The Impact of Natural Catastrophe on Mortgage Delinquency

2018’s Hurricanes and Wildfires Expected to Increase Serious Delinquency Rates

The California wildfires of 2017 were some of the most destructive wildfires on record and 2018 is shaping up to be even more destructive.  In 2017 a total of 9,133 fires burned and damaged more than 10,000 structures in the state.  Then at the end of August 2017, as the wildfires raged in California, Hurricane Harvey hit landfall in Houston as a category 4 hurricane, widely reported as the strongest storm at landfall since Hurricane Charley in 2004 and the second costliest since 1900.  Harvey wind gusts were as high as 132 mph with hurricane force winds extending out 40 miles, spawning at least 29 tornadoes, and dropping record breaking rainfall totals of over 50 inches in some areas.

As Frank Nothaft discusses in CoreLogic’s September 2018 Economic Outlook, delinquency rates and rental growth increases after natural catastrophes occur.  There’s no question natural catastrophe events cause damage to homeowners both emotionally and financially.  When discussing the impact of natural catastrophes, the amount of property damage is well covered.  But what about the financial impact on homeowners well after the catastrophe event is over?  How do people manage to pay their mortgage while also paying to reconstruct their homes?  In addition, the closing of schools, blocked routes to work, and damage to their place of employment often cause disruption in income.  This article takes a closer look at the impact the amount of damage has on delinquency.

90+ Day Delinquency in Hazard Affected Areas (Hurricane Harvey Case Study)

These catastrophes caused tremendous damage to properties causing people to lose their homes, schools and businesses.  To understand the impact of natural catastrophes on mortgage delinquency, CoreLogic researched loan payment performance in Texas, after Hurricane Harvey.  By estimating the amount of damage to a property based on the event’s footprint, as well as using the property location and reconstruction cost data, the research shows devastation caused by the catastrophic hurricane event had an impact on homeowners’ ability to make mortgage payments in the months following the event.  Mortgages in Hurricane Harvey FEMA designated counties saw a significant increase in 90+ day delinquency when compared to delinquency rates just six months prior.  Within FEMA designated counties, properties estimated to have damage saw a 205% increase in 90+ day delinquency, while properties estimated to have no damage saw a 167% increase in 90+ day delinquency (see Figure 1). 

When considering the likelihood of mortgage delinquency, there are key drivers widely accepted in the mortgage industry.  These are factors such as loan to value, FICO score, origination interest rate spread, and other loan characteristics.  However, when a natural hazard event occurs what are the other factors we need to consider when identifying the risk of delinquency? 

CoreLogic studied property damage estimates associated with flooding events after Hurricane Harvey. Damage estimates give information on the amount of money a homeowner must spend to repair the damage.  Let’s say a house has a market value of $300,000 and the homeowner has 30% equity in their home.  If they sold their home for $300,000, they would walk away with $90,000 after paying the outstanding loan amount of $210,000.  If the same home experienced $100,000 in damage due to the event, the homeowner must pay $100,000 to repair the damage, or sell the home at a significant discount.  From the homeowner’s perspective, they have negative equity.  If the homeowner has an NFIP policy (National Flood Insurance Program – a government-backed flood insurance program that enables property owners to purchase insurance coverage for losses from flooding), they will receive a claim payment based upon the building damages from flooding in an amount up to the policy’s limits which could be as much as the statutory limit of $250,000 for the building.  If they don’t have an NFIP policy  and are in a Presidentially Declared Major Disaster Area (PDMDA) designated for Individual Assistance, they may be eligible to receive some funding for the repairs through FEMA or other agencies in the form of grants or loans.  It is important to note, however, that for Hurricane Harvey the average FEMA disaster assistance grant was only $4,000 compared to the average claim payment under an NFIP policy of $110,000.  Therefore, the disaster assistance grant payments for recovery are not nearly enough to recover.  To understand if the estimated damage plays a role in the homeowner behavior, let us add the damage to the loan balance and divide by the pre-disaster market value.  This is called a damage adjusted loan to value or damage adjusted LTV.  In areas not damaged by Hurricane Harvey, the delinquency rate increases slightly at LTV greater than 90%, then jumps significantly when LTV is greater than 110%.  In areas damaged by Hurricane Harvey, as the damage adjusted LTV increases, 90+ day delinquency significantly increases (see Figure 2 and Figure 3). 

Now think of the damage adjusted LTV as a simple parameter to estimate delinquency behavior.  That is, loans with damage adjusted LTV greater than 100% are estimated to be 90+ day delinquent 9.1% of the time, while LTV on loans with no damage are delinquent 8.8% of the time.  If only using LTV without adjusting for damage, loans with LTV greater than 100% are predicted to be 90+ day delinquent only 0.5% of the time (Figure 3). Both the proportion of loans that are high risk and the delinquency rate of high risk loans change.  Incorporating damage into this model provides significant value in identifying loans at risk of default.  Based on a simple example illustrated in the table below, identifying loans more likely to go delinquent in a post event environment has significant financial impact.

Table 1:  Accurately Identify Delinquency Post Event

While this illustration focuses on adjusting LTV when examining mortgage delinquency after a hazard event, the joint effect of event damage and multiple standard mortgage credit risk factors on mortgage performance post event is important to consider as well.  Lenders and servicers can use this post event information to more reliably rank loans for risk mitigation measures (such as borrower outreach) after a catastrophic event and estimate potential financial impact to lenders / servicers.

Evaluating Mortgage Delinquency Risk in 2018 and Beyond

As of September 2018, a series of more than 5,000 wildfires have burned across California covering more than 1.3 million acres – leaving many people to reconstruct, and in the case of smoke damage, repair their homes.  As the Delta Fire rages on in Northern California, Hurricane Florence made landfall in North and South Carolina.  Hurricane Florence winds extended more than 80 miles and dropped more than 33 inches of rainfall in some areas.  Will this unexpected cost to homeowners result in increased delinquency rates?  CoreLogic research suggests it will.  With FEMA declaring the wildfires in California and the areas affected by Hurricane Florence Major Disasters, lenders and servicers should use solutions designed to help quantify risk in hazard affected areas.  As shown in the Hurricane Harvey case study, incorporating damage estimates and reconstruction cost help give lender and servicers a more accurate view of risk, allowing for targeted risk mitigation measures (such as borrower outreach) and increased accuracy on estimating the financial impact of the catastrophe.

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