Citing ongoing analysis of mortgage performance and evolving origination trends, Kroll Bond Rating Agency released an update to its residential mortgage default and loss model.
In the update, KBRA states that its original mortgage default and loss model methodology was published on January 9, 2012 and updated based upon the ratings agency’s view of the current mortgage market and the performance of post-crisis loans.
KBRA made three main changes to its methodology, specifically reducing the default expectations for purchase loans, revising the timeline and expenses associated with liquidated loans and adjusting the penalty for high debt-to-income ratio loans.
KBRA said that purchase loans tend to have a lower default risk than refinances, due to the fact that a purchase represents an actual arms-length transaction which yields a more accurate view of a home’s value than an equivalent refinancing transaction.
But pre-crisis purchase mortgages showed high levels of default due to the practice of extending credit to first-time homebuyers, often on very favorable terms despite the borrowers having little credit history or poor credit history.
With the current stringent lending environment, default risk on purchase mortgages has declined, KBRA said.
“Based on analysis focused on both jumbo and conforming prime mortgages, KBRA has found that, for these loans, the traditional benefits of purchase loans remain well established, and we have adjusted the model’s treatment of purchase loans to reflect lower default expectations relative to equivalent refinancing mortgages,” KBRA said.
KBRA also adjusted its projected timeline and expenses for liquidated loans. “The amount of time a loan is assumed to be REO has been reduced to better reflect the historical data,” KBRA said. “While this does result in a reduction in carrying expenses, it also has the effect of better aligning peak liquidation periods with the peak home price stress, therefore, the net effect is to increase loss severity.”
Lastly, KBRA adjusted its penalty for high DTI loans. “While the KBRA RMBS model does not contain a specific risk parameter based on DTI, it is our opinion that very high DTI loans can bear significant incremental risk,” KBRA said. “When we began to encounter newly originated loans with back-end DTIs in excess of 45%, we assigned an additional default penalty to such loans.”