Are banks taking more underwriting risk?

Late 2023 mortgage origination data shows changes in borrower characteristics that could point to a shift in the way banks are underwriting these loans, according to a new Federal Reserve report.  

Over a two-year span between the fourth quarters of 2021 and 2023, the median front-end debt-to-income ratio for new originations at the largest banks increased by five percentage points and now sits at the highest mark in over a decade at 27%, researchers at the Federal Reserve Bank of Philadelphia said. Similarly, loan-to-value ratios rose to 77% from 68% over the same period. 

Meanwhile, back-end DTI, which factors in all other debts owed by the borrower, inched up to 38% from 35%. But at the same time, credit scores have remained near their same level, with the median of 770 at the end of 2023, a drop from 779 three years earlier. 

"Originated mortgages hint at a possible change in the risk approach of firms," the researchers wrote. 

In the most challenging lending environment in recent history that has been marked by inventory shortages and fewer opportunities for aspiring buyers, total origination volume fell to $45.2 billion, the lowest level since the Philadelphia Fed began tracking the data in 2012. The bank analyzes numbers from institutions with $100 million or more in consolidated assets and loan portfolios of greater than $5 billion.

In combination, the increases in DTI and LTV ratios shine the spotlight on affordability issues as homeownership debt consumes a larger share of borrowers' budgets, the report said.

"Year-end data highlighted shifts in large bank underwriting practices, largely related to rising housing costs," the Fed researchers noted. 

Reflective of the affordability challenges, the median loan size surged 8.5% from $279,431 in late 2021 to $305,550 at the end of last year. The relatively swift rise in mortgage amounts mirrors national housing trends reported universally over the past few years as annual price growth hit record highs.  

The Federal Reserve Bank of Atlanta also reported affordability earlier this year approaching previous all-time lows, with 40.5% of the median national income required to make regular monthly payments. 

Still, even as housing costs continue to head upward alongside interest rates, lenders see an existing pipeline of potential borrowers focused on achieving homeownership, despite the challenges presented by current economic trends.

In spite of concerns about potential elevated risk from higher DTI ratios and mortgage payments, overall borrower distress has shown no significant recent spike. But performance varied across different types of loan products, with delinquencies of Federal Housing Administration-sponsored mortgages climbing up to a two-year high rate of almost 11% in the fourth quarter, the Mortgage Bankers Association recently found. 

Across the board, though, delinquencies remain well below pre-pandemic levels, with both the MBA and Philadelphia Fed reporting the number of past-due loans rising only slightly on a quarterly basis at the end of 2023.