by Calculated Risk on 1/11/2007 11:24:00 AM

Fed Governor Susan Schmidt Bies spoke today on Enterprise Risk Management and Mortgage Lending. On mortgage lending risks:

Effectively managing the risk associated with mortgage lending involves much more than prudent underwriting. Experienced risk managers understand the need to carefully consider the risks should the housing market slow, interest rates change, or unemployment rise. These include the risks that borrowers will not have sufficient income in the future to manage substantial payment increases and that continued home price appreciation may not provide a sufficient equity cushion to minimize losses in foreclosure. In addition, an accumulation of portfolio concentrations could leave an institution exposed in a downturn. Lenders specializing in subprime loans, for example, have endured a string of bad news recently, including increasing loan delinquency and foreclosure rates and the shutdown of some lenders that could not operate profitably in a slower origination environment.

Then Bies reviewed the nontraditional mortgage guidance (see speech), and commented on subprime mortgage lending:

The agencies' guidance on nontraditional mortgage products did not specifically address mortgage lending to subprime borrowers--although, as noted, nontraditional mortgage products are sometimes offered to subprime borrowers. ...

While overall mortgage delinquency rates remain low by historical standards, they have been increasing in recent months, especially in the subprime sector. Performance deterioration is most notable in the more recent vintages. Many industry observers believe the poor performance of more recently originated subprime loans is due primarily to looser underwriting standards, including limited or no verification of borrower income and high loan-to-value transactions. ...

Subprime mortgages typically carry higher interest rates than prime loans. It is not uncommon to find margins of 600 basis points or more on adjustable rate subprime loans after the expiration of a teaser rate. Not surprisingly, some borrowers are unable to keep up with their mortgage payments once these payments fully adjust. In some cases, if alternative financing cannot be found, borrowers may be forced to sell their home or enter foreclosure. And given prepayment penalties, home price appreciation slowing significantly and capital market investors becoming more conservative, some borrowers may be having more difficultly in refinancing to avoid foreclosure.

And from the Financial Times: High-risk loans revealing shaky foundations

In the closing days of last year, something came un-stuck in a small but important corner of the US mortgage market, causing pain for investors and resulting in several mortgage lenders shutting their doors.
...
In the last few weeks of 2006, the poor credit quality of the 2006 vintage subprime mortgage origination came home to roost.

Delinquencies and foreclosures among high-risk borrowers increased at a dramatic rate, weakening the performance of the mortgage pools.

In one security backed by subprime mortgages issued last March, foreclosure rates were already 6.09 per cent by December, while 5.52 per cent of borrowers were late on their payments by more than 30 days.

Lenders also began shutting their doors, sending shock waves through the high-risk mortgage markets.