By Warren Kornfeld, Vice President-Senior Analyst, Moody's Investors Service
The market for non-performing and reperforming Federal Housing Administration (FHA) and Department of Veterans Affairs (VA) residential mortgage loans had historically been a niche segment. However, in 2002, Moody's estimates that approximately $20 billion of FHA/VA reperforming and non-performing securitizations were issued, up from approximately $7 billion in 2001. Record volume may again be achieved in 2003, depending on interest rate fluctuations, although this is a difficult market to forecast. Below is an excerpt from a soon-to-be-published special report titled Moody's Approach to Analyzing Non-Performing and Reperforming FHA and VA Loans, which will be available on www.moodys.com.
Moody's believes the credit quality of the mortgage loans in reperforming FHA/VA residential mortgage securitizations is comparable to the credit quality of weaker-than-average subprime residential mortgage loans, while the credit quality of the mortgage loans in non-performing FHA/VA securitizations is comparable to that of average non-performing loans. However, because FHA insurance and the VA guarantee cover a large percentage of any losses incurred as a result of borrower defaults, the credit enhancement levels for reperforming pools are comparable to prime-quality residential mortgage loan securitizations and significantly lower than subprime residential mortgage loan securitizations. The credit enhancement levels for non-performing/liquidating pools are comparable to Alt-A mortgage securitizations and significantly lower than uninsured non-performing/liquidating mortgage loan securitizations.
While the expected loss severity on FHA-insured and VA-guaranteed loans is similar, the VA loss severity increases more in stressful markets due to the limits of the VA guarantee. Thus the higher the percentage of FHA loans in the pool, the lower the credit enhancement levels required.
The Securitized Pools
The residential mortgage loans in FHA/VA reperforming and non-performing groups typically have been repurchased out of Government National Mortgage Association (GNMA) pools. GNMA gives the loan servicer the option to purchase a delinquent loan out of a GNMA pool at par plus accrued interest if the loan meets one of two criteria: no payments have been made on a loan for 90 days; or one payment remains unpaid for four consecutive months for loans placed into GNMA pools prior to Jan. 1, 2003. GNMA grants this option in order to allow the servicer more flexibility to work with the delinquent borrower.
When interest rates decline, as in the current market, this purchase option becomes more attractive to the servicer, which is able to acquire at par a guaranteed loan with an interest rate above current market rates. Even though the loans have recently experienced serious delinquencies, the vast majority of these borrowers has historically paid their mortgage loans. As the FHA/VA insurance remains in place, the risk of loss even on loans whose borrowers ultimately default is minimal. Currently, the annualized net losses on most FHA/VA reperforming pools fall is five to 15 basis points, or 0.05% to 0.15%.
With the recent change that GNMA enacted which eliminated the option servicers had to buy loans that have been delinquent for four consecutive months, Moody's anticipates that the quality of newly securitized pools will decline slowly. This will result in decreased securitizations of loans that are less than 60 days delinquent. In addition, Moody's also expects to see weaker three-month and six -month payment velocity statistics. Payment velocity is the ratio of the aggregate payments that the borrower has made over a certain period, such as three months or six months, to the sum of the regular monthly payments due over that period. Because the rule only affects loans deposited into GNMA pools after Jan. 1, 2003, and typically the average seasoning of the loans of the FHA/VA reperforming and non-performing securitizations is two or more years, any transition will take place over several years.
General Pool Characteristics
FHA/VA loans are typically first-lien, 30-year, fully amortizing, fixed-rate loans that finance owner-occupied, single-family properties. Recent securitized pools have had average loan balances of $80,000 to $100,000. The loans are, on average, three to five years old and the pools are economically and geographically diversified. The mix has averaged approximately 80% FHA loans to 20% VA loans. Many of the pools have a small portion - typically less than 10% - of adjustable-rate loans.
FHA/VA loans generally have relatively high LTV ratios. Because the VA's guarantee is capped, the loss severity on VA-guaranteed loans is affected by the current property value and the LTV. Recent securitized pools have had average current LTVs of 90% to 95%, based on the current loan amount and the original property value. Based on the sampling of updated values as well as its analysis, Moody's believes that the properties in these reperforming and non-performing pools have appreciated less than the overall housing market as a result of the below-average quality of the properties securing the loans in the FHA/VA securitizations.
Many of the properties are probably located in neighborhoods where the local economy is depressed and the housing inventory is higher than average. In addition, many of the properties may have deferred maintenance. Moody's estimates the average property value in recent FHA/VA securitization pools has increased by approximately 1% to 2% per year since the loans were originated. Consequently, the average LTV, based on the current loan amount and the current estimated property value, is 85% to 95%.
On reperforming pools, the borrowers have generally demonstrated a desire and a certain ability to continue paying their mortgage loans, although they are financially strapped, as reflected in their recent delinquency histories. Typically, a large percentage of the borrowers has made payments totaling one or more regular monthly payments during the past three months, and has made payments totaling three or more regular monthly payments during the past six months. Payment velocity is an important consideration in evaluating these pools. The fact that, on average, the majority of the loans has been outstanding for several years also partially mitigates some of the risks associated with high LTVs and low borrower credit quality.
Insurance and Partial Guarantees
Currently, approximately 80% of FHA-insured loans are made to first-time homebuyers. FHA insurance covers 100% of the principal amount of the loans and most of the lost interest and foreclosure expenses on defaulted loans.
VA loans are partially guaranteed; they allow a veteran or, in certain limited circumstances, the spouse of a veteran, to obtain a mortgage loan guaranty from the VA for the purchase of a one- to four-family house. The borrower is not required to make a downpayment. The VA guarantees payment of a fixed percentage of the loan indebtedness up to a maximum dollar amount. As a result of the cap, the average and the variability of the loss severity of VA loans is greater than that of FHA loans.
Pool Performance
Moody's estimates that the average FHA/VA reperforming pool will have higher default rates prior to recoveries than average subprime mortgage pools. The high default rates are due to a number of factors, including the high LTV ratios of the loans, as well as the high percentage of loans to first-time homebuyers. For most recent reperforming pools, the average lifetime static pool default rate of the fixed-rate loans is approximately 15% in the expected case and approximately 45% to 50% in Aaa stress scenarios. The default rate for adjustable rate loans will be approximately 10% higher.
For most recent reperforming pools, the expected loss severity for the FHA loans is 3% to 5% of the current balance of the defaulted loan and, in Aaa stress scenarios, 5% to 7%. The primary factors that affect the loss severity on FHA loans are the length of the foreclosure period; the amount, if any, by which the mortgage rate is greater than the applicable debenture rate; and the amount of foreclosure expenses not covered by FHA insurance.
For most recent reperforming pools, the expected loss severity for the VA loans is 4% to 6% of the current balance of the defaulted loan and, in Aaa stress scenarios, 10% to 15%. The VA insurance coverage decreases as the loan size increases; thus loss severities are dependent on the size of each loan. Because of the cap on the VA guaranty, the loss severity of the VA loans is more volatile than that of FHA-insured loans. In addition to the amount of coverage provided by the VA guaranty, other primary factors that affect the loss severity on VA loans are similar to non-insured mortgages and include the value of the home securing the mortgage loan, the length of the foreclosure and liquidation periods, and the amount of foreclosure and liquidation expenses.
The historical experience on securitizations that Moody's has rated dates back to 1998. While none of the securitizations has fully paid down, the current balances of many of the early pools are less than 50% of the original pool balances. Given the track record of these pools, cumulative net losses for most of the older FHA/VA reperforming loan securitizations will be 0.35% to 0.45% of the original pool balance.
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