Early payment defaults drop below pre-pandemic levels

A key indicator of loan buyback risk has fallen back below pre-pandemic levels, according to Aces Quality Management’s most recent quarterly report.

Early payment defaults during the second quarter were at 86.5% of their year-end 2019 levels, down significantly from 126.7% in the first quarter of this year. AQM currently measures EPDs using the fourth quarter of 2019 as a benchmark.

In another good sign for lenders concerned about repurchase risk, the report found that critical defects also inched a little closer to pre-pandemic levels in the first quarter, falling to 2.01% from 2.09% at the end of 2020. AQM reports all data except EPDs with a six-month lag.

“With Q1 2021 marking a second consecutive quarter of decline in the critical defect rate, the record spike observed in Q2 2020 appears to have been a one-off increase, which is encouraging,” said Nick Volpe, executive vice president at AQM, in a press release. “However, lenders and servicers should still proceed with caution, as declines in gain-on-sale, the conclusion of the [federal] eviction moratorium, persistent inflation and a potential default wave as forbearances come to an end all have the potential to trigger industry disruption.”

One indicator of potential default risk in the report was a new record high in the share of critical defects linked to income or employment concerns. This number was 31.44% during the first quarter, up from 23.77% at year-end 2020. The previous record of 30.19% was set in the second quarter of last year, when the pandemic was at its peak. AQM categorizes defects using the same classification system as Fannie Mae, a major government-related buyer of home loans.

The largest sub-category within income and employment defects during the first quarter was missing or expired documentation, which represented 47.54% the total. Other types of critical defects that rose on a consecutive-quarter basis were assets, (12.37% compared to 9.02%), and credit (12.89% vs. 7.38%).