Distribution of Credit Risk among Providers of Mortgages to Lower-Income and Minority Homebuyers
Canner, Glenn B., Passmore, Wayne, Surette, Brian J., Federal Reserve Bulletin
The financial institutions that bear the credit risk in mortgage lending are critical because without such participants, mortgages cannot be made. Once an institution agrees to assume the risk that a borrower will not repay a loan as scheduled, the other participants in the mortgage process--originators, funders, and purchasers--are readily available. The bearing of credit risk is an ongoing concern of the mortgage market and the government, and a variety of institutions have evolved for that purpose. The performance of these institutions in taking on credit risk has important public policy implications because home ownership, particularly within lower-income and minority communities, is a well-established national goal and is of intense public interest.
Assessing the performance of mortgage market participants in accepting credit risk is not straightforward for several reasons--lack of data, uncertainties about the most appropriate criteria for assessing performance, and the influence of government subsidies and regulations. The diversity of the participants' goals and strategies also complicates the task: The government mortgage insurers that account for most of the risk-bearing activity in the government mortgage system are nonprofit and accept nearly all the credit risk of the mortgages they insure; the mortgage originators, insurers, and purchasers that make up the conventional mortgage system are profit-seeking and generally act to spread the risk throughout the system.
In an earlier study we assessed the performance of the major participants in the market for home purchase mortgages by examining the distribution of the mortgage credit risk borne by these institutions.(1) For that analysis we combined 1994 data on mortgages collected pursuant to the Home Mortgage Disclosure Act (HMDA) with 1994 data on private mortgage insurance (PMI) activity made available by private mortgage insurers. With that unique database we obtained rough measures of the amount of credit risk that the major participants bore and the distribution of that risk across institutions by the income and racial or ethnic characteristics of the borrowers and their neighborhoods. We found that the largest government insurer, the FHA, was the most involved with lower-income and minority homebuyers, as measured by both portfolio share (the proportion of an institution's own mortgage portfolio extended to these groups) and market share (the proportion of all mortgages extended to these groups for which an institution bears the credit risk). Depository institutions generally had higher portfolio and market shares than the two for-profit government-sponsored enterprises that are active in the secondary market, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
In this article we revisit the issue of who bears the credit risk associated with mortgage lending using 1995 data and refined estimates of the amount of mortgage credit risk borne by market participants.(2) In our earlier analysis we measured credit risk in terms of the number of mortgages held or insured; here we go beyond looking at numbers or simple dollar amounts of mortgages held or insured and instead measure risk in terms of the dollar losses that could be expected on the basis of historical experience.
Institutions' expected dollar losses are determined primarily by the distribution of loan-to-value ratios within their mortgage portfolios: Higher ratios are associated with higher mortgage default probabilities and loss severity rates. Data on these aspects of mortgage lending are not reported under HMDA and are not readily available elsewhere; we obtained the information in a variety of ways, including discussions with industry participants and modeling based on preliminary data from the Federal Reserve's 1995 Survey of Consumer Finances.
Who bears the credit risk for mortgage lending to lower-income borrowers, black or Hispanic borrowers, lower-income neighborhoods, and minority neighborhoods, and how is that risk distributed? …