The Real Credit Risk

According to the mortgage news site HousingWire, credit rating agency Fitch Ratings is coming around to the idea that credit scores aren’t such a great predictor of who will default on their exotic mortgages. Says the HousingWire article:

After studying the collateral attributes of early payment default (EPD) loans and comparing them to loans that did not default in the first 12 months after issuance, Fitch found that Fair Isaac Corp. (FICO) scores have become less significant as an early default indicator when other high risk loan attributes, such as piggyback second liens or loans with no-income verification, are present.

“While FICO scores continue to be highly predictive measures of relative credit risk for loans with similar characteristics, FICO scores play a lesser role when additional risk layers are added,” said Glenn Costello, Managing Director, RMBS, Fitch Ratings.

“In the case of the 2006 vintage delinquencies, additional risk layers that are factoring into the sharply higher delinquencies include high combined loan to value ratios (CLTVs) and stated income loan programs as borrowers with higher FICO scores tend to be highly levered.”

Fitch’s study supports the theory, offered earlier on this blog, that increasing mortgage defaults will likely not be confined to subprime borrowers. Whether a borrower is considered subprime or not is largely dependent on his or her FICO score, which is based on past credit “behavior.”

But a borrower’s past ability to pay the cable bill on time isn’t all that relevant if he or she simply lacks the financial means to make the payments on a resetting exotic mortgage. Such a situation is entirely possible because, as Fitch’s spokesman points out, many borrowers used their good credit scores as a way to get into very risky loans.

The big problems have thus far been confined to subprime mortgages because such loans typically have earlier reset dates and involve borrowers with less margin for financial error. The Fitch study indicates that the default problem is likely to spread beyond subprime in the future.

— RICH TOSCANO