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Mortgage Impairment Portfolio Risk Analysis

Dramatic escalation in real estate values, accompanied by the use of interest only and adjustable rate mortgages, is creating increased default risk to mortgage lenders. Lenders and mortgage holders may not appreciate that these developments are also increasing mortgage impairment risk due to extreme natural and man-made hazard events. As these conditions continue, mortgage lenders are increasingly at risk to widespread defaults should a major earthquake, hurricane or other natural disaster strike an area where lenders' portfolios are concentrated. Further, properties repossessed due to previous defaults and/or those properties held as assets for rental income, increase this risk of major mortgage impairment from "shocks" due to extreme events.

Exposure to mortgage holders for these type of events is heavily dependent upon the loan to value ratio of each individual mortgage, as well as the extent of damage to the region affected, and the equity position on the property by the mortgagee. A sudden decline in real property values can eliminate owner equity, dramatically increasing the default risk following damage to the property from an earthquake or other uninsured peril.

ABS Consulting has developed unique loss algorithms for determining mortgage impairment and loss due to extreme natural and man-made hazard. These methodologies have been developed for use in mid to large-sized portfolios owned by some the well-known mortgage lenders and mortgage portfolio firms in the United States, and have been validated using actual loss data related to several significant earthquakes in the US including Loma Prieta in 1989 and the Northridge earthquake event in 1994.

100 Year Earthquake Damage for Mortgage Portfolio

Calculated 100 Year Mortgage Portfolio Loss from Earthquake

There are several applications of probabilistic results from a mortgage portfolio risk analysis, which are beneficial to mortgage lenders and those investing in mortgage portfolios. The primary applications include:

• Dynamic Financial Analysis

• Reserve Funding and Reinsurance

• Optimal Risk Management Strategy

In many cases, the exposure to a mortgage book may be low, given some of the parameters specific to the portfolio, or could be much higher than perceived due to uncertainty in the underlying hazard, vulnerability of the structure(s) exposed, loan to value distribution within the portfolio, and equity held by the borrower. Unlike insurance portfolios, mortgage portfolios may be significantly impacted for even smaller events, due to some of these conditions unique to the portfolio, which make it more likely for borrowers to default. For these reasons, many mortgage lenders have turned to ABS Consulting and EQECAT to better understand this potentially high, financial risk.

For more information, contact:

Kenneth A. Travers
SVP, ABS Consulting/EQECAT
1-302-239-1145 | ktravers@eqecat.com