NEW YORK--(BUSINESS WIRE)--KBRA just released a report that examines the credit performance of 2001-2003 vintages. The research was prompted by some market constituent’s belief that the market struck the perfect balance between credit availability and prudent underwriting during the period, pointing to pristine mortgage performance for those loans as evidence. Indeed, investors and originators alike tend to use the 2001-2003 mortgage origination vintages to establish underwriting standards and to benchmark base case default expectations on newly originated loans.
On its face, there would seem to be validity to this approach considering that defaults for crisis vintage loans were 5.9x that of loans originated between 2001 and 2003. However, KBRA’s research suggests that credit standards seem to explain only a fraction of this increase when judged through the lens of expected default rates.
While credit standards certainly loosened between the early 2000 and crisis vintages, predominantly through the proliferation of affordability products and layered risk, the economic climate in the early-to-mid 2000s appears to have masked how similar the credit standards were in each time period.
In the report, KBRA demonstrates that observed default rates without proper accounting for macroeconomic effects is a poor indicator of credit standards, as evidenced by the following key takeaways:
- Decreasing mortgage rates led to rapid prepayments for 2000-2002 vintage loans – which shortened mortgage lives and reduced lifetime observed default rates. For example, we project the 2000 vintage defaults could have been 10.2% assuming a less favorable scenario for refinance incentives instead of the 1.6% observed lifetime defaults, a 540% increase.
- Significant home price appreciation for 2000-2003 vintage loans provided borrowers with sizable home equity gains that could be easily converted to cash through refinancing in the event of financial distress due to the increasingly availability of credit from 2003 through 2006. KBRA estimates that borrowers using cash-out refinancing during this period cashed out more than $60,000, on average.
- The relatively low requirements for cash-out refinancing essentially shifted lower-than-average credit borrowers from the early 2000 vintages into later vintages. Accounting for these refinances, made possible by home price appreciation, 2003 vintage default rates could have been 3.0x their observed levels.
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KBRA is registered with the U.S. Securities and Exchange Commission as a Nationally Recognized Statistical Rating Organization (NRSRO). In addition, KBRA is recognized by the National Association of Insurance Commissioners (NAIC) as a Credit Rating Provider (CRP).