Recent Developments in the Subprime Mortgage Market: Ud id ... · Mortgage sales and marketing...

Recent Developments in the Recent Developments in the Subprime Mortgage Market: U d di C Understanding Consumer

Behavior

William ApgarWilliam Apgar

Remodeling Futures ConferencegApril 10, 2007

JOINT CENTER FOR HOUSING STUDIESGraduate School of Design | Kennedy School of Government

Harvard University

Copyright 2007

www.jchs.harvard.edu

Foreclosures on the Rise

Assessing Root Causes

Looking Forward – Thinking Clearly

Examining Policy Options


Harvard University

Copyright 2007

Foreclosures on the RiseForeclosures on the Rise


Harvard University

Copyright 2007

Serious Mortgage Delinquencies Accelerate

5.5

6

3

3.5

4

4.5

5

cen

t

1

1.5

2

2.5

3

Perc

0

0.5

1

Prime Sub Prime FHA

N t S i d li i bi l th t 90 d t

1998Q4 1999Q4 2000Q4 2001Q4 2002Q4

2003Q4 2004Q4 2005Q4 2006Q4


Harvard University

Copyright 2007

Note: Serious delinquencies combine loans that are 90 days past due and loans in foreclosure.

As Overall Lending Eases Back, Non-Prime Lending Advances

Year Total Loans(Billions)

Non-Prime Loans (Billions)

Share of Non-Prime

1995 639 65 10 2%1995 639 65 10.2%

1996 785 97 12.3%

1997 859 125 14.5%

1998 1 450 150 10 3%1998 1,450 150 10.3%

1999 1,310 160 12.2%

2000 1,048 138 13.2%

2001 2 058 173 8 4%2001 2,058 173 8.4%

2002 2,680 213 7.9%

2003 3,835 332 8.7%

2004 2,810 530 18.9%

2005 3,120 665 21.3%

2006 2,980 600 20.1%


Harvard University

Copyright 2007

Source: Inside Mortgage Finance, The 2007 Mortgage Market Statistical Annual.

As Affordability Mortgage Products Gained in Popularity, Their Delinquency Rate Rose Sharply

35

40

2.5

3.0

(%

20

25

30

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rigin

atio

ns

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2.0

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ncy

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e (

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15

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e of

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0.5

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Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

2000 2001 2002 2003 2004 2005 2006

0.0

2000 2001 2002 2003 2004 2005 2006

Interest Only Negative Amortization 60+ Day Delinquency Rate


Harvard University

Copyright 2007

Source: First American LoanPerformance.

Note: Affordability products include interest-only and negative-amortization loans.

Assessing Root CausesAssessing Root Causes


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Copyright 2007

The Ability of Consumers to Make Informed Ch i i Li it dChoices is Limited

Behavioral economic analysis and market research Behavioral economic analysis and market research suggests that consumers often make choices that may not be in their best interests and that they may later regret later regret.


Harvard University

Copyright 2007

Consumers are Vulnerable to “Push Marketing”

Mortgage sales and marketing efforts may exploit various consumer decision making weaknesses. In particular, some mortgage brokers, retail loan officers, and lending organizations use their knowledge of consumer decision making tendencies knowledge of consumer decision making tendencies to aggressively market specific mortgage products that are not in the best interests of the borrower.


Harvard University

Copyright 2007

Mortgage Market Structure Creates Mortgage Market Structure Creates Challenges

The tendency to deploy aggressive marketing and sales techniques is reinforced by the structure of the

t i d t ti l l th id d mortgage industry, particularly the wide spread use of targeted incentives designed to encourage mortgage brokers and loan officers to convince consumers to select specific and often higher-priced mortgage products.


Harvard University

Copyright 2007

Broker Share of Non-prime Lending Grows, While Retail Share of Non-prime Shrinks

100%

60%

80%

40%

60%

20%

0%2001 2002 2003 2004 2005 2001 2002 2003 2004 2005

Broker Correspondent Retail Non-PrimePrime


Harvard University

Copyright 2007

Source: Inside Mortgage Finance, The 2006 Mortgage Market Statistical Annual.

Access to Good Loans Proves ElusiveAccess to Good Loans Proves Elusive

As a result of the current market structure,consumers often fail to obtain a “good loan”consumers often fail to obtain a “good loan”product, where:

The consumer understands both the The consumer understands both the advantages and risks associated with a loan product

The loan is priced in a manner consistent with The loan is priced in a manner consistent with the underlying loan risks and costs

The loan choice reflects both the short- and long-run interests of the borrowerlong-run interests of the borrower

Borrowers have a reasonable prospect of being able to repay the loan


Harvard University

Copyright 2007

Looking Forward – Thinking ClearlyLooking Forward Thinking Clearly


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Copyright 2007

Foreclosure Likely to Increase Over Foreclosure Likely to Increase Over Near Term

With mortgage rates on the rise, home price appreciation softening and larger shares of households holding high loan-to-value, adjustable rate mortgages, the foreclosure boom has yet to run its course.boom has yet to run its course.


Harvard University

Copyright 2007

Subprime Loans Originated in 2006 Are Off to a Very Poor StartPoor Start

Share of Subprime Loans 60+ Days Delinquent or in Foreclosure by Origination Year

Six Months After Origination Twelve Months After Origination

10

12

4

6

8

0

2

4

0Fixed Adjustable Fixed Adjustable

2002 2003 2004 2005 2006


Harvard University

Copyright 2007

Source: First American LoanPerformance.

ES-3: The Wave of Non-Prime Mortgages Hitting Interest Rate Resets is Only a Small Fraction of Total Home Debt Outstanding

Estimated Current Non Prime Adjustable Mortgage Debt Expected to Reset 2007 8

$35

$40

7

8

of M

ortg

age

Estimated Current Non-Prime Adjustable Mortgage Debt Expected to Reset 2007-8

$20

$25

$30

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ions

)

4

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6

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)

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06 07 07 07 07 07 07 07 07 07 07 07 07 08 08 08 08 08 08 08 08 08 08 08 08

0

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ulat

ive

Note: Non-prime are subprime and Alt-A loans Excludes unsecuritized adjustable rate loans that may

Dec

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SubPrime Alt-A Option ARM Share of Outstanding Mortgage Debt


Harvard University

Copyright 2007

Note: Non prime are subprime and Alt A loans. Excludes unsecuritized adjustable rate loans that may also be non-prime.Source: Credit Suisse.

Substantial Restructuring of Subprime Substantial Restructuring of Subprime Sector Will Continue

Unable to meet their obligations to investors to repurchase “failed loans,” many non prime l d f i li idit lenders face serious liquidity problems/bankruptcy. Others are pulling back from subprime lending to reduce their p gexposure to future loan losses and/or limit reputational risk.


Harvard University

Copyright 2007


Harvard University

Copyright 2007

Data Problems Abound

Lack of consistent and readily available data on the characteristics of mortgage loans, loan

f d f l li i performance and foreclosure outcomes limits the ability of policy makers and industry analysts alike to asses likely causes, and y y ,consequences of the current foreclosure boom.


Harvard University

Copyright 2007

Data for Individual Metropolitan Areas Particularly Difficult to Assemble

Metropolitan Area Foreclosures Per

Rank Foreclosures Per

Rank

Loan Performance RealtyTrac

Per Household

Per Household

Akron, OH 0.71% 4 NA NA

Atlanta, GA 0.52% 14 1.43% 2,

Cleveland-Lorain-Elyria, OH 1.00% 1 0.64% 14

Dallas, TX 0.41% 22 1.01% 3

Dayton-Springfield, OH 0.70% 5 0.63% 16Dayton Springfield, OH 0.70% 5 0.63% 16

Denver, CO 0.44% 20 0.95% 5

Indianapolis, IN 0.84% 2 1.45% 1

Memphis TN-AR-MS 0 44% 19 0 99% 4Memphis, TN AR MS 0.44% 19 0.99% 4

Youngstown-Warren, OH 0.76% 3 0.51% 23


Harvard University

Copyright 2007

Source: Abt Associates Identifying Foreclosure Hotspots: Recommended Approaches and Roles for The Center for Foreclosure Solutions.

Examining Policy Options


Harvard University

Copyright 2007

R l R I Lik lRegulatory Response Is Likely

While effo ts to mode ni e eg lations on While efforts to modernize regulations on mortgage lending are long overdue, there is legitimate concern that poorly crafted regulations could make matters worse.


Harvard University

Copyright 2007

Mortgage Channels Matter

Funding for higher-priced mortgages, as opposed to lower-priced mortgages, flows through distinct p g g , gchannels linking investors to borrowers.

Individual mortgage channels differentially serve specific metropolitan areas, neighborhoods, and racial and ethnic subgroups.


Harvard University

Copyright 2007

Regulatory Systems Differ Across Channels

Higher-priced loans are more likely to flow through less regulated channels.

Consequently, mortgages made in individual Consequently, mortgages made in individual metropolitan areas, neighborhoods are subject to differing degrees of regulatory oversight.


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Copyright 2007

L k f U if i f R l i i Lack of Uniformity of Regulations is Inherently Unfair

Under the existing federal regulatory framework, higher-priced loans flow through mortgage channels g p g g gthat are subject to the least extensive regulatory scrutiny.

As a result, the most vulnerable borrowers are less likely to benefit from federally mandated consumer likely to benefit from federally mandated consumer protections that are more widely present in the lower-priced prime market.


Harvard University

Copyright 2007

Larger Independent Mortgage Bankers Account for Most of the Lending of Higher-Priced Loan Specialists

Higher-Price Specialized Lenders

Size of Lender (By Number of Loans)

Less than 10,000 10-75,000 More than 75,000 All Lenders

C dit U i 0 5 0 0 0 0 0 5

Percent Distribution

Credit Unions 0.5 0.0 0.0 0.5

CRA-Regulated Lenders

Assessment Area Lenders 1.2 0.2 1.2 2.6

Outside Assessment Area 1.9 2.6 9.0 13.5

I d d t M t B k 6 1 43 6 33 7 83 4Independent Mortgage Banker 6.1 43.6 33.7 83.4

All 9.7 46.4 43.9 100.0

Lower-Price Specialized Lenders

Size of Lender (By Number of Loans)

Less than 10,000 10-75,000 More than 75,000 All Lenders

Credit Unions 6.9 0.9 0.0 7.8

CRA-Regulated Lenders

Assessment Area Lenders 12 3 7 8 16 9 37 0Assessment Area Lenders 12.3 7.8 16.9 37.0

Outside Assessment Area 4.6 8.6 15.9 29.0

Independent Mortgage Banker 13.8 9.8 2.5 26.2

All 37.6 27.1 35.3 100.0


Harvard University

Copyright 2007

Note: For higher-prices specialized lenders, higher-prices loans account for more than 50% of all lending; for lower-priced lenders, lower-priced loans account for less than 3% of all lending.Source: JCHS enhanced HMDA database.

Lack of Uniformity Can Distort Market

Solutions to existing industry problems – whether they be regulatory or market driven – must be y g yapplied in a uniform manner to all mortgage market segments. Absent that, some will continue to use questionable practices to gain competitive questionable practices to gain competitive advantage.


Harvard University

Copyright 2007

Collective Action Needed to Eliminate “Low Roaders”Low Roaders

To eliminate “low roader” practices, the industry h h ill d h h i i l must have the will and the mechanisms in place to

sanction or otherwise force out of the market those participants unwilling to adhere to industry “best p p g ypractices.”


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Copyright 2007

Develop Enhanced Point of Sale Consumer AssistanceAssistance

Move beyond consumer counseling, and Create a trusted advisor network Build a second opinion hotline Develop an automated loan pricing guideDevelop an automated loan pricing guide Help consumers “opt-into” “good loans” Extend disclosure time lines to promote shopping


Harvard University

Copyright 2007

Expand Interagency Guidance to Non-BanksBanks

Federal regulators should either use existing authority or seek new legislation that would enable them to extend the provisions of the recently enacted Interagency Guidance to all lenders enacted Interagency Guidance to all lenders, including non-banks.


Harvard University

Copyright 2007

Create More Uniform Oversight of Secondary Market Participants

Today, most funding for non-prime loans flows through less regulated non-GSE channels. Efforts to strengthen SEC monitoring and oversight activities are important as are efforts to encourage the GSEs are important, as are efforts to encourage the GSEs to expand their purchases of non-prime whole loans.


Harvard University

Copyright 2007

Recent Developments in the Subprime Mortgage Market: Ud id ... · Mortgage sales and marketing...

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