Subprime Mortgage Lending Faces the Test of a Slowing Economy
February 7, 2002
Entry by FDIC-insured institutions into subprime lending as a targeted line of business was largely a phenomenon of the 1990s. These lending programs are now being tested by recession, in most cases for the first time. Even before the recession began, there was already evidence that some subprime credit card borrowers had begun to show signs of rising stress.1 However, it remains to be seen how entry into subprime mortgage lending might alter the performance of traditionally lower-risk single-family residential lending. So far, it appears that the incidence of significant repayment difficulties among subprime mortgage borrowers is increasing.
Subprime mortgages are not separately reported on Bank and Thrift Call Reports, making it difficult to monitor from off-site the performance of these portfolios. However, loans insured by the Federal Housing Administration (FHA) tend to exhibit characteristics similar to those of subprime loans because these loans are often extended to borrowers with more limited financial resources.2 The delinquency rate on FHA-insured mortgages rose 2.3 percentage points to 11.4 percent in the year ending September 2001 (Chart 1). In contrast, the national delinquency rate on conventional mortgages (reported by the Mortgage Bankers Association) rose by only 0.6 percentage points over the same period.
The effect of a slowing economy is also evident in a vintage analysis of subprime loan pools. As Chart 2 illustrates, loans originated in 2000 are exhibiting higher delinquency rates than earlier vintages at a comparable point in the life cycle. This higher delinquency rate may reflect not only the onset of recession but also looser underwriting standards during 2000 relative to prior years. The recent refinancing boom may be amplifying the sharp rise in delinquencies in subprime loans originated in 2000, because the worst-performing loans are likely to remain in the origination pool, while the best-performing loans have been refinanced at a lower mortgage rate.3
The FDIC estimates that fewer than one percent of all insured institutions have significant subprime residential mortgage exposures.4 However, a much larger number of institutions have some limited involvement in subprime mortgage lending. A survey by the Minneapolis Federal Reserve Bank found that 29 percent of banks in the Minneapolis District offered loans to low-credit-quality consumer borrowers in 1999.5 While the larger universe of insured institutions may be adversely affected if subprime mortgage indicators continue to deteriorate, those institutions with less-diversified loan portfolios are likely to be more affected.
The outlook for subprime mortgage performance in 2002 and beyond depends not only on the economic outlook but also on the prospects for consumers who are more exposed to economic adversity. Current trends do not suggest any near-term improvement in the performance of subprime mortgages.
More information on this topic and other housing-related lending issues will be available in the first quarter 2002 edition of the FDIC's Regional Outlook, forthcoming in March.
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1. "Emerging Risks in an Aging Economic Expansion," Regional Outlook, Fourth Quarter 2000. http://www.fdic.gov/bank/analytical/regional/ro20004q/na/Infocus1.html 2. For more information about the FHA, see the U.S. Department of Housing and Urban Development. http://www.hud.gov/offices/hsg/hsgabout.cfm 3. "Another Look at the 2000 Book," The Market Pulse, Mortgage Information Corporation, Winter 2001. 4. Significant subprime residential mortgage exposure is defined as holding total direct and indirect interest in subprime residential mortgages greater than 25 percent of tier-1 capital. 5. Ron Feldman and Jason Schmidt, "Why All Concerns About Subprime Lending Are Not Created Equal," Fedgazette, Minneapolis Federal Reserve, July 1999.