Loan Defect Risk Trends Up Following Hurricanes

If history is any indicator, the Carolinas and the Florida Panhandle can expect to see loan defect spikes in the coming months, said First American Financial Corp., Santa Ana, Calif.

The company’s monthly Loan Application Defect Index reported frequency of defects, fraudulence and misrepresentation in the information submitted in mortgage loan applications increased by 1.3 percent in September compared to August; from a year ago, the Defect Index decreased by 6.0 percent. However, the Defect Index remains down by 23.5 percent from the high point of risk in October 2013.

The report said the Defect Index for refinance transactions increased by 1.4 percent compared August and is unchanged from a year ago. The Defect Index for purchase transactions increased by 1.3 percent from August and fell by 11.1 percent from a year ago.

“While we have not yet seen the full impact of the hurricane season on defect risk trends, we already see preliminary defect risk spikes in states impacted by Hurricane Florence,” said First American Chief Economist Mark Fleming. “Beyond the devastating effect of hurricanes on the lives of those in their path and the damage on their homes, natural disasters also impact loan application defect risk. Hurricanes, especially the flooding associated with these natural disasters, create the potential and opportunity for significant misrepresentation of collateral condition and identity fraud in mortgage applications.”

Based on historic trends, Fleming said the potential for mortgage fraud risk is more likely in the Carolinas and Florida going ahead. Since the beginning of the year, the Defect Index steadily decreased nationally, falling by 8.4 percent from January through July. However, the past two months have seen a reversal in this trend, with overall defect risk increasing by 2.6 percent from August 1 through September 30, with September marking the first month this year to experience an increase in the Defect Index for purchase transactions.

“While we have not yet seen the full impact of the hurricane season on defect risk trends, we already see preliminary defect risk spikes in states impacted by Hurricane Florence, North and South Carolina,” Fleming said.

Recent estimates show that Hurricane Florence’s flooding and wind destruction damaged approximately 50,000 residential units, with nearly 80 percent of these homes located in North Carolina. Worst-case projections estimate a total of $28.5 billion in flooding losses, plus an additional $1.5 billion in wind damage. North and South Carolina experienced nearly identical monthly increases in the Defect Index in September, 5.3 percent and 5.2 percent respectively. First American said the rise in defect risk is more pronounced when comparing with three months ago, as North and South Carolina experienced 6.6 percent and 9.7 percent respective increases in defect risk.

Using data from DataTree by First American and the National Hurricane Center, First American estimates Hurricane Michael, the strongest hurricane on record to hit Florida, could impact $125 billion of residential real estate in the state.

“Defect Index trend data from 2017 provides a glimpse at what we might expect in the months ahead,” Fleming said. “Before Hurricane Irma hit Florida in 2017, defect risk was decreasing. However, following the storm, the trend reversed course in September 2017, rising 10 percent through December. Since December 2017, defect risk has declined in Florida. Unfortunately, historical trends indicate that we should expect defect risk to increase in Florida over the next few months.”

The good news, Fleming noted, is that defect risk spikes due to natural disasters tend to stabilize given time. “In the case of Hurricane Irma, defect risk in Florida took approximately three months to stabilize, while defect risk in the New York metropolitan area took almost a full year before defect, fraud and misrepresentation risk returned to pre-Hurricane Sandy levels,” he said.

Other report data:

–States with the greatest year-over-year increase in defect frequency were Hawaii (9.7 percent), Maine (8.6 percent), Alaska (6.3 percent), Wyoming (4.3 percent) and California (3.9 percent).

–States with the greatest year-over-year decrease in defect frequency were Vermont (-19.4 percent), Minnesota (-18.6 percent), Arkansas (-17.0 percent), Alabama (-16.7 percent) and North Dakota (-15.7 percent).

–Among the largest 50 metros, markets with the greatest year-over-year increase in defect frequency were San Diego (11.7 percent), Los Angeles (11.1 percent), Virginia Beach, Va. (9.6 percent), Richmond, Va. (7.2 percent), and Orlando, Fla. (5.9 percent). Markets with the largest year-over-year decrease in defect frequency were Minneapolis (-21.4 percent), Birmingham, Ala. (-21.2 percent), Raleigh, N.C. (-18.8 percent), St. Louis (-16.9 percent) and Salt Lake City (-14.9 percent).