Individual Borrower and Regional Factors Contributing to Subprime and Prime Mortgage Delinquency and Default Rates: An Analysis by Origination Vintages and Projections for 2009

Abstract

This study looks at the causes of the residential real estate and mortgage market collapse in terms of the delinquency and default experience of subprime, Alt-A and Prime mortgages at the individual borrower level in metropolitan (MSA) housing markets. It is recognized that not all high risk loans will become delinquent and/or default and so the study attempts to develop proxies of loan and borrower factors that indicate the profile of those loans and borrowers most likely to default taking into consideration the characteristics of the MSA housing markets. Consideration of the MSA characteristics is an attempt to address the question of why there occurred so many defaults during a period of no recession and a high rate of employment. To do this it is recognized that borrowers’ willingness to pay depends largely on their desire to be a home owner rather than an investor in a residential property. To capture this desire, variables from the Loan Performance data base on loan and borrower characteristics at the time of loan origination are used. This will develop a cross-section analysis of delinquency and default rates of residential, subprime, Alt-A and Prime mortgages. The hypotheses tested represent the effects of loan and borrower level characteristics and MSA economic factors, such as MSA employment growth, unemployment rate, household income and housing price changes and their volatility on the level of delinquency and default rates on mortgages of different types and differing origination dates (vintages). From a previous study (Hanweck 2008) that aggregated individual loan data to the MSA level, we found that loan and borrower level characteristics such as loan-to-value ratio weighted by original loan balances, the weighted proportion of loans that have no documentation or the borrowers’ weighted FICO score and MSA level economic factors such as employment growth and house price index rates of change are highly statistically significant and economically important in explaining MSA loan delinquency and default rates over the 359 MSAs for 2005 and 2006 vintages mortgages. Using the 2006 vintage parameters delinquency and default rates for the 2007 vintage loans were projected by MSA.

The uniqueness of the proposed study, that the Q Group Research funding will permit, is that it will develop estimates of individual loan level conditional probabilities of borrowers moving from one payments’ status to another – current to 30-days delinquent to 90-days delinquent to 180-days delinquent to default, ROE or foreclosure. The data is from Loan Performance Corp. and is collected from securitizations on a monthly basis for the years 2004 to 2009. The results of this study can be used by investors to more efficiently value the conditional likelihood of default, expected losses due to default and portfolio retention, and potential recoveries from mortgage modifications or sale. The probability of severe delinquency or default within any specified period from a specified date can be estimated conditional on loan payment status, estimated LTV, other loan and borrower characteristics and metropolitan area economic conditions including house price trends.

Keywords: mortgage defaults, subprime mortgages

JEL Classification: G12, G21, G28