High loan-to-value loans could drive losses in residential mortgage backed securities as the Qualified Mortgage Patch expires, according to a new report from Fitch Ratings.
Known as the QM patch, the rule exempts GSE-backed loans from abiding by the full scope of the Ability to Repay/Qualified Mortgage rule, which requires lenders to adequately verify a borrower’s ability to repay their mortgage in the underwriting process.
Recognizing that the rule has shifted an increasing market share toward the GSEs, the Consumer Financial Protection Bureau has expressed its intent to allow the rule to expire as planned. The QM Patch was put in place since the beginning of the Ability to Repay rule in 2014, and is set to expire in January 2021.
The rule also includes a stipulation that a borrower’s monthly debt-to-income ratio cannot exceed 43%, but that condition does not apply to loans backed by the government (Federal Housing Administration, Department of Veterans Affairs, or Department of Agriculture).
But as high debt-to-income loans will no longer be eligible for purchase by the GSEs, lenders could see higher levels of loss if the loans also have high LTVs, Fitch explained.
“Fitch’s analysis shows that factors such as credit score and LTV are more influential than DTI as drivers of borrower performance,” the report stated. “The absence of the GSE backstop for mortgage insurance claims is expected to contribute to loss levels with the end of the Temporary Safe Harbor status that generally exempts Fannie Mae and Freddie Mac from liability under the Qualified Mortgage rules.”
And a significant number of loans will fall into the non-QM space once the QM Patch expires. Fitch estimates Fannie Mae and Freddie Mac will acquire more than $200 billion in mortgages this year with DTI rations about the 43% threshold.
“DTI is a good predictor of borrower behavior but other loan attributes play a larger role in borrower performance,” Fitch explained. “The serious delinquency rate behavior of borrowers with DTI ratios above 45% changed for loans acquired after 2011 when the GSEs tightened LTV and credit score thresholds for higher DTI borrowers.”
The performance of mortgages above 45% originated after 2011 showed that credit scores and LTV are actually more influential predictors of a borrower’s performance than the DTI. In fact, DTI ranks fifth in predictive influence in Fitch’s loan loss model, surpassed by credit score, LTV, economic risk and the number or borrowers of the mortgage note.
However, despite its lower level of influence, there is still uncertainty surrounding the end of the QM Patch. And if loans have a high DTI combined with other factors such as high LTV, the RMBS market could begin to see losses.