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Another important element of “delinquency status” definitions is the notion of “rolling delinquencies” or “payment velocity.” It is possible for “delinquent” borrowers to resume making current payments without making up for past missed payments. In this regard, a CSFB research report demonstrated two important points:4
• “A significant percentage of delinquent loans are cash flowing. Therefore, the high delinquencies of seasoned subprime deals don’t directly translate into losses.”
• “Over the 18-month period that we analyzed, the cumulative default rates are significantly lower for loans that are cash flowing, regardless of the delinquency status.”
These points highlight the incompleteness of a count variable like “delinquency status” as a summary statistic for delinquency behavior.
For example, it is not immediately obvious which borrower should be considered “worse” from an overall delinquency standpoint: one who is 3 payments behind but made the most recent 4 payments; or one who is 2 payments behind today. It is clear that primary and secondary market participants would benefit from knowing when the missed payments occurred. It may be that the pattern of missed payments also contains information. AD&Co is actively pursuing research into a practical but rigorous method to capture the additional information in delinquency status.
3. Definitions of Default
Given our two standards for calculating delinquency, our next task is to come up with a definition of “default.” The definition of default will be a major task as we pursue the creation of industry-standard models of prepayment and default. We will argue that models of mortgage risk need to include at least two definitions of default —– one for primary market institutions such as banks and thrifts and the other for secondary market investors.
4 See Dubitsky, et. al. (April 2004) — “Payment Velocity: Are your Delinquent Borrowers’ Payments Flow’n or Slow’n?”, Credit Suisse First Boston (CSFB).
