot explain the worse credit in the post-pandemic vintages – even with a loan level model (which handles the tail risk). We emphasized this observation in our prior publications on the FHA sector. It is critical to emphasize the implications of this regime shift: credit models calibrated to pre-pandemic data will severely underestimate the future credit risk of the portfolio.

Topic: The implications of rising credit risk are multi-faceted and include numerous capacity and financial issues for MSR owners and sub-servicers.

MIAC Comment: Again – we fully agree with the panelists. Capacity issues would include (1) staffing issues (e.g., for the new FHA/VA Loss Mitigation waterfalls), (2) warehouse funding for advances and buyouts, (3) technology capacity and (4) third party providers (e.g., foreclosure attorneys). We would add that lengthening foreclosure timelines (especially in long judicial states) and increased escrows further exacerbates these issues. Our MSR calculator includes an asset/liability module that allows clients to test their funding adequacy across a user-defined set of macro stress conditions (such as HPA declines).