Non-qualified mortgages are coming back, but with tighter guidelines

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Non-qualified mortgage originators are crawling back into the marketplace, but the lack of uniformity around forbearance policies is triggering concerns with securities purchasers and in the secondary market.

"The reason we're not buying is we think that the future is very murky right now," said Caroline Chen, a senior research analyst at Income Research + Management, an $83 billion fixed-income manager that had been a purchaser of non-QM securitizations before the coronavirus spread began, but is currently out of the market.

Since May, about $5.7 billion in non-QM deals has been issued and all the loans were oversubscribed, Chen noted.

"On the credit factors, it is a more mixed picture," she said.

Prime jumbo loans typically have borrowers with high credit scores and full documentation. Forbearances here are in low single digits. But for most non-QM loans, the credit score is under 700 and the documentation status varies.

"Deal by deal, you might see differences, shelf-by-shelf, vintages-by-vintages, but in general for some deals … delinquencies on average are at 20% to 25%," said Chen.

All of the post-COVID-19 issuances were originated in pre-pandemic conditions, Chen said. Some of the newer transactions involve borrowers whose initial forbearance expired and was subsequently extended. Ultimately, the industry will see loss mitigation strategies involved for some borrowers because not everyone can roll back to current pay status.

At Quontic Bank, a community development financial institution chartered as a bank, forbearances aren't granted to borrowers on new originations. However, any borrower who was current as of March 31 and expressed that they were impacted by COVID-19 was granted three months of payment deferments with extensions if needed, CEO Steven Schnall said.

Among borrowers, it was a "very, very mixed bag. Some people that asked for deferments ended up paying," said Schnall. They had the money, decided they'd rather not accumulate the debt and just went ahead and paid the mortgage. Some missed the first payment or two and then started paying.

But some that took the deferment "are in dire need of additional time," Schnall said.

Then there are the call options that many of the non-QM deals have, in which the issuer can repurchase the bonds. If delinquencies reach a certain level or remain high, the call option will not be exercised "because it doesn't make economic sense" to call the deal, Chen said.

According to data from DBRS Morningstar, the vast majority of loans in rated non-QM deals, over 42%, were from California, one of the current coronavirus hot spots. The next closest state was Florida, at over 15%. Texas and New York were in the area of 5% each within the non-QM universe.

"To date, the post-COVID-19 origination volume has been very limited, but we see [the newer] loans originated were underwritten with much tighter credit box," Chen said.

Quontic was one of the many non-QM lenders that stepped to the sidelines after the secondary market disruption. From March until approximately mid-July, the bank "turned off our wholesale business and dramatically curtailed our retail non-QM lending," Schnall said.

Because Quontic is a community development institution, it can keep mortgages on its balance sheet; it can also use deposits and funding from that balance sheet to originate loans as well.

Thus, rather than having to sell loans at distressed prices as some nonbank lenders did, it was able to hold them until secondary market pricing stabilized.

But its guideline changes are driven by concerns over forbearances, Schnall said.

"What we've done to mitigate that risk is two things. One, we're requiring all borrowers to sign an attestation basically attesting to the fact that they do not have a forbearance on any existing mortgages, that their business or employment has not been affected, that the business is up and running and is operating at levels to support the debt. They also attest to the fact that they understand they are not entitled to a forbearance," Schnall said.

The non-QM market that Quontic serves includes people that have small businesses, whose income is volatile and hard to document for meeting ability-to-repay requirements.

He gave the example of a restaurant owner, whose industry has been heavily affected by the pandemic. To be considered for a loan from Quontic, the restaurant should be open for take-out and delivery to generate revenue. They should also have Payroll Protection Program money to prove they have a viable business, Schnall said.

During underwriting, Quontic does a "cursory Google check" to make sure the borrower's business has a website, that the website doesn't say the business is closed and that it is a consumer-facing business.

Quontic also reduced loan-to-value ratios from pre-pandemic levels, and raised credit score requirements. "So we've made the loans somewhat safer than the pre-COVID loans," he said.

Also confirming Chen's point regarding tighter guidelines was Tom Hutchens the executive vice president of production at Angel Oak Mortgage Solutions.

Still, "the originations are coming back quickly," he said. The company is originating bank statement mortgages for business owners.

For example, on owner-occupied products, regarding those adjustments "it's more on the bottom half of the curve…it's not major, major changes," Hutchens said. For example, where Angel Oak once had a product at 90% LTV, it is now at 85%.

"It's not that it's gone to 60% LTV, it's just a tweak,” Hutchens said. “Angel Oak built our brand on quality originations, so we want to be originating good loans that perform … but still meet the needs of the market. That matters."

In addition to originating these loans, Angel Oak offers an investor property debt service coverage product as well.

Both Quontic and Angel Oak have originated non-QM in the wholesale channel; Angel Oak also makes bulk purchases in the correspondent channel.

Quontic is in the process of rebuilding its wholesale sales team as it reenters that channel, but it is fighting for attention from mortgage brokers for the product, Schnall said.

Pre-COVID, a lot of Quontic's non-QM business was coming from the wholesale channel. Today, with mortgage rates at or near record lows, "a lot of the brokers that were sending us the non-QM business are deeply entrenched in refinancing their agency portfolio, so that they're not focusing as strongly on non-QM loans as they were," Schnall said.

He expects to see brokers bringing Quontic non-QM customers as they get the word out that they're resuming these originations.

"It's a big market and there aren't non-QM players back at it, we're one of the few," he said.

For example, nonbank Impac Mortgage Holdings, totally shut down in March and only started doing conforming and government loans recently. The company has announcedplans to reenter non-QMat some point in the third quarter as secondary market outlets return. Nearly all of that company's non-QM came through third-party originations.

And while Angel Oak Mortgage Solutions is a nonbank lender, it has a sister company in the Angel Oak family that acts as a takeout investor.

As a result, even though Angel Oak put non-QM on pause in March, it was back in the market in the last week of April, said Hutchens. So far, Angel Oak has not come to market with an issuance consisting of loans originated after the coronavirus first shut down the economy.

But it was not only the secondary market disruption that drove Angel Oak's decision. On the origination side, as businesses started shutting down because of shelter in place order, "we had no way of determining a borrower's ability to repay. So it kind of was like the perfect storm of why we had to put things on pause," Hutchens said.

In recent years, non-QM lending volume has grown exponentially. MBS issuance went from $483 million in 2015 to $14 billion in 2018 and between $25 billion and $26 billion in 2019, according to Fitch. This was supposed to be another year of near 100% annual growth for the product. But in the first half of the year, just $9.5 billion of non-QM was securitized. While the pandemic pause has put a hold on that, Hutchens said these loans are making a comeback now.

"Our non-QM business is growing extremely rapidly, much faster than we had anticipated. Non-QM borrowers did not go away because of the pandemic.

"But we believe the economy will recover and there's always going to be a need for products and programs outside of agency and government guidelines. And we — and the entire non-QM space — were really hitting our stride before the pandemic," Hutchens said.

And that is a sign that the product is now an integral part of the industry, Hutchens said. "It's still on people's radar, whereas five years ago that might have been a different story, because we were working really hard to get it" there.

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