Mortgage market not open to risky borrowers (despite what some say)

Why lenders actually need to take on more risk

Mortgage lenders are increasingly entering the non-qualified mortgage market, but does this mean we are going back to the old subprime days? 

Let me give you the short answer: no.

The Wall Street Journal recently published an article titled: Mortgage market reopens to risky borrowers. It says that  the strict lending requirements that were put in place after the financial crisis are starting to erode. 

The author makes the argument that risky mortgages are making a comeback under a new name: non-QM.

Where he’s right

The author has some good points. First off – what is non-QM? These are mortgages that don’t comply with post-crisis standards set by the Consumer Financial Protection Bureau.

Non-QM mortgages can’t be sold to Fannie Mae, Freddie Mac, or any other government agency, but are instead either sold to investors or kept on as portfolio loans. 

The author makes the point that non-QM loans are rising in popularity, and he’s right. 

Recently, Citigroup Global Markets Realty announced it is entering the non-QM space by issuing its first non-QM mortgage backed security.

Back in 2018, DBRS predicted that a comeback for non-QM mortgage loans would be near.

The company explained increasing home prices and the shortage of housing inventory, alongside rising interest rates, will result in more lenders expanding their loan offerings to include products outside the QM space, according to the DBRS’ U.S. Residential Mortgage Review and 2018 Outlook.

Last year at the Mortgage Bankers Association Secondary Marketing conference, a major talking point was the growing appetite for non-QM loans. It’s a tough market, and the easy loans where borrowers neatly line up with Qualified Mortgage standards are harder and harder to find.

The WSJ article points out that borrowers took out $45 billion in non-QM lending in 2018, the highest amount since 2008, and is on track to surpass that in 2019, according to data from Inside Mortgage Finance.

Where he’s wrong

But while all that may be true – non-QM is certainly the buzz of the industry right now, his conclusions on the increased activity are not. 

Non-QM is not the subprime of the past, and in fact many experts warn again this kind of thinking. 

“Non-QM is not what we saw leading up to the crisis,” said Michael Brenning, chief production officer at Deep Haven Mortgage, at MBA Secondary in 2018. “These are clean, super-prime borrowers with one little thing about their profile. You will find the weighted average FICO is more than 700, all ATR compliant.”

In an article in HousingWire Magazine’s June issue, Managing Editor Ben Lane explained that one major difference between today’s non-QM loans and the subprime of the past is that these new loans are not backed by mortgage giants Fannie Mae and Freddie Mac. 

In a LinkedIn article, Raymond James Head of Whole Loan Trading John Toohig explained that many mortgages fall under the non-QM category simply because they are different than traditional QM mortgages, not because they are “subprime.”

“I had a great conversation with an originator last week as he lambasted the market and its prejudice to pricing his loans,” Toohig wrote. “His particular program was more of a mid-tier credit, heavy equity / down payment, but self-employed (think lesser documentation) borrower on jumbo loan balances. These are generally very wealthy borrowers that have been locked out of the current mortgage market.”

And another example:

“JPM has now completed their first non-QM deal,” he wrote of JPMorgan Chase. “A great example of non-QM loans not being confused with non-prime. A 770 FICO, with nearly 30% equity down, but what makes these loans non-QM? ‘Most of the loans were classified as non-QM because they were underwritten using tax transcripts rather than signed tax returns.’”

Another expert explained that if you took the time to look at the non-QM of today, you would see it is very different from the past subprime lending. 

“If you take the time to analytically look at Non-QM loan characteristics today, including in most cases, meeting ATR requirements,” First Guaranty Mortgage CEO Aaron Samples said. “In conjunction with the diligence requirements associated with today’s securitization market.”

“We are a long way from past loans described in this article,” Samples said, referring to the WSJ article. “With the probable expiration of the GSE Patch the mortgage markets will look much different in years to come. We need to learn from the past but continue to look forward.”

In MBA Secondary’s session on housing finance solutions for the future, Gary Acosta, National Association of Hispanic Real Estate Professionals co-founder and CEO, pointed out that, “approximately 78% of new households being formed nationwide are from diverse communities. They tend to have slightly different experiences and behavioral habits when it comes to managing finances.”

“They may have thinner credit files, need low down payments, pool resources among families and multi-generations to make that first home accessible,” Acosta said.

“Given the frequently weaker credit profiles of non-QM borrowers, some market participants have equated them to pre-crisis Alt-A or subprime mortgages,” DBRS’ analysts said in a recent report. “However, DBRS deems the credit quality of non-QM securitizations issued to date to be considerably improved from pre-crisis standards based on three key factors: ATR rules, tighter underwriting and independent appraisal process, and robust loan attributes.”

And even government officials are keeping an eye on the matter, but say they have not seen unsustainable borrowing.

“We have not seen unsustainable borrowing, financial booms, or other excesses of the sort that occurred at times during the Great Moderation, and I continue to judge overall financial stability risks to be moderate,” Federal Reserve Chair Jerome Powell said at the Federal Reserve symposium entitled Challenges for Monetary Policy. “But we remain vigilant.”

Assessing the risk

In order to truly see how the market compares to the subprime of the past, you can’t measure the volume of non-QM originations. Instead, you have to assess the current risk appetite of the market. 

Even with this increase in non-QM activity, it is nowhere near pre-crisis levels. The Monthly Chartbook July 2019 from Urban Institute shows mortgage credit availability increased from 5.75% in the fourth quarter of 2018 to 5.95% in the first quarter of 2019 due to an increase in risk taken in the portfolio and private-label securities channel.

And while this is the highest level it has been since 2013, it is down significantly from pre-crisis years, showing lenders still have plenty of room to increase their risk. Since 2013, product risk has fluctuated below 0.6% and borrower risk remains around 2%.

In fact, Urban Institute explained that credit remains tight, and the average FICO score remains high compared to pre-crisis levels.

“Access to credit remains tight, especially for lower FICO borrowers,” the Urban Institute explained in its report. “The median FICO for current purchase loans is about 36 points higher than the pre-crisis level of around 700.”

“The 10th percentile, which represents the lower bound of creditworthiness to qualify for a mortgage, rose slightly to 644 in April 2019, compared to low-600s pre-bubble,” the report continued. “Higher FICO scores serve as a strong compensating factor.” 

While mortgage lending is getting riskier, it is not the subprime lending of the past.

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