We have long been of the opinion that the current housing downturn is as much a function of deteriorating affordability as an issue of oversupply from fleeing investors and aggressive homebuilders’ building inventory. In order to mitigate the record price increases seen throughout the majority of the country, homebuyers became increasingly dependent on exotic mortgage products intended to reduce down payments and monthly mortgage payments. We initially highlighted the proliferation of these mortgage products and easing lending standards nearly four years ago in our report titled “Mortgage Liquidity: Don’t Underestimate the Underwriting.” Since our initial discussion on the topic, the evolution of the mortgage market has only accelerated further in the form of sustained easing of lending standards and more innovation of exotic mortgage products. In this report, we begin by slicing the mortgage market into five major segments and estimate the overall share of prime conforming, jumbo, Alt-A, subprime, and government (FHA and VA) loans in the purchase mortgage market. Although there is plenty of grey area in terms of defining and reporting lending data (with particular ambiguity surrounding the Alt-A, jumbo and subprime universes), we believe our estimates provide a reasonable depiction of the purchase mortgage market and how it has evolved in the past few years.

We provide investors with a factual understanding of how the loan characteristics of each segment of the market differ, and how easing underwriting standards in recent years have led to a change in the mortgage product mix used by homebuyers. We use data from Loan Performance, SMR Research, the Credit Suisse ABS and MBS research teams, and our proprietary network of private homebuilders and mortgage contacts (covering roughly 10% of the total new home market) to determine which states have seen the most dramatic shift into subprime, Alt-A and other exotic mortgages. We then delve into the specific alternative mortgage products that have grown to represent a significant portion of the market, such as interest-only loans, negative amortization loans (option ARMs), piggybacks/second mortgages, and low/no documentation mortgages. We highlight the prevalence of these products, the inherent risks involved, and discuss how recent scrutiny from regulators and legislators will likely impact these loan programs and the entire housing market going forward. Although regulatory actions taken thus far have primarily been on the state level, the Credit Suisse Group of External Affairs and Public Policy believes that this legislation could potentially be brought to the federal level within the next 18 months, implying that we will likely see the share of exotics decline drastically throughout the country in the coming months.