FHFA Methodology for Determining Credit Risk Scenarios for Stress-Testing Mortgage Related Assets

The FHFA stress test is updated each quarter according to objective rules derived from fundamental economic relationships.  These rules affect a dynamic adjustment to the severity of the stress test that accounts for current economic conditions, specifically the current level of house prices relative to the ongoing house price cycle.  The stress test incorporates different house-price level (HPI) stress paths for each state, thus accounting for the fact that house price cycles can differ significantly from one state or region to another.  The severity of the economic stress imposed by the test, as measured by the projected percentage drop in HPI, changes over time for each state corresponding to the deviation of current HPI from its long-run trend.  As a result of this design, the FHFA stress test will produce countercyclical economic capital requirements, in that the estimates of​ potential losses on new mortgage loan originations increase during economic expansions, as current HPI rises above its long-term trend, and decrease during economic contractions, as current HPI falls to or below trend.  The dynamic adjustment feature of the stress test allows that it will accommodate any size current house price cycle, even those of greater amplitude than any observed previously.  Further, the severity of the stress test is calibrated to produce economic capital requirements that are sufficient, as of the day of origination, to fully capitalize the mortgage assets for the life of those assets.

Starting with the April 2016 Countercyclical paths, the trend line for each state used to project the HPA shock paths (which revert to trend at 10 years out) and troughs (recall expressed as a percentage of trend) has been updated to incorporate actual data through December 2015.   The prior paths were all based on trend lines based on data through 2001.   In order to not bias the trend lines by including data from an incomplete HPI cycle, we only update the trend lines once an HPI cycle is perceived to have been completed at the national level.   Therefore, these new trend lines will likely not be updated for perhaps 5 to 15 years.  As a consequence of updating the trend lines, the troughs calculated with the new 2015 trends are generally less severe (or less deep) than they would have been if determined from the 2001 trend lines.  Specifically,  for 26 states the new trend lines generate troughs that are less than 5 percent higher (in HPI level, meaning less severe), including for some key states like California, Arizona, Nevada, New Jersey, New York, Illinois, and Texas.  For 10 states the new troughs are between 5 and 10 percent higher, and for another 10 states between 10 and 15 percent higher.  The increases in the troughs for the remaining 4 states (all with small populations except for Virginia) are between 15 and 21 percent higher, and D.C. is about 25 percent higher.  Based upon these changes, the corresponding capital charges, for a geographically diversified portfolio, determined using the countercyclical stress paths will almost certainly be lower than what would have been estimated using the 2001 trend line.​

For a more detailed description of the methodology, see the working papers listed below.

Questions or comments can be sent to FHLBcountercyclicalshocks@fhfa.gov.

Note: Provided below is a link to graphs for each state and the District of Columbia that shows real HPI from 1990 to the present, the corresponding trend and trough lines, and the latest CMAST house price stress path. Please note, however, that credit risk models require the scenarios be entered in norminal terms. Consequently, the stress path tables contain nominal monthly house price appreciation values. These graphs are useful in quickly identifying states where mortgage credit risk may be building.

​Last Updated: March 8, 2024