In light of the weakening housing market, Fitch Ratings has identified three major predicators of mortgage loan defaults -- FICO scores, credit sector and combined loan-to-value ratios (CLTVs). These are all emphasized in both the rating agency's new criteria as well as its loan default model.
These criteria are documented in a new report just released by Fitch, which will also be making its model publicly available to market participants as part of its efforts to bring greater transparency to Fitch's rating methodology.
Fitch's new criterion identifies 13 mortgage credit dimensions used to predict loan level defaults. The rating agency also incorporates national and regional economic stress factors to show the varying risk levels in different regions. Fitch's criteria, which is based on decades worth of historical data, actually shows that the FICO score is still be the best single predictor of mortgage default risk.
Analysts determined that the underwriting standards that lenders use to distinguish between Prime, Alt-A and subprime borrowers have a significant influence on default and loss as well. The rating agency's research further confirms that low homeowner equity limits borrower incentive to avoid foreclosure. Aside from this, Fitch's criteria report cites occupancy, loan purpose and documentation type as important risk dimensions.
The new model is based on actual historical loss severity data, instead of projections of home price movements and expenses. The model gives insight into which loan attributes are predictive of higher loss severity as well as captures the difference in severity among the various credit sectors. The rating agency's analysis also found that Fitch Servicer Ratings are good indicators of risk.