Mortgage Performance: Is the Credit Cycle Turning

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Mortgage Performance is Beginning to Deteriorate

The contours of a typical economic expansion and recession are strongly driven by loan performance. When times are good, lenders expand loan production to more marginal borrowers but when loan performance begins to deteriorate, lenders become more conservative, which often exacerbates an economic downturn. Therefore, an understanding of the credit cycle is important to understanding the economic cycle. While loan performance improved across various loan types throughout the first five years of the expansion, over the last year three of the four major types of loans began experiencing a deterioration in loan performance (Figure 1). The exception to the deterioration in credit performance was real estate, which continues to improve. However, a closer look reveals performance is deteriorating, albeit from pristine levels of performance.

The most common methods of evaluating mortgage performance are delinquency or foreclosure rates. While they are fine to gauge credit trends, they are backward looking and a lagging performance indicator. There are several methods to address that shortcoming, such as transition rate analysis, which tracks early stage changes in performance and is forthcoming in our new Loan Performance Insights Report, or vintage analysis, which controls for time by typically focusing on only a year’s worth of loan production and allows for a much more nuanced view of performance.

Analyzing the vintages for the performance of the first 10 months of each year allowed me to evaluate 2016 using the most recent data. While loan performance after only 10 months for any vintage may seem to be an early starting point to evaluate performance, historically after 6 to 9 months performance has very strong persistence and remains on a similar track years later. Since 2010 was the first full year of the expansion vintage and underwriting has remained roughly similar since then, it is a good starting point for the analysis in the post great recession world.

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Analyzing the 2010 to 2016 vintages reveals three important trends. First, the 2016 vintage was the first year in which the serious delinquency rate[1] after 10 months was worse than the prior year (Figure 2). Second, there is clear clustering for certain years when the economy was weak versus when it was healthy. For example, ten months into the year, the 2010 and 2011 vintages had a 0.32 percent serious delinquency rate compared with 0.21 percent average for 2012 through 2014. Performance in 2010-2011 was weaker because the economy was still recovering from the recession and home price growth was nascent. Third, the trough in performance was during 2015 when the serious delinquency rate 10 months into the year was only 0.13 percent, the lowest rate in the last two decades. The stellar 2015 performance reflects a combination of the highest economic growth since the Great Recession, a labor market approaching full employment and steady home price growth.

During 2016, economic growth slowed by a substantial full percentage point and affordability cracks began to show, causing the serious delinquency rate for that vintage to worsen modestly to 0.17 percent at the 10-month mark. While performance for the 2016 vintage is still very good from relative to the last two decades, it is beginning to worsen. Historically, when the mortgage credit cycle begins to deteriorate it continues to do so until the economy bottoms and the credit cycle begins to improve again. While the deterioration in mortgage performance is very small and rising from very low levels, it is important to track because turning points are critical but difficult to identify in real time.  

[1] Serious delinquency rate is defined as 90 or more day past due and includes loans in foreclosure.

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