London Market Monitor – 31 August 2022
Our August review of the markets and Solvency II discount rates.
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The Milliman Mortgage Default Index (MMDI) is a lifetime default rate estimate calculated at the loan level for a portfolio of single-family mortgages. For the purposes of this index, default is defined as a loan that is expected to become 180 days or more delinquent over the life of the loan.1 The results of the MMDI reflect the most recent data acquisition available from Freddie Mac and Fannie Mae, with measurement dates starting from January 1, 2014.
Mortgage originations continued to decline over the first quarter (Q1) of 2022 compared to the fourth quarter (Q4) of 2021. With interest rates on the rise, both purchase and refinance mortgage originations have decreased.
The index value of the MMDI was 2.39% for loans originating in 2022 Q1 compared to 1.90% for 2021 Q4 originations. Figure 1 provides the quarter-end index results for these loans, segmented by purchase and refinance. For both purchase and refinance, the primary driver of this increased default risk is an expected slowdown of home price growth over the next several years.
To explore the MMDI data on a more granular level, including loan origination and type, click here.
Our latest MMDI results show that mortgage risk increased for Freddie and Fannie acquisitions over 2022 Q1. There are three components of the MMDI: measures for borrower risk, underwriting risk, and economic risk. Borrower risk measures the risk of the loan defaulting due to borrower credit quality, initial equity position, and debt-to-income ratio. Underwriting risk measures the risk of the loan defaulting due to mortgage product features such as amortization type, occupancy status, and other factors. Economic risk measures the risk of the loan defaulting due to historical and forecasted economic conditions.
For government-sponsored enterprise (GSE) loans, borrower risk increased from 1.35% in 2021 Q4 to 1.43% in 2022 Q1. Refinance loans continued to make up the bulk of loan originations at about 57% of total originations; this is generally consistent with the prior quarter when 58% of originations were refinance loans. Refinance loans typically have lower borrower risk as it is typical for the borrowers to have higher credit scores and lower loan-to-value ratios. In June, Freddie released data indicating refinance loan volume has declined as interest rates have increased. Our 2022 Q2 update will reflect this decrease in refinance originations, and therefore we anticipate that the MMDI will increase with the next quarterly update, reflecting greater borrower risk from purchase mortgages.
Underwriting risk represents additional risk adjustments for property and loan characteristics such as occupancy status, amortization type, documentation types, loan term, and others. Underwriting risk after the global financial crisis remains low and is negative for purchase mortgages, which were generally full-documentation, fully amortizing loans. For refinance loans, a greater portion of originations are cash-out refinance loans (as opposed to refinancing for more favorable rate/length-of-loan terms) given recent robust home price growth. Cash-out refinance loans are assigned a greater default risk and are contributing to increases in underwriting risk.
Economic risk is measured by looking at historical and forecasted home prices. Actual house price appreciation has been robust from 2014 through 2022, which has resulted in embedded appreciation for older originations. This results in reduced default risk for older cohorts. For more recent cohorts, we anticipate slower home price growth (or negative growth for some local geographies), which contributes to increases in economic risk for recent origination years.
Figure 2 shows the economic risk component of the MMDI for GSE mortgages as of 2021 Q4 and 2022 Q1.
We notice from the chart that economic risk has remained steady for older originations, while economic risk for newer originations has sharply increased as we anticipate slower home price growth in the future. However, in the 2022 Q1 release economic risk decreased quarter over quarter (i.e., the lines in the chart for the 2022 Q1 release are lower relative to the 2021 Q4 release). This is because actual home price movements were more favorable than previously forecasted. As previously noted, this publication of the MMDI uses the most recent data available to provide timely information on credit trends. Therefore, comparable Q3 data is not available.
The MMDI reflects a baseline forecast of future home prices. To the extent actual or baseline forecasts diverge from the current forecast, future publications of the MMDI will change accordingly.
For more detail on the MMDI components of risk, visit milliman.com/MMDI.
Milliman is expert in analyzing complex data and building econometric models that are transparent, intuitive, and informative. We have used our expertise to assist multiple clients in developing econometric models for evaluating mortgage risk both at the point of sale and for seasoned mortgages.
The Milliman Mortgage Default Index (MMDI) uses econometric modeling to develop a dynamic model that is used by clients in multiple ways, including analyzing, monitoring, and ranking the credit quality of new production, allocating servicing sources, and developing underwriting guidelines and pricing. Because the MMDI produces a lifetime default rate estimate at the loan level, it is used by clients as a benchmarking tool in origination and servicing. The MMDI is constructed by combining three important components of mortgage risk: borrower credit quality, underwriting characteristics of the mortgage, and the economic environment presented to the mortgage. The MMDI uses a robust data set of over 30 million mortgage loans, which is updated frequently to ensure it maintains the highest level of accuracy.
Milliman is one of the largest independent consulting firms in the world and has pioneered strategies, tools, and solutions worldwide. We are recognized leaders in the markets we serve. Milliman insight reaches across global boundaries, offering specialized consulting services in mortgage banking, employee benefits, healthcare, life insurance and financial services, and property and casualty (P&C) insurance. Within these sectors, Milliman consultants serve a wide range of current and emerging markets. Clients know they can depend on us as industry experts, trusted advisers, and creative problem-solvers.
Milliman's Mortgage Practice in Milwaukee is dedicated to providing strategic, quantitative, and other consulting services to leading organizations in the mortgage banking industry. Past and current clients include many of the nation's largest banks, private mortgage guaranty insurers, financial guaranty insurers, institutional investors, and governmental organizations.