Not all jumbo issuers are alike

Mortgage Banking, Dec, 1998 by David Teicher, Mark H. Adelson, Linda A. Stesney

General observations include the following:

* Retail originations and a low tolerance for underwriting exceptions are correlated with better historical performance.

* Delegated underwriting and bulk purchases are correlated with higher performance variability.

* The impact of broker originations is variable, depending on a company's business practices.

These results are not startling. The observation that retail originations tend to outperform wholesale originations has been made repeatedly by a variety of commentators (including Donaldson, Lufkin & Jenrette Securities Corporation's "Comparison of Seven Private Label RMBS Entities," 1998; and Ed Staples' "Study Finds Higher Delinquencies for TPO Loans," in Real Estate Finance Today, August 12, 1996).

In addition, more recent data compiled independently by Mortgage Information Corporation, San Francisco, provides further confirmation of this phenomenon. According to recent MIC data, 1.2 percent of loans classified as wholesale originations were "seriously delinquent" (i.e., 90 days or more delinquent or in foreclosure), as compared with only 0.79 percent of loans classified as retail originations. (Within the MIC data, retail originations made up 27.2 percent of the loans and wholesale originations made up 24.7 percent. The remaining 48.1 percent of the loans were Classified as "other," and a full 2.07 percent of such loans were 90 days or more delinquent or in foreclosure. The combined rate of serious delinquency for the wholesale and "other" categories together was 1.77 percent. This is about 2 1/4 times the rate of serious delinquency for the retail originations.)

A significant corollary to the conclusion that business practices do affect the credit quality of an issuer's mortgage loans is the notion that changes in business practices can drive changes in loan quality. Thus, as companies modify their practices in response to market evolution or competitive forces, their baseline credit-enhancement levels may need to be adjusted. Similarly, as previously untested companies prove their mettle by establishing substantial track records, their baseline levels should undergo downward adjustments, reflecting the success of the companies' methods.

Certain of the following summaries also reveal that credit quality is a key concern when looking at jumbo mortgage pools. Some of the jumbo pools from major MBS issuers have performed poorly - even during the strong economic climate of the 1990s. Hence the adequacy of the low credit-enhancement levels in many recent deals needs to be viewed against the backdrop of history (see "7-6-5-4-3. . . . . Credit Enhancement for Jumbo MBS: Where Is the Bottom?," Moody's Structured Finance, July 10, 1998).

Common Sense vs. Conventional Wisdom

Equally important, though, is the clear conclusion that brings us full circle: All MBS issuers are not equal. Differences in strategy and business practices create different expectations about future pool performance. This is natural and should not be surprising. Nonetheless, it may be contrary to the conventional wisdom that jumbo mortgage pools are fungible commodities whose sources are of little or no consequence in gauging credit quality. The conventional wisdom is flawed.