In a Q&A with HousingWire, Ben Wu, executive director of LoanScorecard, discusses the recent surge in non-agency/non-QM mortgage lending, the challenges in that market and how technology can be utilized to help lenders with these challenges.
Q. For years, many have claimed that the non-agency/non-QM market will take off. What are you seeing in this space that makes you think this year will see a significant increase in activity?
A. The non-agency market has indeed been taking off, doubling or tripling in origination and issuance each year, albeit restarting from scratch post-crisis. Investors are now gaining a comfort level with non-agency securities, with their higher yields yet low delinquency rates. Unlike the private-label residential mortgage-backed securitzations pre-crisis, these new pools are composed of well-underwritten, fully-documented loans that comply with the Consumer Financial Protection Bureau’s Ability-to-Repay rules, leading to strong loan performance that rival that of agency RMBS. In addition to non-agency loans going into bank portfolios, the issuance of non-agency securities continues to climb, with a mix of non-QM loans, prime jumbos, and investor loans for single-family rentals. Portfolio managers are finding the risk/reward of non-agency lending compelling, and are actively looking to deploy new capital to replicate the success of pioneers in this space.
Q. What type of loans and deals are getting done in the non-agency/non-QM space?
A. Post-crisis, new issuance first re-emerged with “super prime” jumbos, with low loan-to-value ratio, low debt-to-income ratio, and high FICO borrowers. Growth in jumbo securitizations has since been capped by both a robust agency market, as well as competition from banks with strong balance sheets wanting to hold such loans in portfolio. This has shifted activity toward near-prime and non-prime borrowers, still fully underwritten, meeting the investment community’s appetite for both yield and performance. With more than 20 million sole proprietors in the U.S., there is pent-up demand for mortgage product that can accept income documentation other than the “Appendix Q” requirement of QM loans. Because of this, bank statement loans have increased as a way to qualify self-employed borrowers who can demonstrate a reliable income stream through deposits into their bank account, rather than traditional W2’s, paystubs, and tax returns. To serve other segments of the population, some are offering an asset depletion documentation option to high net worth borrowers as an income stream equivalent, and interest-only products and debt coverage ratio loans to professional investors in single family rentals.
In Q1 2018, we saw $6.28-billion in issuance of non-agency RMBS with prime jumbo loans and expanded-credit mortgages, which was more than double the activity in Q1 2017. What’s driving this are not necessarily new entrants (yet), but larger players, who have been in the market for the past three years or so, doing even more securitizations. For example, Caliber Home Loans issued its first 2018 securitization in January, nearly three months ahead of its first 2017 deal. The $401-million transaction, dubbed COLT 2018-1 Mortgage Loan Trust, included 865 high-balance mortgages mostly originated last fall to wealthy borrowers who have slightly blemished credit or loan terms that do not comply with the QM rule.
Q. How are today’s non-agency loans different from pre-crisis non-agency loans? And what does the average non-agency borrower look like?
A: Pre-crisis, guidelines for Alt-A or subprime loans were very loose. LTV’s went up to 100% or higher, so the borrower had no “skin in the game”. Loan files were poorly supported, including no income documentation or “liar” loans. Fast-forward to the recent crop of non-agency loans, and you’ll find the exact opposite. Most borrowers are bringing at least 20% down, plus sufficient reserves to help weather the next downturn. Every file is well documented and thoroughly underwritten, with due diligence performed on 100% of the underlying pool. The average FICO is surprisingly strong near 700, with average DTI below that of the 43% threshold established by QM, though outliers are allowed through risk-based pricing. Gone are the days where all it takes is to “fog a mirror” to get a mortgage. Every borrower is fully underwritten to meet CFPB’s Ability-to-Repay standard, with or without QM.
Q. What are the current challenges non-agency/non-QM lenders face?
A: The level of regulatory scrutiny, documentation and investor requirements, and the nuance in the underwriting criteria, puts tremendous burden on originators. A decade of primarily agency lending has led to an industry accustomed to agency guidelines and agency processes, so there is some fear associated with doing that “first non-QM loan”. In the era of Rocket Mortgage and instant response, originators don’t want to set themselves up to fail, if they lead the borrower on to think he qualifies for a program that he in fact cannot get, or if they quote the borrower an incorrect interest rate that’s missing a critical risk adjustor. And while alternative forms of documentation now exist to help self-employed borrowers, high net worth individuals, and professional investors, the average originator today is simply not familiar with how to put together such a loan file for submission, nor do they want to keep their borrower in limbo while they wait for a response back from underwriting, with loan conditions they did not expect.
Q. How can technology be used to help them overcome these challenges?
A: For decades, the agency channel has relied on technology in both pricing engines and automated underwriting systems (AUS) with DU and LPA. The same automation is available for non-agency origination and delivery as well, to assist in the underwriting of these new innovative loan programs. These custom-tailored AUS tools can not only help first-time originators with non-QM lending, but also help them keep up with the rapid growth and change happening in the broadening non-agency market. Through automated underwriting, aggregators can deploy product with confidence into the market place, and take advantage of new opportunities quickly, without relying on memos and product announcements that they hope their originators will read and understand. With an AUS findings report run on every file, money managers can have transparency in the non-agency pool they are investing in, even exceeding the clarity of agency pools, without relying solely on the carefulness of human underwriters and the risk of unchecked underwriter discretion.