TransUnion: Borrowers with Modifications Perform Better on Consumer Loans

A new study has found that consumers
who received mortgage modifications outperformed
those who did not on new
consumer loans they opened after their initial mortgage delinquency.   The study, conducted by TransUnion, looked at
consumers who were 120 days past due at some point on their mortgages and
compared the credit performance of those who had received a loan modification
and those with a similar credit score who had not.

The study found that 41.9 percent of
mortgages that were modified during the period studied – 2008 to 2010 – were 60
days delinquent on that mortgage at the 12 month mark following modification
and 59.1 percent by the end of 18 months.

Generally speaking, borrowers who
received a loan modification and then opened a new auto loan or credit card
account performed better on those new loans than those who had not received a
modification.  For those with modifications
6.06 percent were 60 or more days delinquent on that loan 12 months after
opening the account.  For credit cards
the rate was 13.63 percent.  Where borrowers
had not received a mod the 60 day delinquency rates were 11.40 percent and
17.13 percent.

Within the population of modified
mortgages, the study looked at borrowers who had defaulted on their mortgages
but on no other loans compared to those with multiple delinquencies. The
12-month recidivism rate for mortgage-only (MO) defaulters was 38.8%, while the
recidivism rate for multiple delinquency (MD) borrowers was 46.2%.

The subset of borrowers who had
multiple defaults also performed more poorly on new credit than MO borrowers.  The former group at the end of 12 months had
a 60 day delinquency rate on auto loans of 8.65 percent and credit cards of
27.69 percent.  The group with only a
mortgage default had rates of 4.03 percent and 6.55 percent respectively.

“MO defaulters significantly outperformed MD defaulters on new loans
opened after mods even when controlling for credit score,” said Charlie
Wise, director of research and consulting in TransUnion’s financial services
business unit. “After 12 months, MO defaulters had an average 45% lower
delinquency rate on new auto loans opened following a mortgage mod, and an
average 63% lower delinquency rate on new bankcards.”

Of more than 5 million mortgage
that were originated prior to 2008 and were delinquent during the study
period TransUnion identified approximately 559,000 records of mortgage
which were analyzed for 6-, 12- and 18-month performance.  It may be worth mentioning that the 41.9
percent redefault rate at the 12 month and 59.1 percent rate at 18 months noted
by this study are much higher than the redefault rates reported by the Home
Affordable Modification Program (HAMP) which accounts for about one-sixth of
the 5.5 million modifications done since 2008. 
HAMP claims that about 27 percent its modifications completed within that
period (HAMP began modifications in 2009) were delinquent at the 18 month mark.

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S&P: Second Mortgage Defaults at Lowest Point in 7 Years

Default rates fell in May for all types
of loans tracked by the S&P/Experian Credit Default Indices. For most loan types it was the fifth
consecutive drop and four loan types posted their lowest rates since the end of
the recession.

The national composite default rate
declined to 1.62 percent in May from 1.86 percent in April and the first
mortgage rate was down to 1.50 percent from 1.76 percent. Second mortgage defaults were at 0.88 percent,
compared to 0.93 percent and bank card defaults dropped to 4.35 percent from
4.49 percent. Auto loans fell four basis
points to 1.03 percent, a low point in the eight year history of the index.

Second mortgage defaults were at their
lowest point in seven years and first mortgage and credit card defaults were
the lowest since May 2007 and 2008 respectively.

“May 2012 data show continued
improvements in consumer credit quality,” says David M. Blitzer, Managing
Director and Chairman of the Index Committee for S&P Indices. “Consumer
default rates continue to fall and we are reaching new lows across all the loan
types. In the last recession, default rates peaked in the spring of 2009, since
then the decline has been bumpy but consistent.  Only bank cards remain
above their pre-recession lows.

S&P/Experian covers five
metropolitan statistical areas (MSAs) and all five saw their default rates fall
to post-recession lows. Chicago declined
for the fifth straight month to 1.85 percent, down nearly a percentage point
since December. Miami and New York recorded
their fourth consecutive decreases with Miami down by 59 basis points and New
York by 17. Dallas hit an index low at
0.94 percent, down from 1.25 percent in April and Los Angeles moved down
slightly from 1.88 percent to 1.82 percent.

The table below summarizes the May
2012 results for the S&P/Experian Credit Default Indices. These data are
not seasonally adjusted and are not subject to revision.

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FHFA Sends Annual Report to Congress on GSEs, FHLBanks

As required under the Housing and
Economic Recovery Act (HERA), the director of The Federal Housing Finance
Agency (FHFA) submitted the agency’s annual Report to Congress on the two government
sponsored enterprises (GSEs)
for which it is responsible and for the Federal
Home Loan Banking System (FHLBanks.)  In
addition to a lengthy recounting of the performance of the regulated entities
during the course of 2011, FHFA also provided an assessment on their safety and
soundness including information on any material deficiencies in their
operations, their overall operational status, and an evaluation of their
performance in carrying out their respective missions.

FHFA reported that it had conducted an examination
of both GSEs as to their financial safety and soundness and overall risk
management practices on a framework known as GSEER which stands for Governance,
Solvency, Earnings, and Enterprise Risk which comprises credit, market, and
operational risk management.  The agency
assigned rating of critical concern to both Fannie Mae and Freddie Mac in a
number of areas and ratings of substantial concerns in others. 

In the case of Fannie Mae, the report
says that the GSE “exhibits critical financial weaknesses as evidenced by its
poor performance and condition and prospects”. 
Credit risk remains high but is somewhat mitigated by the higher quality
of the single family book of business since 2009.  Business operations are vulnerable to
disruption, especially by human capital risk, and capital is wholly dependent
on the support of the U.S. Treasury.

In the case of Freddie Mac FHFA says its
credit risk remains high, the control structure is weak, human capital risk is
elevated, and their capital is also wholly dependent on the Treasury.

The most significant
risks facing Fannie Mae are credit risk, human capital risk, dependence on a
legacy infrastructure that needs to be updated, and the need to execute the
strategic plan for the conservator ships. 
Fannie Mae’s management and its board were responsive throughout 2011 to
FHFA findings and are taking appropriate steps to resolve issues the report
says.  However Fannie Mae must continue
to identify and proactively reduce the risk and complexity of its business
activities, focus on loss mitigation and foreclosure prevention, and maintain
sound underwriting criteria for single family and multifamily portfolios.

FHFA assigns a limited concerns
rating to Fannie Mae governance, an upgrade from the last examination and is
working with the company to identify a new president and chief executive
officer.  This solvency or capital
classification for ratings remains suspended as it has been since the beginning
of conservatorship, but FHFA assigns earnings a critical concern rating.  Fannie Mae’s net losses increased in 2011 to $16.9
billion from $14 billion in 2010, driven primarily by high provisions for credit
losses.  New delinquencies along with
further declining home prices resulted in a substantial increase in loan loss
reserves.  These reserves increased $10.6
billion to $76.9 billion in 2011.  In
addition a steep decline in long-term interest rates led to mark-to-market
losses on derivatives used for hedging purposes.

Fannie Mae’s credit risk also rates
a critical concern.  Although risk is
high and the quality of risk management is adequate and the level of risk is
decreasing the principal concerns are the credit characteristics of Fannie Mae’s
legacy 2005 to 2008 vintage single-family book of business, opportunity’s to
improve multifamily risk management, and continued weakness of its mortgage
insurer counterparties.

FHFA assigns market risk a
significant concern rating, an upgrade from 2010.  Risk levels are high but the quality of risk
management is adequate.  The concerns are
largely centered around increased balance sheet illiquidity because of the
amount of distressed assets and whole loan portfolios resulting from loss
mitigation activities, the need to strengthen attendant risk management
practices, and the continued negative effects on earnings from the mark-to-market
negative effects from derivative contracts. 
However liquidity and funding risks are low and the related risk
management is adequate.

risk is a significant concern, another upgrade from 2010.  The level of risk is high and increasing but
the quality of operational risk management is adequate although Fannie Mae needs
to further strengthen project management. 
Its uncertain future, legacy information technology, manual processes that
reduce its flexibility, and the requirement to implement the strategic plan
keep operational and process risks at elevated levels.  However the company improved risk management
in 2011 by installing new operational risk leadership, implementing a risk
management framework, centralizing the reporting structure and other

In conducting its examination of
Freddie Mac, FHFA focused on matters previously identified as requiring
attention and the board and management’s response to deficiencies and
weaknesses identified by internal and external audits.

Governance was considered a
significant concern in the examination of Freddie Mac.  The company’s enterprise risk management
structure continues to benefit from a recent redesign however management is
finding it difficult to maintain an adequate control structure because of
increased employee turnover and reliance on manual processes.  The quality of information the Board of
Directors receives has improved and FHFA is working with the board to identify
a new CEO.  The board should continue to
focus on the key risks and issues facing Freddie Mac including the effect
employee turnover has on its ability to manage its information technology.

Freddie Mac received a critical concerns
rating on earnings.  Total revenues
increased slightly in 2011 and credit related expenses and mark-to-market
losses on derivatives also increased.  Derivative
losses were offset partly by interest rate related gains on assets. 

Credit risk was also considered a critical
concern although it is decreasing and its risk management is considered
adequate.  As with Fannie Mae, the
principal concerns center around the GSE’s 2005 to 2008 vintage single family
loans, coupled with underwriting and controls in the multifamily business line,
weak mortgage insurer counterparties, and increased concentration of
counterparty risk.   FHFA said that the
higher quality of Freddie’s more recent single family business and management’s
success in loss mitigation is alleviating some concerns.

Market risk is considered a significant
concern.  The level is high relative to
earnings and capital for the quality of risk management is adequate.  The retained portfolio’s growing proportion
of illiquid assets is increasing risk because of the level of distressed assets
and whole loan portfolios.  These assets
are less liquid, causing prepayment modeling difficulties and less reliable
interest rate risk metrics.  Human
capital risk in the investment and capital markets group and continued negative
effects from the mark-to-market derivative contracts are also a concern. 

Operational risk is a critical concern
as it is high and increasing and the quality of risk management needs
improvement.  Human capital risk and the dependence
on legacy operational and information technology infrastructure are among the
highest risks facing the GSEs. 

Model risk is a significant
concern but while the level is high it is stable.  FHFA’s concerns include the timeliness of
model valuations and the efficacy of models in the current economic

followed up a special review in October of 2011 with a directive requiring
Freddie Mac to phase out its retained attorney network and to work with FHFA
and Fannie Mae through the Servicing Alignment Initiative to develop and
implement consistent requirements, policies, and processes for default and foreclosure-related
legal services.

reported that as of the end of 2011, the FHLBanks exceeded the minimum leverage
ratio by having at least 4 percent capital-to-assets.  The weighted average regulatory capital to assets
ratio for the system was 6.9 percent in 2011 compared to 6.5 percent in 2010.  All FHLBanks were profitable for the year and
the system’s advance business continues to operate with no credit losses.  However the quality of the FHLBanks’
investments in private label mortgage backed securities (MBS) remains a
significant concern.  Exposure to such
securities dropped by 20 percent during 2011 as did the credit charges
associated with the securities.

2011 two FHLBanks were under consent orders because of their financial
conditions.  The FHLBank of Seattle saw deterioration
in the value of its private label MBS starting in 2010 while Chicago had been
operating under a cease and desist order since October 2007.  Seattle remains under the enforcement action
but Chicago’s order was removed in early 2012.

overall all scale of the FHL banks advance operations continued to decline in
2011 reaching $418 billion at year end compared to $479 billion at the end of
2010.  Investments in private label MBS
have adversely affected the overall operation of some banks reducing their
ability to repurchase or redeem stock as the banks shrunk.  FHFA has taken action where needed to address
this problem.

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FHA Stepping up Bulk Sales Volume

Federal Housing Finance Agency (FHA) Commissioner Carol Galante and Housing and
Urban Development (HUD) Secretary Shawn Donovan announced late Friday afternoon
a new bulk sale program to liquidate some of the reported 700,000 delinquent loans
backed by FHA insurance
.  The Distressed Asset Stabilization Program is an outgrown of a pilot program that
allows private investors to purchase pools of mortgages headed for foreclosure.  The pilot has resulted in sales of more than
2,100 single family loans to date.

Beginning with the September 2012
scheduled sale, FHA will increase the number of loans available for purchase
from approximately 1,800 each year to a quarterly rate of up to 5,000, and add
a new neighborhood stabilization pool to encourage investment in communities
hardest hit by the foreclosure crisis.

According to an article in the Wall Street Journal published before the sale was officially announced, FHA is undertaking
bulk sales in an effort to reduce its growing portfolio of distressed loans and
to avoid the costly process of foreclosure, but also because its own rules
limit ways in which the mortgages can be modified, leaving little room for aggressive
loan modifications like those done by Freddie Mac, Fannie Mae, and proprietary
lenders.  Once sold these strictures
disappear, the new servicer can take more drastic steps to bring the loans back
on line.

Under the new program, the current servicer
can place a loan into the bulk sale loan pool if the borrower is at least six
months delinquent on his mortgage and has exhausted all steps in the FHA loss
mitigation process.  The servicer must
also have initiated foreclosure proceedings and the borrower cannot be in bankruptcy.

accepted from the servicers, the notes are sold competitively at a
market-determined price generally below the outstanding principal balance. To
minimize the chance “vulture investors” will take advantage of the program, potential
investors must agree to hold off foreclosure for a minimum of six months and
work with the borrowers to help find an affordable solution to keep them in
their homes. FHA also seeks to provide some protection to the market by
requiring purchasers to hold back from sale at least 50 percent of the homes
backing the loans for at least three years.

“The Distressed Asset Stabilization
Program offers a better shot for the struggling homeowner and lower losses to
the FHA,” Galante said. “By addressing the growing back log of distressed
mortgages, FHA is helping to mitigate the negative effects of the foreclosure
process as part of the Administration’s broader commitment to community

“While our housing market has
momentum we haven’t seen since before the crisis, there are still thousands of
FHA borrowers who are severely delinquent today – who have exhausted their
options and could lose their homes in a matter of months,” said HUD Secretary
Shaun Donovan. “With this program, we will increase by as much as ten times the
number of loans available for purchase while making it easier for borrowers to
avoid foreclosure. Finding ways to bring these loans out of default not only
helps the borrower, but helps the entire neighborhood avoid the disinvestment
and decline in value that accompanies a distressed property.”

 “Currently, FHA’s inventory of REO properties
available for sale is at its lowest level since FY 2009,” added Galante. “At
the same time, the inventory of seriously delinquent loans is near an all time
high. With many neighborhoods still fighting to recover from the housing
crisis, going upstream will allow us to help more borrowers before they go
through foreclosure and their homes ever come into the REO portfolio.” 

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Paper Suggests Lower GSE Fees May Pay Off in Reduced Defaults

The Federal Reserve Bank of New York
recently released a paper that looked at the impact of HARP revisions on loan
defaults and pricing
.  The paper, Payment Changes and Default Risk: the Impact
of Refinancing on Expected Credit Losses
was written by Joseph Tracy and
Joshua Wright. 

When the Home Affordable Refinance Program
(HARP) was initiated, its goal to stimulate the economy and reducing defaults
by lowering mortgage payments in households with high loan-to-value mortgages. These
were borrowers who were otherwise unable to refinance.

HARP was implemented in 2009 but refinancing
activity was much lower than expected. 
Just over one million refinances have been done under HARP rather than
the 3 to 4 million expected.  This
confirms, the authors say, the original rationale for HARP, that in the wake of
the housing bust borrowers need help refinancing.

HARPS lackluster results have provoked discussion
about the impediments to refinancing including credit risk fees, limited lender
capacity, a costly and time consuming appraisal process, limitations on
marketing, and legal risks for lenders.  HARP
was recently revised to better address these impediments. .

Concerns about revising HARP included
doubts about its fairness and about macroeconomic efficiency.  The Federal Housing Finance Agency (FHFA) has
a responsibility to weigh the value of any proposed changes in terms of a possible
impact on the capital of the government sponsored enterprises (GSEs).  These could include a reduction in the income
generated through interest on the GSE’s Holdings of MBS, on the expected
revenues from the put-backs of guaranteed mortgages that default, and finally
on the impact of refinancing on expected credit losses to the GSE fees. 

One outcome of an improved program would
be more borrowers in a position to refinance. 
Estimates can be made of the average reduction in monthly mortgage
payments that would result from a refinance; the question is how this payment
reduction would affect future defaults. 
Ideally a study could determine the difference in expected credit losses
from two identical borrowers with identical mortgages where one borrower
refinances and the other does not.  However,
once the existing mortgage is refinanced it disappears so both
mortgage/borrower sets cannot be similarly tracked and the impact of the
payment change on a borrower’s performance must be inferred.

A recent congressional budget office
working paper estimates that reduced credit losses would produce an incremental
2.9 million refinances of agency and FHA mortgages and that such a program
would reduce expected foreclosures by 111,000 or 38 per 1000 refinances,
reducing credit losses by $3.9 billion.

Using data from Lender Processing
Services the authors selected eligible borrowers from among borrowers who had
been current on mortgage payments for at least 12 months and had estimated loan-to-value
ratios (LTV) over 80 percent. To measure motivation the authors selected loans
where the borrower could recover refinancing costs in two years.  Using these parameters it was determined that
refinancing would reduce the required monthly payment by 26 percent on average.

The authors found impacts on results
from various combinations of local factors such as house prices, employment
rates, the local legal methods of handling delinquencies, and contagion risk,
i.e. the exposure of the borrower to others who had defaulted.  There were also effects from FICO scores and
debt to income ratios and loan specific factors such as the purpose of the
loan, full documentation of the loan, and length of loan term.  Various methods were used to control for
these variables including excluding loans from the sample.

It is acknowledged that LTV ratios have
a significant correlation with default and the authors did test and confirm
this relationship.   The next step was to estimate the impact of a
26 percent payment reduction on the average default rate.  The authors used estimated ARM default and
prepayment hazards to do a five-year cumulative default forecast holding the
local employment rate and home prices stable. 
At five years the models imply that the expected cumulative default rate
would be 17.3 percent. When the payments are reduced by 26 percent the expected
default rate is reduced to 13 percent a 24.8 percent reduction.   The same analysis was run for borrowers with
prime conforming fixed-rate mortgages obtaining a cumulative default rate of
15.2 percent which refinancing reduced to 11.4 percent, a decline of 3.8
percentage points. 

These figures were used to conduct a
simple pricing exercise to measure the difference between a refinancing fee
that maximizes fee income for a certain category of borrowers and a fee that
maximizes the combination of the fee income and the reduction in the expected
future credit losses using the GSE pricing categories for their loan level adjustments.  It was found that FICO score strongly impacted
both payment reductions and default rates ultimately resulting in reductions in
the default rate of 1.9 percentage points for a high FICO borrower and 9.1
points for a low one.  This implies that
incorporating the impact of expected credit losses into the pricing decision
should generate higher price discounts for weaker credit borrowers as measured
by FICO score and LTV.

The authors found that incorporating the
impact of expected credit losses after refinancing on average lowed the desired
pricing by 17 basis points.  Looking at
the averages by LTV intervals shows an impact of 15 basis points for mortgages
with a current LTV of 80 to 85 and increases to 14 basis points for mortgages
with a current LTV of 105 or higher. 
Basing fees on FICO scores involves a much more complicated set of

The authors conclude that the average
HARP refinance would result in an estimated 3.8 percent lower default
rate.  Assuming a conservative average
loss-given default of 35.2 this indicates an expected reduction in future
credit losses of 134 basis points of a refinanced loan’s balance.

The paper concludes that the impact
of refinancing on future default risk is important to the current debate of the
GSE fee structure for HARP loans.  “These
results suggest that refinancing can be fruitfully employed as a tool for loss
mitigation by investors and lenders.  The
optimal refinance fee will be lower if this reduction in credit losses is
recognized.”  Reducing fees, the authors
say, will increase incentives to refinance but at the cost of fee income to the
GSEs.  “Our analysis shows, however, that
there is an offset to this lower fee income today which is lower credit losses
in the future.”

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