Study Finds Loan Performance Tied More to Housing Prices Than Creditworthiness

The excerpts below from a WSJ article are very interesting from a risk perspective. Factors such as home prices and interest rates are better predictors of loan performance than credit scores. If this is correct it looks like there is more pain ahead.

An analysis of federal data on nearly 14 million U.S. home loans made last year portends more misery for subprime borrowers, lenders and investors, as existing loans are pressured by falling home prices and lenders put tougher underwriting standards in place.

The study by the Federal Reserve, based on data collected each year under the Home Mortgage Disclosure Act, found that the percentage of U.S. mortgages carrying high interest rates (generally, subprime loans) climbed to about 29% last year from 26% in 2005.

In the report, Fed researchers said the data affirmed that the rise or fall of home prices is the biggest factor in predicting mortgage-loan performance, as opposed to the creditworthiness of borrowers and other variables. The study also linked higher concentrations of high-rate loans to rising rates of serious delinquency, or mortgages with payments overdue by at least 90 days. (my emphasis)

The study examined loans issued by 8,886 lenders nationwide, which generate an estimated 80% of U.S. home mortgages. The lenders are required to disclose dozens of pieces of information about each mortgage made or applied for, including pricing information for loans with interest rates exceeding certain thresholds. For first-lien loans, lenders must report which loans have interest rates at least three percentage points higher than Treasury securities of comparable maturity.

The 2006 increase in high-rate loans was fueled partly by the flattened yield curve, or gap between long-term and short-term interest rates, which causes the number of loans exceeding the reporting thresholds to rise even if lenders don't charge borrowers higher interest rates. Still, the data suggest frenzied competition for subprime loans, even as the housing market was weakening.
Market shares of the 10 largest high-rate lenders by volume declined to 35% from 59% in 2005, the Fed said. Banks and other depository institutions increased their penetration of the high-rate market, likely reflecting aggressive promotion of subprime loans to borrowers with blemished credit histories.

The overall denial rate for home loans climbed to 29%, from 27% in 2005. The report didn't cite the likely reason for the increase, but it could reflect stricter underwriting by lenders as well as borrowers stretching for larger loans or sinking into financial trouble.

The percentage of first-lien purchase loans to investors or second-home buyers fell for the first time since 1996. Such loans are considered riskier than those to owner occupants. The decline was modest, possibly reflecting that widespread real-estate speculation continued well after the housing market slowed.

According to the study, African-American and Hispanic borrowers also remain much more likely than whites to pay high interest rates on mortgages. In 2006, about 54% of first-lien home-purchase loans to African-Americans exceeded the high-rate threshold, compared with 18% for non-Hispanic whites.

Lenders and bank regulators say the disparities largely reflect differences in income and credit histories, not race discrimination. Home Mortgage Disclosure Act data don't include credit scores, so regulators use the information as a starting point in investigating possible discrimination.