2021 RMBS to benefit from tighter underwriting put in place for COVID

Tighter underwriting criteria put into place by lenders as a result of COVID-19 will mean 2021-vintage residential mortgage-backed securities should have strong credit metrics, a Moody's report predicts.

"The credit quality of new assets will remain strong across product types as lenders stay vigilant about fallout from the pandemic," said Ruomeng Cui, assistant vice president, and Yehudah Forster, senior vice president at Moody's. "However, as economic conditions normalize, origination standards will likely loosen. Similarly, while warranted, sponsors will continue to include structural features in new deals that look to shield investors from potential cash flow disruptions in the event that obligor finances further deteriorate."

Comparing transactions from the same issuers (JPMorgan and Wells Fargo) in late 2019, the start of 2020 and this fall show measurable tightening in most metrics, including credit scores, along with loan-to-value and debt-to-income ratios.

But existing transactions are likely to report weaker performance as pandemic-related defaults and modifications rise due to expiring forbearances.

Historically high home prices and an expected decline in unemployment will mitigate default risk for existing RMBS. However, low interest rates, combined with those rising values, will drive up prepayment speeds, and that will also have an effect on deals.

Strong borrower credit quality in the loans making up prime jumbo securitizations and government-sponsored enterprise credit risk transfer deals position these to withstand the COVID-19 economic disruption, Cui and Forster said. But deals that include high concentrations of self-employed borrowers are more vulnerable to performance issues.

"Stable home prices will bolster both single-family rental and inactive reverse mortgage RMBS, whose credit quality highly depends on property values, and SFR will additionally benefit from positive rental market fundamentals, especially in the suburbs," Moody's said. "Reperforming, nonprime and expanded prime transactions will be more exposed to COVID-19 economic disruption, as these sectors are exposed to borrowers with weaker credit quality."

Next year's criteria for prime jumbo mortgages will keep in place narrowed employment verification windows, Moody's said. They will also prohibit or restrict cash-out refinance originations, and look to avoid counting business assets as reserves.

Meanwhile, for nonprime originations in 2021, Moody's said more restrictive underwriting in response to COVID-19 will improve the credit quality. But if the government enacts proposals to allow loans with higher debt-to-income ratios and looser income documentation to achieve qualified mortgage status, it will result in more competition for the better-quality nonprime loans. That could leave just the lower quality remaining nonprime collateral to be securitized, the report said.