Subprime Vs. Prime Delinquency Shifts

High unemployment rates have turned prime loans into the high foreclosure risk category of yearend 2009 and 2010.

The 3Q09 Mortgage Bankers Association delinquency report showed the number of 90-plus-day delinquent prime loans more than doubled, indicating that prime loans are the loan type most affected by the prolonged economic crisis.

While all loan types performed poorly in the third quarter collectively contributing to quarter-to-quarter increases in foreclosure inventory and foreclosure starts - according to MBA data - changes in employment rates have resulted in higher delinquency rates primarily in the prime fixed-rate loan market. "We've had a 5.5 million increase in the number of the unemployed in the country over the last year - that compares to about 2 million loans that are seriously past due," said MBA's chief economist and SVP, Jay Brinkmann.

"The biggest increase in delinquent categories for all loans was in 90-day-plus, up 71 basis points, driven by loans pending a loan modifications and workouts."

The prime fixed-rate loans showed the same pattern with a big increase in the 90-day past due - when the foreclosure inventory and the seasonally adjusted past-due number increased 7.8% or at least one payment past due.

At the same time, up to 22.6% of the prime ARM market is at least one payment past due.

Delinquency rates in both markets are increasing. And while the prime fixed rate loans represent a bigger component, prime ARMs are performing considerably worse than the prime fixed, he said, especially in the top four problematic states of California, Arizona, Florida and Nevada.

MBA data also show a drop in the relative weight of the subprime loan category within the overall delinquency rate. For example, subprime fixed-rate loans continue to perform better. Foreclosure rates for both fixed- and adjustable-rate subprime loans dropped by 16 and 60 basis points, respectively, in the third quarter.

Is the foreclosure crisis floating from the subprime loan market onto the prime loan market?

Yes and no, Mr. Brinkmann said.

Just as his colleague Frank Nothaft at Freddie Mac, who earlier this month at the SourceMedia Loan Modifications Conference in Dallas stated that the industry's newest concern is the performance of prime loans, Mr. Brinkmann sees the prime loan delinquency rates as an indicator of the future market health.

Lenders almost stopped originating subprime loans, particularly subprime ARM loans since the first part of 2007, Mr. Brinkmann said, and some lenders have been holding them into their portfolio, or in a sense somewhat improved the quality of the loan by modifying a subprime ARM loan into a subprime fixed-rate loan.

Normally loans tend to default in the first there years. Since the market is walking its way through the peak default period for these loans, the expectation is that it will improve.

"We have seen short-term delinquency rates improving for some time. The problem though is that they will be impacted by the job market," he said. "In general, because of the seasoning curb, we have seen that getting better, particularly in contrast now to the prime fixed-rate loans where we're seeing sort of first hit on some of the weaker borrowers there."

The MBA said it sees future solutions within an overall economic improvement.

But some customer advocates see solutions elsewhere. The Center for Responsible Lending, Washington, commented on MBA findings suggesting new legislation against reckless lending as a way to protect vulnerable borrowers form foreclosure.

Quoting MBA third-quarter data that show one in seven loans is delinquent, up from one in 10 a year ago and one in 22 families in the U.S. is in the process of losing their home, compared to one in 34 a year ago, CRL said these delinquencies will turn into roughly 2.9 million foreclosure starts in 2009 alone.

CRL president Michael Calhoun stated, "The damage from reckless lending continues to harm more families and the economy." And that, in his view, calls for the creation of a Consumer Financial Protection Agency that will "avoid another housing debacle."

While well intended, CRL suggestions cannot help change the current national unemployment rate, which stands at the 26-year record of 10.2%.

Looking at the economic climate as a whole, especially in areas like California and Florida where real-estate troubles have had a negative impact on all other financial products, delinquency rates remain highly elevated over the national average across all financial products, said Experian's senior vice president and general manager of decision sciences Charles Chung.

Comparative data analysis have indicated that while in 1Q 2009 loan originations increased by 38% compared to 4Q 2008 "driven primarily by a mortgage refinancing wave, the increase was limited to the most creditworthy consumers," he said. At the same time loan originations for subprime and deep subprime consumers has continuously declined reflecting lenders' reduced appetite for credit risk.

By 2009 subprime loan performance expectations were quite low, so a recent Experian survey made an effort to quantify the deterioration and migration toward different borrower credit scores. Quarterly Experian-Oliver Wyman Market Intelligence Reports found that subprime and deep subprime outstanding balances increased by over 33% in the past three years in part due to a wider downward trend showing that this year the number of consumers in the prime grade (as measured by VantageScore) had declined by 10% since 3Q 2008.