Disciplined Underwriting Guides Lender's Non-QM Strategy
Many lenders and investors have been steering clear of loans outside of the qualified mortgage credit box due to an inability to get their arms around these loans' higher compliance risks. But that's changing for some players.
Lenders who make or buy non-QM loans — which aren't protected by the government safe harbor protections that QM loans enjoy and can also add to regulatory constraints in the secondary market — are learning how to get more of a handle on this risk, in part by ensuring they don't stray too far away from the QM boundaries by providing originators with compliance training on their guidelines.
The real key to mitigating non-QM risk is using well-documented, manual underwriting and avoiding the excessive layering of multiple risks that decimated loan performance during the mortgage crisis, according to Tom Hutchens, senior vice president of Angel Oak Mortgage Solutions, a wholesale lender licensed in 20 states that funds some non-QM product.
"With a disciplined approach to offering these programs, we can offer them in a safe way," he said.
Hutchens' comments extend not only to non-QM, but also to other areas of the market that lenders have shied away from due to post-downturn liability risks. His firm is using this approach to carefully target products like brokered loans and a form of subprime credit that investors may ultimately securitize.
Borrowers whose debt-to-income ratio exceeds a 43% threshold are a common attribute for many non-QM products, but not so at Angel Oak, where the average DTI is 35%. Rather, Hutchens' company funds brokered originations that are non-QM primarily because they exceed a 3% points and fees maximum, but don't exceed high-cost loan limits that would further add to liability.
This is an example of what Hutchens calls "common sense underwriting," where underwriters work to extend credit to a broad range of borrowers without bending too many rules to the point where loans are left with little protection from the type of widespread defaults that emerged during the downturn.
In addition to the low DTI ratio, Angel Oak's non-QM loans have a maximum 80% loan-to-value ratio and an average 71% LTV to protect against the steep drop in home values that prompted some underwater borrowers to strategically default.
And since that population of former homeowners has been largely shut out of the government-backed loan products that currently dominate the market, Angel Oak is marketing its non-QM products to former strategic defaulters.
Angel Oak is showing moderation with subprime borrowers with poor credit histories by setting a minimum 500 credit score in some cases, though its average credit score is 600, and most loans are above 600.
The lender is selling most loans servicing-released, but may retain servicing on others, and investors may eventually securitize the loans at some point in 2015, Hutchens said. Rates on Angel Oak's loans average roughly 7%. This may seem high, given that average interest rates are below 4.5%, but it compensates lenders and investors for the loans' higher risk profile, he said.
Some lenders have been leery of working with brokers due to post-downturn regulation that holds them responsible for third-party business partners' actions. Angel Oak has been addressing this by having its account executives train the brokers on programs and guidelines with compliance incorporated in that process. The cost savings involved in working with the broker channel help the company manage the mortgage business' compliance expenses, which are significant even when non-QM loans aren't involved, he said.
"We're taking risks with, we like to say, 'our eyes wide open,'" he said. "There is a market that has not been served at all for seven plus years, and we believe those borrowers didn't disappear."