Loan Application Defect and Fraud Risk Reaches Historically Measured Low Point, According to First American Loan Application Defect Index

Fewer defects and less misrepresentation will reduce repurchase risk and expenses for underwriters in the future, says Chief Economist Mark Fleming


June 30, 2016, Santa Ana, Calif.

First American Financial Corporation (NYSE: FAF), a leading global provider of title insurance, settlement services and risk solutions for real estate transactions, today released the First American Loan Application Defect Index for May  2016, which estimates the frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications. The Defect Index reflects estimated mortgage loan defect rates over time, by geography and by loan type. It’s available as an interactive tool that can be tailored to showcase trends by category, including amortization type, lien position, loan purpose, property and transaction types, as well as state and market comparisons of mortgage loan defect levels.

May Loan Application Defect Index

The First American Loan Application Defect Index decreased 2.7 percent in May as compared with April and decreased by 9.9 percent as compared with May 2015. The Defect Index is down 28.4 percent from the high point of risk in October 2013.

“The Defect Index continues to decline, reaching a historically measured low point. Apart from the increases in risk in 2013 and early 2015, the Defect Index has been consistently trending lower since inception. As we reported in March, loan production expenses have been increasing, which reflects the industry’s investment in technology and improved standards, as well as greater demand for compliant loan production processes,” said Mark Fleming, chief economist at First American. “Now, additional data from the Mortgage Bankers Association shows that underwriters are taking more time to close each loan transaction. Productivity, which measures the number of loan applications processed per month by an underwriter, is down significantly from the rate of underwriting present at the height of the housing boom.”

The Defect Index for refinance transactions declined 3.1 percent month-over-month, and is 10 percent lower than a year ago. The Defect Index for purchase transactions declined 2.4 percent month-over-month, and is down 11.4 percent compared to a year ago. Since defect risk for both purchase and refinance transactions peaked in late 2013, defect risk on refinance transactions continues to decline much more than defect risk for purchase transactions, declining 38.0 percent as compared to 22.1 percent for purchase transactions.

“Better technology and standards in the loan application process combined with more time spent underwriting each loan application may be increasing the cost of loan production, but we continue to see clear benefits too,” said Fleming. “While the costs of compliance are higher and reducing the profitability of mortgage lending, there is long-term financial benefit to increased loan quality. Fewer defects and less misrepresentation will reduce repurchase risk and expenses for underwriters in the future.”

May 2016 State Highlights

  • The five states with the highest year-over-year increase in defect frequency are: North Dakota (+19.3 percent), Maine (+10.0 percent), Missouri (+10.0 percent), Utah (+5.2 percent), and Oklahoma (+4.7 percent).
  • The five states with the highest year-over-year decrease in defect frequency are: Michigan (-27.5 percent), Florida (-20.0 percent), West Virginia (-16.9 percent), New Mexico (-16.5 percent), and Delaware (-16.0 percent).

May 2016 Local Market Highlights

  • Among the largest 50 Core Based Statistical Areas (CBSAs), the four markets with year-over-year increase in defect frequency are: St. Louis (+15.9 percent); Salt Lake City (+4.0 percent); Oklahoma City (+3.7 percent); and Houston (+3.4 percent).
  • Among the largest 50 CBSAs, the five markets with the highest year-over-year decrease in defect frequency are: Detroit, MI (-33.0 percent); Jacksonville, Fla. (-21.4 percent); Miami (-20.2 percent); Hartford, Conn (-19.0 percent); and Buffalo, N.Y. (-17.6 percent).

Loan Application Mix Matters in Understanding Locational Differences

“It is important to understand that the overall national as well as geographic trends that we observe in defect, misrepresentation and fraud risk are in part driven by the relative mix of loan purpose, occupancy type, property type and transaction type,” said Fleming.       “Based on a review of the proprietary data we use in the Defect Index, refinance loan transactions are 23.5 percent less risky than purchase loans. Owner-occupied loans are 30.1 percent less risky than investor loans. Single family properties are 11 percent less risky than condos and FHA loans are 15 percent less risky than conventional loans.

“When rates begin to rise consistently higher, which is now less likely in 2016 given Britain’s decision to exit the European Union, there should be less refinance activity relative to purchase loan applications. We expect this relative shift away from lower risk refinancing to higher risk purchase loans will put upward pressure on the overall risk indices,” said Fleming. “More generally, because the indices don’t hold the ‘mix’ of refinance and purchase applications constant, the overall index measures the underlying risk trend, but also any change in the mix.

“Every month, the loan application mix can change across a number of different categories. Also, the month-to-month change in the loan application mix in one location will be different than the change in another location,” said Fleming. “For example, Florida, and Miami in particular, is consistently ranked as a hot spot for loan defect, misrepresentation and fraud risk. But, it is also a market with a high concentration of loans for investor-owned condominiums, which involve higher risk loans. In other words, part of Miami’s risk profile is driven by its unique mix of transactions.

“While we have often stated that location matters, it is important to keep in mind that part of the locational variances in loan defect risk among markets is due to the unique mix of loan applications in each market,” said Fleming. “We expect misrepresentation and fraud risk to move higher with more purchase, investor and condominium transactions. The loan application mix influences the Defect Index, even when compliance drives the overall trend down.”

Next Release

The next release of the First American Loan Application Defect Index will be posted the week of July 25, 2016.

Methodology

The methodology statement for the First American Loan Application Defect Index is available at http://www.firstam.com/economics/defect-index.

Disclaimer

Opinions, estimates, forecasts and other views contained in this page are those of First American’s Chief Economist, do not necessarily represent the views of First American or its management, should not be construed as indicating First American’s business prospects or expected results, and are subject to change without notice. Although the First American Economics team attempts to provide reliable, useful information, it does not guarantee that the information is accurate, current or suitable for any particular purpose. © 2016 by First American. Information from this page may be used with proper attribution.

About First American

First American Financial Corporation (NYSE: FAF) is a leading provider of title insurance, settlement services and risk solutions for real estate transactions that traces its heritage back to 1889. First American also provides title plant management services; title and other real property records and images; valuation products and services; home warranty products; property and casualty insurance; and banking, trust and investment advisory services. With revenues of $5.2 billion in 2015, the company offers its products and services directly and through its agents throughout the United States and abroad. More information about the company can be found at www.firstam.com.

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