Will a Rising VQI Materially Impact Servicing Costs and MSR Valuations?
RiskSpan’s Vintage Quality Index computes and aggregates the percentage of Agency originations each month with one or more “risk factors” (low-FICO, high DTI, high LTV, cash-out refi, investment properties, etc.). Months with relatively few originations characterized by these risk factors are associated with lower VQI ratings. As the historical chart above shows, the index maxed out (i.e., had an unusually high number of loans with risk factors) leading up to the 2008 crisis.
RiskSpan uses the index principally to fine-tune its in-house credit and prepayment models by accounting for shifts in loan composition by monthly cohort.
Will a rising VQI translate into higher servicing costs?
The Vintage Quality Index continued to climb during the third quarter of 2021, reaching a value of 85.10, compared to 83.40 in the second quarter. The higher index value means that a higher percentage of loans were originated with one or more defined risk factors.
The rise in the index during Q3 was less dramatic than Q2’s increase but nevertheless continues a trend going back to the start of the pandemic. The increase continues to be driven by a subset of risk factors, notably the share of cash-out refinances and investor properties (both up significantly) and high-DTI loans (up modestly). On balance, fewer loans were characterized by the remaining risk metrics.
What might this mean for servicing costs?
Servicing costs are highly sensitive to loan performance. Performing Agency loans are comparatively inexpensive to service, while non-performing loans can cost thousands of dollars per year more — usually several times the amount a servicer can expect to earn in servicing fees and other ancillary servicing revenue.
For this reason, understanding the “vintage quality” of newly originated mortgage pools is an element to consider when forecasting servicing cash flows (and, by extension, MSR pricing).
Each of the risk layers that compose the VQI contributes to marginally higher default risk (and, therefore, a theoretically lower servicing valuation). But not all risk layers affect expected cash flows equally. It is also important to consider the VQI in relationship to its history. While the index has been rising since the pandemic, it remains relatively low by historical standards — still below a local high in early 2018 and certainly nowhere near the heights reached leading up to the 2008 financial crisis.
A look at the individual risk metrics driving the increase would also seem to reduce any cause for alarm. While the ever-increasing number of loans with high debt-to-income ratios could be a matter of some concern, the other two principal contributors to the overall VQI rise — loans on investment properties and cash-out refinances — do not appear to jeopardize servicing cash flows to the same degree as low credit scores and high DTI ratios do.
Consequently, while the gradual increase in loans with one or more risk factors bears watching, it likely should not have a significant bearing (for now) on how investors price Agency MSR assets.
Population assumptions:
- Monthly data for Fannie Mae and Freddie Mac.
- Loans originated more than three months prior to issuance are excluded because the index is meant to reflect current market conditions.
- Loans likely to have been originated through the HARP program, as identified by LTV, MI coverage percentage, and loan purpose, are also excluded. These loans do not represent credit availability in the market as they likely would not have been originated today but for the existence of HARP.
Data assumptions:
- Freddie Mac data goes back to 12/2005. Fannie Mae only back to 12/2014.
- Certain fields for Freddie Mac data were missing prior to 6/2008.
GSE historical loan performance data release in support of GSE Risk Transfer activities was used to help back-fill data where it was missing.
An outline of our approach to data imputation can be found in our VQI Blog Post from October 28, 2015.
