Berson's Weekly Commentary
Economic Commentary
December 19, 2005
Mortgage delinquencies rise in the third quarter -- special factors or a trend?
According to data just released by the Mortgage Bankers Association (MBA), mortgage delinquency rates climbed by 10 basis points to 4.44 percent in the third quarter -- the highest level in a year. Since peaking in the third quarter of 2001, delinquency rates had been trending downward. Does this increase suggest that the downward trend in mortgage delinquencies is over, or is it simply a blip on the way to even lower rates?
We usually view three factors as having an important impact on mortgage delinquency rates: movements in the unemployment rate, the age of the mortgage stock, and the characteristics of mortgages originated. How does each of these factors affect the probability of a borrower being delinquent?
Unemployment rates: households typically are current with their mortgage payments when they are employed and earning at least the income they had when they first took out their mortgage loans. Unemployment rates are a reasonable proxy for a number of job and income-related variables that affect delinquency rates.
Age of the mortgage stock: the longer a household has a mortgage, the greater the chance of a negative life-changing event occurring (e.g., divorce, disability, job loss, death, etc). Since home prices tend to rise over time, however, at some point the accumulated equity in a house is great enough that even if one of these events occurs, the household will be able to successfully sell the house to ensure it doesn't lose that equity -- reducing the risk of a default.
Mortgage characteristics: certain characteristics of mortgages can affect the probability of defaults, including: fixed-rate vs. adjustable-rate (with ARMs being riskier), the chance of payment shock (that is, the upward adjustment to ARM payments could be significantly greater than income increases), loan-to-value ratios (the more equity a household has in its home, the greater its desire not to lose it in a default), and the past credit history of the household (often summarized by a credit score).
The job market has generally been improving in the past year, and most analysts expect it to continue to expand in 2006, so this should be a positive factor for delinquency rates. Note, however, that delinquency rates have tended to be highest in those states that have had the weakest economic expansions in recent years (Indiana, Ohio, Michigan, etc). Given the record home sales and mortgage refinancings of recent years, the age of the mortgage stock is unusually low -- suggesting that there could be a rise in the delinquencies trend until enough equity is accumulated to offset the risk of negative life events. The rapid home price increases of recent years has reduced the risks of a younger mortgage stock, but now that it appears home price gains are slowing (and perhaps prices will fall in some areas) -- so the young age of the mortgage stock may be riskier. Finally, there has been a surge of borrowing in recent years using riskier mortgage products (including: ARMs, interest-only ARMs, payment option ARMs, limited documentation, investors, and simultaneous second liens). We are especially concerned about the layering of risk, as borrowers have increasingly used mortgage products with more than one of these characteristics.
On balance, we think that these three factors suggest that delinquency rates should edge up a bit in the coming year -- although what happens to home prices could have a significant impact. But there is another factor that helps to explain the third quarter increase in mortgage delinquencies: the impact of the hurricanes on the Gulf Coast states. While the majority of states had a modest rise in delinquency rates in the third quarter (illustrating the interplay of the three factors noted previously), Louisiana, Mississippi, and Alabama all had skyrocketing delinquency rates -- climbing to nearly 25 percent, more than 17 percent, and greater than 7 percent, respectively. These rates could move even higher in the fourth quarter given job losses in those areas. Over time, as job prospects improve, insurance payments are made, and perhaps additional government assistance is delivered, these delinquency rates should decline -- but they are likely to remain elevated for a while.
This will be a fairly busy week for economic indicators, with lots of housing-related information.
On Monday, the National Association of Homebuilder's (NAHB) builder survey should rise just a tad to 61 for December -- reflecting more stable mortgage rates.
On Tuesday, housing starts for November are projected to fall slightly to 2.01 million units -- in response to slower home sales and continued high multifamily vacancy rates.
Also on Tuesday, the producer price index is expected to fall by 0.3 percent in November, with the core rate rising by 0.3 percent -- as energy prices dropped sharply.
On Wednesday, the final estimate for real GDP growth in the third quarter should be unchanged at an increase of 4.3 percent -- although recent data suggest that fourth quarter growth will be substantially slower.
On Thursday, personal consumption expenditures and income are projected to rise by 0.4 and 0.3 percent, respectively for November -- suggesting that the consumer sector still has life.
Also on Thursday, initial unemployment claims are expected to edge down to around 325,000 for the week ending December 17th -- little changed over the past four weeks.
Additionally on Thursday, the Conference Board's index of leading economic indicators should climb by 0.5 percent in November -- the second consecutive strong increase.
On Friday, durable goods orders are expected to increase by 1.3 percent in November -- helped by strong aircraft orders.
Also on Friday, new home sales are projected to drop to 1.24 million units in November -- offsetting the surprising surge to a record 1.42 million units in the prior month.
Finally, on Friday, the final December reading from the University of Michigan's consumer sentiment index is expected to show a modest increase to 90.0 -- the strongest level since July.
David W. Berson
Fannie Mae Economics
Last Revised: December 19, 2005
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