Subprime Mortgage Credit Derivatives

CHAPTER 2

First Lien Mortgage Credit

In this chapter, we take a detailed look at first lien mortgage credit. We focus primarily on subprime collateral, although we do compare with prime and Alt-A mortgages when it is necessary. Loan-level data from Loan-Performance are used throughout our analysis.

We hope to convey the message that our analysis is important not in terms of the magnitude or the historicalness of the recent credit performance. It is in our methodology and way of analyzing mortgage credit that we have made the biggest strides.

The chapter is divided into four sections. In the first section we discuss how to define and measure mortgage credit. We review various ways of analyzing delinquencies, discuss the usefulness of roll rates in monitoring short-term performance trends, and explain some common misconceptions about loss severities.

In the second section, we identify the collateral characteristics that drive mortgage credit performance. In doing so, we analyze the classic drivers of credit performance, namely, FICO score and loan-to-value (LTV) ratio. We highlight the role of deterioration of the four Cs in mortgage underwriting (i.e., credit, collateral, capacity, and character) in the subprime debacle.

The third section focuses on how recent foreclosure/REO timelines and severity compare with historical observations. We concentrate on the role of geography on timelines and severity. Geography affects timelines since different states have different foreclosure ...