Mortgages used to buy homes historically default less than replacement loans, partly because of the greater vigor employed by lenders in underwriting the first category of debt, the New York-based ratings firm said today in a report. The dynamic is beneficial for investors as higher rates reduce how many consumers can benefit by refinancing, boosting the share of purchase loans in pools backing nonagency bonds, Moody’s said.
“It’s a very clear trend we’ve seen,” said Kruti Muni, an analyst at Moody’s who worked on the report, which addressed the quality of securities tied to “jumbo” mortgages, the only type now being packaged into nonagency bonds.
A slowing of the Federal Reserve’s debt buying and an improving economy has driven the average rate on typical 30-year mortgages to 4.5% from a record low 3.47% in December 2012, according to Mortgage Bankers Association data. A slump in new loan volumes caused by the drop in refinancing is curbing nonagency issuance, along with banks’ demand for loans for their balance sheets and bond investors’ desire for higher yields after record defaults.
Fewer refinance mortgages should be a “credit positive” for new jumbo-mortgage bonds, according to Moody’s. The average share of purchase loans in deals by Redwood Trust Inc., the most active issuer since the market restarted in 2010, rose to 54% in the second half of 2013, from 26% in the previous six months, according to the report.
While purchase mortgages are generally given to borrowers with higher credit scores, that doesn’t fully explain their better historical performance, Moody’s said. Lenders also “have typically subjected purchase obligors to more stringent credit reviews and property valuations since purchase borrowers have no history of residing in the home,” the firm said in its report.
One type of purchase mortgages guaranteed by Freddie Mac in 2005 carried a five-year default probability of 1.7%, compared with 2.7% for similar refinance loans not used to extract cash from home equity, according to Moody’s.
Tighter underwriting standards since the 2008 financial crisis and the introduction last month of “qualified mortgage” rules creating new legal risks for lenders may mean the difference isn’t as pronounced in the future, Muni said in a telephone interview.
While issuance of nonagency securities tied to new loans jumped to about $13.5 billion last year from $3.5 billion in 2012, the sales collapsed after September, according to data compiled by Bloomberg. Less than $1 billion of the deals were completed from October through December, and less than $650 million so far this year, the data show.
Jumbo mortgages are those larger than allowed in government-supported programs, currently as much as $729,750 for single-family properties in high-cost areas. For Fannie Mae and Freddie Mac loans with the lowest costs for most borrowers, limits range from $417,000 to $625,500.
Home-loan originations will fall to $1.12 trillion in 2014 and $1.23 trillion in 2015, from $1.76 trillion last year, the mortgage-banker association forecasts. Refinancing will account for 39% of new loans this year and 35% next year, down from 63% in 2013.