Lender competition will reduce speedy prepays of non-QM loans: S&P

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Increased competition among non-qualified mortgage lenders leading to lower starting interest rates for borrowers should result in fewer of these loans prepaying within one year of origination, said Standard & Poor's.

Lower interest rates at the time of origination reduces one of the motivations to prepay a non-QM loan.

But even as prepayment speeds for these loans slow, they will still be quicker than for conventional and jumbo prime mortgages.

Right now, prepayment speeds for non-QM loans in residential mortgage-backed securities are much faster than for other types of loans with many paying off soon after they are originated, according to the S&P report.

Non-QM have a conditional prepayment rate of approximately 35%. Prime nonagency jumbo loans' CPR is between 5% and 15%, while the historical norm for borrowers' relocating, upsizing or downsizing (also known as turnover) is about 6% to 8%.

"What is most interesting about the non-QM behavior is that, unlike prime borrowers, options for non-QM borrowers are more limited," the report pointed out.

S&P looked at 3,700 loans from 10 non-QM securitizations that closed on or before this past January. The loans were those that prepaid before aging 12 months and those that were older than 12 months but still on the books. It also included investor loans, which are exempt from QM but are included in non-QM deals.

Getting a lower interest rate and improving one's credit score, while factors in seeking a quick refinance, are not as important as whether the borrower was able to fully document income for the original loan or used alternative methods like bank statements, whether the loan is for an owner-occupied or investor property and whether the borrower was able to verify his or her income for more than two years, the analysis found.

"While we don't know specifically the channel the rate-incentivized non-QM loans prepay into (assuming the prepayment is in fact a refinance), we believe that obtaining a lower interest rate loan within the non-QM market, rather than in the conventional financing market, will eventually account for a smaller portion of the total prepayments and possibly reduce the overall prepayment rate," S&P said.

"This is because the market for non-QM origination is becoming more competitive and active (as demonstrated by securitization activity and the number of issuers). Going forward, we expect the non-QM borrower to receive a lower rate at origination than would be possible absent this market competition. Also, the distribution of rates within the non-QM space should tighten as more originators enter the market."

Over 90% of the non-QM originations studied had interest rates between 5.5% and 9.25%, with smaller percentages above and below those marks.

"This suggests that borrowers looking to improve their financing terms don't necessarily have to qualify for a GSE-eligible (or similar) loan. Rather, they can potentially obtain a lower rate within the increasingly competitive non-QM space," the report said.

That is important as mortgage interest rates rise in general, making refinancing a less attractive proposition.

The assumption for those non-QM loans that were unable to refinance is that they were weaker in credit quality. "After reviewing the original and surviving populations, however, the risk profile from a projected loss perspective was largely the same, on average. This may be attributed to a lack of risk layering," S&P found.

Besides rising interest rates and increased competition, documentation trends will contribute to slower prepayment speeds. More bank statement and investor loans are being placed into non-QM RMBS pools and those are more difficult to refinance into a conventional product.

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Refinance RMBS GSEs Jumbo mortgages Underwriting Qualified Mortgages S&P