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Fundamentals Showing Strength

While experts see plenty of reason to be cautious about credit quality trends, third quarter data suggests that at least so far, a strong economy is outweighing factors that could push up home loan delinquencies.

In the third quarter of last year, the delinquency rate on single-family home loans stood at 4.44%, a slight improvement from the second quarter. Excluding the impact of Hurricane Katrina, the delinquency rate was lower than it had been one year earlier for all loan types.

Despite the good news, Mr. Duncan noted that delinquency and foreclosure rates could come under some pressure from rising energy costs and the seasoning of loans originated during the 2003 and 2004 refinancing boom years.

In addition, Mr. Duncan and other economists say that the rising popularity of new loan products, such as option-payment loans and interest-only loans, could have long term consequences for credit quality. The MBA has also noted an increase in non-prime credit quality loans in its survey universe.

"Just that averaging process is likely to raise the delinquency rate to some degree," Mr. Duncan said during a conference call in December. "On a weighted average basis, the underlying risk profile in the portfolio going forward will be higher."

The home equity sector, which also has been the subject of concern about credit quality, has weathered those pressures as well to date. Both banks and rating agencies saw declines in home equity credit problems late last year.

Delinquency rates on home-equity loans at banks fell in the third quarter of last year, reflecting overall improvement in the consumer credit sector despite rising short-term interest rates, according to the American Bankers Association.

The home-equity loan delinquency rate dropped to 2.33% from 2.75% in the second quarter. However, past due accounts among home-equity lines of credit increased slightly to 0.46%, from 0.43% in the second quarter, according to the ABA survey. The ABA's delinquency report tracks home equity and other consumer loans held by banks, but not those loans held by other sources.

The delinquency rate on mobile home loans fell to 3.31% from 3.74%.

Overall, banks reported a fall in key consumer credit types, including credit cards. The credit-card delinquency rate had reached a record in the second quarter of last year. The composite ratio measuring the delinquency rate on a variety of closed-end, consumer loan types fell to 2.17% in the third quarter from 2.22% of accounts in the third quarter.

"The fall in delinquencies was a welcome change, but signs of financial stress still are present," said James Chessen, ABA's chief economist. "The persistent interest rate increases by the Federal Reserve and record high gas prices in the third quarter provided a one-two punch that continued to inflict pain on personal budgets."

He also said the impact of the 2005 hurricane season will likely be spread across the fourth quarter of 2005 and the first quarter of 2006 when those results are released.

And Moody's investors service noted a similar trend among securitized home equity loans, reporting a decline in charge-offs among securitized home equity loans late last year.

While the trends were positive last year, it is important to remember that delinquency and default rates tend to be lagging economic indicators. Almost all market watchers believe that next year, pressures relating to new loan products, higher interest rates and fallout from the hurricanes could push up delinquency rates. Still, with job growth relatively strong and economic fundamentals solid, most economists believe the industry is unlikely to see a dramatic deterioration in credit quality.

SINGLE-FAMILY DELINQUENCY RATES 3RD QUARTER '05

All First Liens 4.44%

Prime Loans 2.34%

Subprime 10.76%

FHA 12.75%

Source: MBA

BANK DELINQUENCY RATES 3RD QUARTER '05

Home Equity Loans 2.33%

HELOCS 0.46%

Mobile homes 3.31%

Property Improvement 1.55%

Source: ABA

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