Bank Risk Managers expect mortgage delinquencies to continue to fall
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The Professional Risk Managers’ International Association (PRMIA) and Fair Issac Co (FICO) put out a quarterly survey of risk managers and gets their views on how credit risk will change over the next six months. The PRMIA is a professional organization dedicated to best practices for risk management and administers the Professional Risk Management (PRM) designation. Fair Issac is a major credit reporting agency.
The survey asks risk managers about their outlook for delinquencies in auto loans, credit cards, student loans, small business loans, and mortgages. It also asks them about current conditions, especially the housing market
Key findings of the report
The biggest feature of the report is increased optimism regarding future delinquencies. In mortgages, the vast majority (83.7%) expect delinquencies to stay the same or fall. A post-bubble record 38.5% expect mortgage delinquencies to decline. Of all the categories of debt, only student loans are projected to experience increases in delinquencies.
Nearly 70% expect small business credit requests to increase. This is in contrast to the latest National Federation of Independent Businesses (NFIB) Optimism report, which showed that over half of all small businesses have no interest in borrowing. 70.8% see the increases in home prices as sustainable. Overall, this report would seem to forecast an easing of credit.
Declining Delinquencies means good things for non-agency REITs
Non-agency REITs such as Pennymac (PMT), Two Harbors (TWO), or Redwood Trust (RWT) take credit risk, while agency REITs invest in government guaranteed, or government supported, mortgages such as Capstead (CMO) and American Capital (AGNC) do not. While agency REITs do not take credit risk, defaults act like prepayments, which means they have to reinvest at lower rates. So they aren’t completely insensitive to delinquencies. Falling delinquencies are extremely important to non-agency REITs, especially those that invest in the junior tranches of securitizations. These bonds are high-risk and high-reward. This portion of the mortgage-backed securities market has rallied significantly over the past two years.
A last segment that stands to benefit are the mortgage servicers like Nationstar (NSM) and Ocwen (OCN). When a borrower starts missing payments, servicers must advance the principal and interest payments to the bondholders. This can cause a large capital drain on the servicers and explains why Basel III increased the capital requirements for mortgage servicing rights (MSRs). In fact some of the servicers ended up refusing to advance principal and interest until their previous advances were recouped.