M

O

R

T

G

A

G

E

M

A

R

K

E

T

T

R

E

N

D

S

Volume 3

Issue 1

March 1999

CAPITAL REQUIREMENTS

FOR

HOME MORTGAGES

Research & Analysis

Office of Thrift Supervision

Washington, DC
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 1 March 1999

INTRODUCTION•

ecent market innovations, such as the Federal Home Loan Bank of Chicago’s

Mortgage Partnership Finance plan, have raised some interesting questions about

the appropriate capital treatment of home mortgages. See, for example, the last issue

of Mortgage Market Trends. This issue begins an occasional series in which we will examine

some of these regulatory capital questions about home mortgages from an economic

perspective. The views expressed here are only those of the authors and should not be

construed in any way as representing those of the Office of Thrift Supervision.

Current OTS risk-based capital standards require that single family residential mortgages with

loan-to-value (LTV) ratios greater than 80 percent be placed in the 100 percent risk-weight

category and, as a result, carry an 8 percent capital requirement. Mortgages at or below an 80

percent LTV (including mortgages with LTV ratios above 80 percent with mortgage

insurance that brings the credit exposure below 80 percent) are risk-weighted at 50 percent

and thus carry a 4 percent capital requirement. Other banking regulators require “prudently

underwritten” mortgages with “appropriate LTV ratios” to qualify for the reduced risk

weighting. Certain types of mortgage-backed securities with AA or AAA ratings are riskweighted at 20 percent and thus carry a 1.6 percent capital requirement.

Previous issues of Mortgage Market Trends have shown that low (below 60 percent) LTV home

mortgages rarely become seriously delinquent

(ninety days past due or in foreclosure). For

example, Table 1 shows by LTV category the

percent of conventional (non-governmentbacked) mortgages tracked by the Mortgage

Information Corporation that are currently

seriously delinquent. Low LTV mortgages have a

seriously delinquent rate of only 0.17 percent.

Conversely, very high LTV (more than 95

percent) mortgages become seriously delinquent at a rate more than ten times that of low

LTV mortgages (1.71 percent versus 0.17 percent).

Delinquency rates only tell part of the story, however. Of equal concern to regulators are the

consequences of a default, the losses a thrift incurs. Current thrift industry data indicate that

average losses on all 1-4 family mortgages held in portfolio run about 18 basis points (0.18

percent) per year in this most favorable economic environment. Is a 400 basis points (4

percent) capital requirement too much or too little for the typical qualifying mortgage

portfolio held by thrifts? Given that most thrifts find it beneficial to be “well capitalized,” the

400 basis point capital requirement actually becomes 500 basis points for qualifying

mortgages.1

 

• Prepared by Fred Phillips-Patrick, Jonathan Jones, and John LaRocca, Research & Analysis Division, Office of Thrift

Supervision. Please email any comments or questions to fred.patrick@ots.treas.gov.

1 To be classified as well-capitalized, savings associations must maintain 10 percent risk-based capital. Qualifying mortgages

are risk-weighted at 50 percent. Thus, a savings association that wants to maintain its well-capitalized classification will tend

to hold 500 basis points of capital for its qualifying mortgages rather than the minimum 400 basis points.

R

Table 1: Conventional Home Mortgage

 Delinquency Rates (Source: MIC, 9/98)

LTV Percent Seriously Delinquent

20-60 0.17

61-70 0.35

71-75 0.52

76-80 0.43

81-90 0.85

91-95 1.09

96-105 1.71
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 2 March 1999

To answer these questions, we need a framework in which to evaluate capital adequacy.

Before we start that, though, let’s look at current mortgage market conditions.

CURRENT MORTGAGE MARKET CONDITIONS

National Delinquency Rates Remain Low

igure 1 plots the percentage of seriously delinquent (90 days past-due or in

foreclosure) residential mortgages, using both the Mortgage Information Corporation

(MIC) and Thrift Financial Report (TFR) data. The MIC data comprise almost 24

million mortgages. Since the first issue of the Mortgage Market Trends, we have divided the

MIC data into two groups: the market, which includes all MIC participants (Freddie Mac,

Fannie Mae, and eighteen other large banks, thrifts, and private mortgage lenders), and a

subgroup, depository institutions, which includes only the FDIC-insured MIC participants (a

mix of S&Ls and commercial banks). As the trend line in Figure 1 shows, the national

delinquency rate improved again in the last quarter. Both the MIC depository and OTSregulated (TFR) thrift delinquency rates improved as well.

Figure 1 also shows that depositories, as a group, have had a higher delinquency rate than the

national average for the entire period. The gap between the depository and the market

delinquency rates has remained fairly constant since June 1997. The thrift industry, though,

has improved its performance so much over the last few quarters that its delinquency rate

has dropped below the MIC national rate (which is dominated by the GSEs’ portfolio of

conforming mortgages) for the last four consecutive quarters.

Figure 1: Percentage of Seriously Delinquent Mortgages

0.6

0.8

1

1.2

1.4

1.6

1.8

Sep-94 Mar-95 Sep-95 Mar-96 Sep-96 Mar-97 Sep-97 Mar-98 Sep-98

D epository

TFR

M arket

Source: MIC and TFR.

The Market contains the combined data of the depository and non-depository participants in MIC’s Loan

Performance System. Depositories comprise both bank and thrift MIC participants. The thrift MIC participants

are very large institutions located primarily on the East and West coasts. TFR represents all OTS-regulated

institutions except one that specializes in defaulted mortgages.

Figure 2 shows the regional detail behind the improvement of the overall thrift delinquency

rate. The West region experienced the greatest improvement, with the Northeast and

Southeast regions also registering significant declines. The Central and Midwest regions

maintained the lowest delinquency rates among the regions. For the first time since we have

been tracking these data, all regions reported a seriously delinquent rate below 1%.

F
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 3 March 1999

Figure 2: OTS Regional Delinquency Rates

0.50%

0.70%

0.90%

1.10%

1.30%

1.50%

1.70%

1.90%

2.10%

Jun-94 Dec-94 Jun-95 Dec-95 Jun-96 Dec-96 Jun-97 Dec-97 Jun-98

National NE SE Central Midwest West

Serious Delinquencies Vary by Location and Product Type

n September 1998, according to the MIC data, the states with the highest rates of

seriously delinquent loans (by dollar value) were Hawaii (1.7%), Maryland (1.6%), District

of Columbia (1.5%), New York (1.4%), New Jersey (1.4%). The national average was

0.84%. California, which has previously drawn national attention because of its poor

performance, had a rate of 0.93%, a rate better than, for example, Connecticut (0.96%).

In individual markets, Riverside, CA, again leads the nation with a seriously delinquent rate of

2.36%, followed by Scranton, PA (2.03%), and Memphis, TN (1.80%). Among major

markets, Miami was fifth with a rate of 1.67% and New York was tenth with a rate of 1.48%.

Table 2 shows the percentage of mortgages that are seriously delinquent for different

product types (conventional and government-backed, fixed rate and adjustable) based on

whether the mortgages were made for purchase or for refinancing. These data show that

fixed rate mortgages outperform adjustable rate mortgages; 15 year fixed rate mortgages

outperform 30-year mortgages.

Refinanced mortgages perform much

better than home purchase mortgages in

all cases except one, COFI ARMs, where

the refinanced mortgages have a slightly

higher delinquency rate than COFI ARM

home purchase loans. Delinquency rates

on government-backed loans substantially

exceed those on conventional loans. For

home purchase mortgages, governmentbacked loans have a seriously delinquent

rate five times higher than that for 30-

year conventional loans (3.36 vs. 0.60);

for refinancing loans, the rate is six times

higher (1.91 vs. 0.32).

I

Table 2: Percent Seriously Delinquent, as of 9/98

Home Purchase Refinancing

Conv: Fixed Rate 0.55 0.24

 15-Yr Fixed 0.27 0.09

 30-Yr Fixed 0.60 0.32

Conv: Adj Rate 1.02 0.85

 T-Bill 0.94 0.74

 COFI 1.12 1.17

Government 3.36 1.91

 FHA 3.64 1.75

 VA 2.86 2.13

All Loans 0.99 0.39

Source: MIC, based on $ amounts
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 4 March 1999

Mortgage Origination Market Shares

n the past, we have relied on HUD’s Survey of Mortgage Lending Activity (SMLA) for

origination and market share data. However, the fourth

quarter 1997 data are the most recent available, the same

as reported in the last issue. Table 3 presents the volume of

home mortgages originated by OTS regulated thrifts since

1990. Note the level of activity in 1992 and 1993, the boom

refi years. Prior to June 1996, OTS reported thrift origination

data on an unconsolidated basis. Now OTS reports the data

on a consolidated basis so that the data reflect not only the

thrift’s own activity but that of any mortgage subsidiary that it

might own. Thus the data are not directly comparable. But

even so, 1998 has turned out to be a banner year. OTSregulated thrifts originated more than $275 billion worth of home mortgages in 1998, more

than they originated in all of 1993, the best year in their history. As default rates tend to be

quite low in the first two or three years of a mortgage’s life, this infusion of recently

underwritten loans augurs well for default rates in the next couple of years, especially because

of the high proportion of refinancing mortgages.

Interest Rate Changes

he demand for mortgages that has driven the record setting origination activity has

come primarily from two sources – falling interest rates and new home purchases.

Figure 3 depicts

the movement of key

interest rates since

January 1996. The 1 year

constant maturity

Treasury rate (1 Yr

CMT) is frequently used

as an index for adjustable

rate mortgages. The 10

year constant maturity

Treasury rate (10 Yr

CMT) serves as an

overall risk-free

reference rate for longerterm contracts. The

FHLMC 30 day commitment rate for 30 year fixed rate conforming mortgages provides a

commonly used mortgage rate benchmark. During the last quarter (July through September)

shown in Figure 3, both domestic and worldwide events prompted a flight to safety that

drove down Treasury rates. Mortgage rates also fell but not as sharply. Thus the spread

between Treasury rates and mortgage rates widened in the third quarter, even as mortgage

rates declined.

Table 3: Thrift Home

Mortgage Originations

 (Source: TFR)

Year $Billions

1990 120

1991 121

1992 182

1993 189

1994 133

1995 106

1996 136

1997 150

1998 276

I

T Figure 3: 30 Year FHLMC commitment rate, 1 and 10 year

constant maturity Treasury rates

4.5

5

5.5

6

6.5

7

7.5

8

8.5

9

Jan96Apr96Jul96Oct96Jan97Apr97Jul97Oct97Jan98Jun98Sep98

30 Yr Mortgage

10 Yr CMT

1 Yr CMT
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 5 March 1999

Originations by Product and LTV

he Federal Housing Finance Board conducts its Mortgage Interest Rate Survey (MIRS)

monthly among mortgage lenders on the interest rates and terms of their recently

closed conventional (non-government-backed) mortgages. Table 4 reports the survey

results for the months ending each quarter over the last eighteen months.

Table 4 shows that, for all three lender groups, effective mortgage interest rates (which

include the amortization of initial fees and charges over a ten-year period) have declined

sharply since the end of June 1997. For S&Ls, the current average is 6.72%, for commercial

banks, 7.01%, and for mortgage companies, 7.11%. The average effective interest rate was

substantially lower for S&Ls than

that for the commercial banks and

mortgage companies in every

quarter surveyed.

The flat yield curve over the last

year continues to affect ARM

originations. S&Ls have

traditionally originated a higher

proportion of ARMs than either

commercial banks or mortgage

banks, and this pattern persists.

While more than half of S&L’s

originations are typically ARMs,

the percentage had fallen to just

35% in September. At commercial

banks and mortgage companies,

the decline in ARM originations

has been even more dramatic.

Only 7% of the commercial banks’

and 4% of the mortgage

companies’ originations were

ARMs during the third quarter of

1998.

The distribution of originations by

loan-to-value ratios can also create

differences in the effective interest

rates between S&Ls and

commercial banks and mortgage companies. Over the last year and a half, S&Ls have

originated a much smaller percentage of their loans in the highest LTV category (greater than

90% LTV ratio) than the other two originators. This difference between commercial banks

and S&Ls should eventually be reflected in the respective charge-off rates, as high LTV loans

are riskier than low LTV loans. Because of their higher credit risk, higher LTV-ratio loans

(without mortgage insurance) should carry higher rates and/or more fees and charges than

lower LTV-ratio loans.

T

Table 4: Mortgage Rates and Terms

(Conventional Home Purchase Mortgages)

Effective Rate Percent of Loans by LTV Class % Arms

< 70% 70-80 80-90 >90

S&Ls 90%

Mar-97 7.34 21 47 16 16 46

Jun-97 7.33 22 45 16 17 56

Sep-97 7.12 21 49 15 15 53

Dec-97 7.05 25 48 13 14 45

Mar-98 6.96 24 46 14 16 36

Jun-98 6.90 25 47 13 15 39

Sep-98 6.72 26 47 12 15 35

Commercial Banks

Mar-97 7.77 20 39 19 22 31

Jun-97 7.86 21 38 18 22 21

Sep-97 7.59 22 37 17 24 16

Dec-97 7.46 18 32 16 35 9

Mar-98 7.22 15 34 16 36 9

Jun-98 7.21 15 31 14 40 9

Sep-98 7.01 17 34 17 33 7

Mortgage Companies

Mar-97 7.92 19 34 17 30 14

Jun-97 8.03 18 36 17 28 16

Sep-97 7.77 19 36 18 27 13

Dec-97 7.51 19 36 17 27 8

Mar-98 7.28 20 37 17 27 6

Jun-98 7.29 19 37 16 28 7

Sep-98 7.11 19 36 16 28 4

Source: Mortgage Interest Rate Survey, Federal Housing Finance Board
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 6 March 1999

CAPITAL REQUIREMENTS AND MORTGAGES

egulatory capital serves many purposes. It acts primarily as a buffer against unexpected

losses. It protects depositors, debt holders, and the FDIC insurance fund, among

other claimants on the thrift, from unanticipated declines in the value of the thrift.

(Expected losses should already be accounted for in loan loss reserves.) Regulatory capital also

acts as a brake on excessive risk-taking because the owners of the thrift (equity holders)

absorb losses first. It can also lower the cost of financial distress, such as the protective

actions taken by others before insolvency occurs, as seen in panic withdrawals during a run

on a bank.

Unexpected declines in the value of a thrift can occur for many reasons. Unexpected

increases in interest rates can lower the value of assets relative to liabilities. A downturn in

economic conditions can cause borrowers to default. A mispriced product line can perform

poorly. A bad management decision can create excessive costs.

Creditors are interested in the overall risk of loss on their claim. To address this, practitioners

have created an elaborate taxonomy of risk, which includes interest rate risk, liquidity risk,

credit risk, exchange rate risk, transactional risk, and operational risk, among others.

However, these risks are often analyzed separately, although approaches like value-at-risk that

look at overall risk are gaining acceptance. While interest rate risk is appropriately measured

by OTS at the institution level with all the interactions between various assets and liabilities

taken into account, credit risk is usually (and inappropriately) measured asset by asset,

ignoring correlations among assets and liabilities. But that is the approach all the banking

regulators take in calculating risk-based capital.

If unexpected losses are large enough, the thrift can become insolvent – its assets are no

longer sufficient to cover its liabilities. In the private sector, bond holders, through

covenants, impose restrictions on a firm’s activities and can gain control of the assets of the

firm if it can’t meet its obligations. Similar to bond covenants, banking regulators impose

restrictions on the types of assets and liabilities insured depositories can have, and by how

much the value of those assets has to exceed the value of liabilities (capital requirements).

They do so to promote the safety and soundness of the banking system by limiting the

probability of failure. Because of deposit insurance, the FDIC is also keenly interested in the

relationship between the value of an insured depository’s assets and its liabilities.

Interestingly, capital itself is really an accounting fiction. It is the tasteless, odorless, can’t-bespent numerical difference between the value of assets and the value of liabilities. There is no

cash drawer marked capital from which to pay off creditors. Rather, the thrift uses its assets,

such as cash and securities, to pay off its creditors. The capital account is on the liability side

of the balance sheet, not on the asset side, and it reflects the residual difference between

assets and liabilities. Higher capital requirements lower the risk of insolvency by increasing

the relative amount of assets available to cover liabilities.

Measuring Capital

ot all capital is the same. For example, some assets are pledged as collateral to

specific claimants and wouldn’t be available to cover other liabilities in case of

financial distress. Some assets may not fetch their full value if they have to be

R

N
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 7 March 1999

liquidated quickly. Some assets are not worth what their accounting book values say they are.

Regulatory capital requirements are based on accounting book values. In the past, some bank

and thrift failures have been triggered because of massive write-downs of asset book values

that were no longer warranted by their underlying economic value. Although regulatory

capital requirements are based on accounting values, banking regulators are beginning to use

market data as a signal of potential problems.

The economic value of equity capital (the difference between assets and liabilities) depends

on the current market values of the assets and liabilities. The values of some assets and

liabilities are easier to observe and monitor than others. For example, Treasury bonds that

actively trade can be valued easily and carry essentially no credit or liquidity risk. But their

values can change dramatically with even small changes in interest rates.

Other assets, such as a commercial mortgage on a partially vacant office building, are more

difficult to value. From a economist’s point of view, the accuracy (in the sense of measuring

the current underlying value) of accounting data is directly proportional to the

“transparency” of the assets or liabilities involved, where transparency is the ease with which

market values can be verified. Assets that trade frequently in deep secondary markets are

transparent. If assets on a thrift’s books are very much like those that trade freely in the

market, they can be valued more easily. Conforming home mortgages are bought and sold

frequently. Thus, the assets of a thrift holding a portfolio of conforming mortgages is more

transparent than one that holds a portfolio of commercial construction loans.

Transparency provides some assurance that the value of the assets on the books won’t

disappear on closer scrutiny. The book values of assets whose market values are easy to

verify are less likely to be overstated because accounting rules require that they be marked

down when their market values indicate that they have become permanently impaired.

Active trading over time in a particular asset can also provide insights into the sensitivity of

that asset to changes in credit conditions, interest rates, etc. This makes assessing the risk of

those assets easier.

A strict reliance on market value accounting is no panacea, though, as it has its own

problems. Not all assets are traded in deep secondary markets in arms-length transactions.

Thinly traded or infrequently traded assets can provide misleading price information. Cherry

picking loans out of portfolios to sell could inflate the reported value of the remaining loans

on the books, etc.

Measuring Risk

he risk of an asset (credit risk, interest rate risk, liquidity risk, etc.) has to do with how

quickly it can lose value, how frequently such changes occur (the frequency of loss),

and the depth of the losses if they occur (severity). For example, a collateral-backed

loan, like a mortgage, presents less risk than an unsecured loan because the collateral stands

to lower the severity of loss should a default occurs.

Risk-based capital requirements focus on credit risk. Consider two types of $100 loans, A and

B. The principal on type A loans is paid off in full 95 times out of a hundred. The other five

times, however, the borrower defaults and pays back nothing. As a result, type A loans have

an expected loss of $5. Type B loans always default, but the lender always receives $95 back

T
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 8 March 1999

on the loan. Type B loans also have an expected loss of $5. Type B loans are not risky (like

loans to your brother-in-law), because you always know the outcome. Type A loans are risky,

because the loans could unexpectedly turn out to be worthless. Expected losses alone tell

you little about the risk of an asset. Information on the frequency and severity of loss is

much more important in gauging risk than expected losses.

As long as a default on one loan isn’t related to the default on another loan, a lender can

lower the risk (but not the expected loss) by building a portfolio of loans. Loan pools of

similar types of loans have less risk than single loans because some bad outcomes are offset

by some good outcomes so that the overall variability is smaller. Mortgage loan pools gain

from diversification. However, adding very risky loans to a portfolio of safe loans will raise

the overall risk, not lower it, despite the diversification gained by adding the risky loans.

How then do you gauge the risk of home mortgage pools? Fortunately, we have historical

data on the performance of home mortgage pools. Moody’s, for example, has rated over

$500 billion of nonconforming one-to-four family residential mortgage backed securities.

The Office of Finance Housing Enterprise Oversight (OFHEO) is developing capital

guidelines for the millions of conforming mortgages held by or guaranteed by Freddie Mac

and Fannie Mae.

Both OFHEO and Moody’s use historical data to determine how mortgage pools have

performed. Moody’s looks specifically at how performance is affected by underlying factors

such as LTV, regional concentration, borrower credit profile, servicer/originator

performance, and interest rate levels2. From these analyses, analysts can sketch a loss profile

for a specific pool of residential mortgages. This profile relates a specific level of dollar ($)

losses with the likelihood that such specific losses might occur, creating a loss density

function for a specific loan pool (see Figure 4.) In other words, given the various

characteristics (LTV, location, servicer, credit score, etc.) of the mortgages in a given loan

pool, rating services such as Moody’s forecast the level dollar losses such a pool would

experience (graphed along the x axis) and assesses the probability such an event might occur

(graphed along the y axis).

For a given loss profile of a mortgage pool, an investor can limit exposure to potential losses

by requiring that any losses up to a point be absorbed by a third party. These loss-absorption

structures have a variety of names, such as spread accounts, guarantees, and recourse

agreements, but their common function is to limit potential losses to the investor by creating

a capital support level.

Expected and unexpected losses play totally different roles. To calculate the expected loss on a

loan pool, you take a weighted average of all the possible losses, where the weights are the

probability that each loss would occur. The dollar amount “A” in Figure 4 represents the

expected loss on this particular pool. A capital support level equal to the expected losses

would still leave the investor exposed to substantial risk of loss.

 

2

 See “Moody’s Approach to Rating Residential Mortgage Pass-Through Securities,” Moody’s Investor Service

Special Report, November 8, 1996.
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 9 March 1999

Figure 4: Loss Density Function

0

2

4

6

8

10

12

$ Losses

Probability

Unsupported

Loss Exposure

Supported

Loss Exposure

Expected loss

Capital Support

Level

A B

The dollar amount B represents a capital level that would cover most losses, both expected

and unexpected. The investor would still be exposed to some unlikely (low probability of

occurrence) but large pool losses. If large losses did occur, though, the capital support

structure would absorb $B dollars of those losses before the investor lost any money.

By varying the amount of capital support ($B), a seller can vary the investor’s exposure to

loss. For example, with a very high level of capital support, a mortgage pool could achieve a

‘AAA’ rating. A lower $B level might garner a ‘BBB’ rating. Etc.

Loan pools have widely varying loss density profiles. A pool constructed from very high

LTV loans would have a much different profile from that of a low LTV loan pool. A

geographically concentrated pool would have a more disperse loss profile (less spiked, but a

fatter tail – a higher probability of larger losses because of a lack of diversification.) By

varying capital support levels appropriately, one could equalize the risk of different loan

pools.

By extension, this analysis could be applied to banks and thrifts. For example, capital

requirements could be set such that risk faced by the FDIC of a bank or thrift failure is

equivalent to that of an investor in an investment grade bond. The amount of capital

required of each institution would vary by the risk profile of that institution.

The Probability of Insolvency

t the bank or thrift level, how much regulatory capital is enough? To answer that

question, you need to ask another question: How often are regulators willing to have a

bank or thrift fail? They can set capital requirements so high that a thrift engaged in

mortgage business would almost never fail. Why not set it that high? Capital is costly

for thrifts to hold. Too high capital requirements would drive thrifts out of business and

consumers would end up paying more for a mortgage than they should.

Private insurance companies set fees and the deductible (capital requirement) on the basis of

expected insurance claims. A higher deductible lowers their expected payouts. A higher

capital requirement for thrifts would lower the probability of insolvency. As Alice Rivlin said

A
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 10 March 1999

in a speech in December 1996, “The question should not be how high is the bank’s capital

ratio, but how low is its failure probability.” And a zero probability of failure is not an

economically sound solution. But setting an appropriate capital level requires an

understanding of the potential loss profile of each thrift or bank based on its specific assets

and liabilities.

It should be noted that thrifts and banks have private incentives for holding capital.

Additional capital lowers the cost of issuing debt. Capital also acts as a signal to both

depositors and borrowers who invest time and money in the relationship with the institution

that it will be around for a while. Currently, most thrifts hold more capital than is required by

regulation, which may mean that overall regulatory capital requirements might not be

binding. However, current regulatory capital requirements may misprice the risk of individual

assets and by doing so provide an incentive to either avoid or take on more of that type of

asset than is warranted by the underlying economics.

CONCLUSION

n future issues, we will look in more detail at the loss distributions of different types of

assets, especially mortgage related assets. At this point we know that LTV plays a critical

role in determining the shape of the loss function for home mortgages. We also know

that the size of the mortgage loan pool and its geographical diversification also play key roles.

Smaller pools with less geographical distribution will have a more disperse loss distribution,

which means a higher level of “unsupported losses” for any given level of capital. Other

research has shown that the credit quality of the borrower and his/her willingness to pay

back the mortgage plays a larger role in determining losses than previously thought.

Do home mortgages make a good asset base for capital calculations? In other words, do they

provide a firm foundation for the capital = assets - liabilities equation? Home mortgages are

more transparent than most loans. But swings in interest rates and prepayments, as well as

changes in underlying credit quality can affect their economic value. However, evidence from

the 1980s suggests that traditional home-mortgage-lending thrifts, even when they failed,

kept more of their value than non-traditional failed thrifts. Is a 4% capital requirement (8%

capital requirement * 50% risk bucket for qualifying mortgages) too high for home

mortgages?

To be continued...

I
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 11 March 1999

Mortgage Market Trends

Volume 3 Issue 1

March 1999

Data Appendix

National and Regional Trends in Mortgage Delinquency Rates

As of September 30, 1998
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 12 March 1999

Regional and State Analysis

Seriously Delinquent & Home Price Appreciation Rates as of 9/30/98

(Based on $)

MIC SD TFR SD Home Price Appreciation

Market Depositories TFR 1-Year 5-Year

National 0.84 1.20 0.81 4.98 20.1

Northeast 1.10 1.64 0.79

Connecticut 0.96 1.33 0.45 4.80 5.25

Delaware 0.82 1.40 0.41 2.81 6.60

Maine 0.71 1.31 0.82 5.47 11.40

Massachusetts 0.53 0.71 0.43 7.43 20.57

New Hampshire 0.41 0.61 0.56 6.75 14.84

New Jersey 1.43 2.28 1.20 4.30 7.37

New York 1.44 1.85 0.77 4.30 7.37

Pennsylvania 1.04 1.77 0.82 3.39 9.50

Rhode Island 0.75 0.98 1.84 2.55 3.38

Vermont 0.43 0.83 1.07 2.48 7.13

West Virginia 0.47 1.34 0.75 3.04 22.14

Southeast 1.00 1.45 0.87

Alabama 0.61 1.44 1.19 5.20 24.41

DC 1.51 1.87 2.63 4.78 4.70

Florida 1.16 1.44 0.59 4.80 16.27

Georgia 0.77 1.24 0.78 6.03 26.09

Maryland 1.63 2.40 2.05 2.51 6.64

North Carolina 0.60 0.97 0.45 4.97 27.95

Puerto Rico 0.94 2.90

South Carolina 0.75 1.13 0.45 5.08 22.80

Virginia 0.76 1.11 0.68 3.15 10.41

Central 0.57 1.19 0.69

Illinois 0.82 1.31 0.80 3.19 20.43

Indiana 0.63 1.35 0.99 3.88 26.80

Kentucky 0.41 0.85 1.00 3.88 28.30

Michigan 0.23 0.54 0.74 5.96 40.85

Ohio 0.56 1.24 0.57 4.67 27.54

Tennessee 0.86 1.76 0.61 5.23 30.32

Wisconsin 0.27 0.64 0.26 3.76 32.88

Midwest 0.54 0.89 0.63

Arkansas 0.73 1.21 0.55 3.78 23.35

Colorado 0.32 0.49 0.13 5.77 44.21

Iowa 0.21 0.27 0.34 4.12 28.53

Kansas 0.40 0.64 0.31 4.54 29.84

Louisiana 0.85 1.41 0.39 4.85 29.51

Minnesota 0.35 0.52 0.34 5.30 28.85

Mississippi 0.65 2.02 0.90 5.83 27.02

Missouri 0.42 0.78 0.43 3.23 24.46

Nebraska 0.20 0.29 0.72 4.03 32.17

New Mexico 0.69 0.99 0.89 2.98 27.72

North Dakota 0.35 0.42 0.22 4.90 25.54

Oklahoma 0.77 1.33 0.35 4.06 20.93

South Dakota 0.46 0.70 0.64 3.55 29.25

Texas 0.74 1.16 0.89 4.94 15.16

West 0.84 0.99 0.91

Alaska 0.47 1.25 0.00 4.03 20.19

Arizona 0.53 0.69 0.50 4.55 29.67

California 0.93 1.07 0.98 8.52 6.93

Hawaii 1.66 2.60 1.77 1.24 -8.74

Idaho 0.61 0.70 0.28 3.26 26.37

Montana 0.61 1.13 0.50 2.57 33.62

Nevada 1.11 1.31 - 2.16 14.84

Oregon 0.33 0.35 0.31 4.01 46.41

Utah 0.62 0.87 0.66 3.93 59.49

Washington 0.54 0.54 0.26 6.96 26.49

Wyoming 0.39 0.62 0.42 3.15 32.11
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 13 March 1999

OTS Regions

Seriously Delinquent Mortgages (%)

Based on Thrift TFR Data by Location of Headquarters

0.50%

0.70%

0.90%

1.10%

1.30%

1.50%

1.70%

1.90%

Sep-94 Mar-95 Sep-95 Mar-96 Sep-96 Mar-97 Sep-97 Mar-98 Sep-98

National NE SE Central Midwest West

Percent Home Price Appreciation

1997Q3 to 1998Q3

(Source: OFHEO Resale Database)

5.3 to 8.52 (10)

4.78 to 5.3 (10)

4.01 to 4.78 (10)

3.19 to 4.01 (10)

1.24 to 3.19 (11)
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 14 March 1999

National Cohort Performance by Quarter of Origination

Percent Seriously Delinquent after 24 Months, All Loans

(Source: MIC)

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Sep-93 Mar-94 Sep-94 Mar-95 Sep-95 Mar-96 Sep-96

Origination Quarter

Home Purchase vs. Refinancing Mortgages

 (Source: MIC, Percent Seriously Delinquent, All Loans)

0

0 . 5

1

1 . 5

2

2 . 5

1991 1992 1993 1994 1995 1996 1997 M a r -

9 8

Jun -

9 8

Sep -

9 8

P u r chase

R e f i nanc i n g

Fixed Vs. Variable Rate Mortgages

(Source: MIC, Percent Seriously Delinquent, All Loans)

0

0 . 5

1

1 . 5

2

2 . 5

1991 1992 1993 1994 1995 1996 1997 M a r -

9 8

Jun -

9 8

Sep -

9 8

V a r i a b l e

F i xed
Mortgage Market Trends Volume 3 Issue 1

Research & Analysis 15 March 1999

States with Higher Percentages of Very High LTV Mortgages

(Source: MIC, 96% to 105% LTV Conventional Mortgages)

1.41 to 1.73 (2)

1.07 to 1.41 (4)

0.73 to 1.07 (10)

0.39 to 0.73 (15)

0.05 to 0.39 (20)

States with Higher Percentages of High LTV Mortgages

(Source: MIC, 91% to 95% LTV Conventional Mortgages)

16.1 to 18.8 (2)

13.2 to 16.1 (9)

10.3 to 13.2 (13)

7.4 to 10.3 (19)

4.5 to 7.4 (8)