MBS: LTV and DTI rise in prime jumbo RMBS, balances fall
admin | April 12, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Prime jumbo RMBS continue to add to a tail of credit risk through loans with higher loan-to-value and debt-to-income ratios. Although still a small part of overall exposure, high LTV principal from 2017 to 2018 increased by nearly 250%. And high DTI loans also more than doubled. There has been little to no slippage in borrower credit scores or underwriting as lower FICO or limited documentation borrowers are virtually non-existent in these deals. Prepayment risk has actually marginally declined. Pricing on prime jumbo RMBS suggests investors have limited if any concern about the shifting risks.
More loans above 90 LTV
Prime jumbo issuance totaled roughly $30 billion last year, dwarfing other private RMBS and nearly tripling the prior year’s issuance. Growth in prime jumbo has been spurred by a host of factors. Better private-label execution on certain conforming loans has been a key driver . Additionally, as deposit rates have risen, securitization for banks has become an increasingly viable alternative to holding the loans.
Rising home prices have likely contributed to higher LTV and DTI loans. But this is evident in both agency and expanded credit lending as well. Loans with original CLTVs greater than 90 were relatively non-existent in prime jumbo deals issued in 2016, made up just 2% of all securitized prime jumbo volumes in 2017 and jumped to 4.5% last year. While this has been offset to some degree by a decline in 80 to 90 LTV loans, the growing tail above 90 LTV loans could suggest the need for an increase in risk premiums in thinner, less enhanced mezzanine and subordinate bonds. (Exhibit 1)
Exhibit 1: Average original combined LTV across prime jumbo issuance
The increase in high LTV loans has been fairly uniform across major prime jumbo issuers ranging from roughly 5% to 6.5% of total 2018 issuance across the CSMC, JPMMT and SEMT shelves. While the tail may be growing, there does not appear to be layered risk as average FICO scores remain strong, ranging from 747 on the CSMC shelf to 786 on Redwood’s SEMT issuance. (Exhibit 2)
Exhibit 2: LTV distribution by issuer and vintage
A rise in DTIs above 45
Borrower leverage is not only increasing in the form of higher LTVs, as the populations of higher DTI loans are increasing as well. Loans with DTIs between 45 and 50 have grown from 2.7% of total issuance volume in 2016 to 6.0% of last year’s issuance. Higher DTI loans tend to have modestly lower LTV ratios. Loans securitized in 2018 with DTIs between 45 and 50 had an average LTV of 68, three points lower than the broader vintage. (Exhibit 3)
Exhibit 3: Average DTI across prime jumbo issuance
The populations of higher DTI loans were fairly uniform across major issuers last year as loans with DTIs ranging from 45 to 50 comprised roughly 10% of all collateral with the notable exception of the CSMC shelf where high DTI collateral made up just 2% of last year’s volumes. Year to date issuance appears to fairly consistent with last year with 45 to 50 DTI loans making up 9% of all collateral issued in the first quarter. Higher DTI loans across major issuers generally had modestly lower than average LTVs and higher than average FICOs with only the CSMC shelf showing modestly more layered risk albeit in a far smaller population of higher DTI loans than other issuers. (Exhibit 4)
Exhibit 4: DTI distribution across issuer and vintage
Falling loan balances
While the tail of credit risk has grown slightly, the tail of prepayment risk as declined. The population of higher balance loans in prime securitizations has actually decreased. Super jumbo loans with balances greater than $1 million made up nearly a third of total collateral in 2015 and fell to roughly half that amount last year. In contrast, loans with balances between $400 and $600 thousand, which roughly align to jumbo conforming limits jumped by 50% between 2015 and 2018 from 21% to 31%. Conforming balance volumes as a percentage of total issuance peaked in 2016, making up nearly a quarter of total issuance. Those loans made up 12% of total collateral last year. However total issuance in 2018 was more than triple that of 2016 meaning a billion more in conforming balance collateral made its way into private-label deals in 2018 than in 2016. (Exhibit 5)
Exhibit 5: Loan balance distribution by vintage
Little shift in compensation for shifts in risk
While tail risk in prime jumbo credit may be increasing, there has been little in the way of increased compensation for that risk – at least at the top of the capital structure. The lack of increase in risk premiums is most likely driven by the belief that despite increased tail risk, cumulative losses to these pools will continue to be small coupled with the fact that AAA pass-throughs often carry up to two times the credit enhancement required for a AAA rating and as such are likely extremely loss remote. That being said, even a modest downturn in what to date has been pristine collateral performance would likely drive spreads wider. While we did see some widening in AAA pass-through spreads late last year into the first quarter of this year, we would attribute that to a general widening across risk assets and less so a reaction to a change in the risk profile of the asset. Spreads on 4% coupon super-senior pass-throughs traded as wide as two points back of their TBA counterpart in January of this year and have tightened by half a point since then. Increased compensation for growing tail risk would likely be more evident in newer vintage prime AAA mezzanine and subordinate bonds but AAA mezzanine bonds have tightened one for one with super seniors and spreads on the subordinate stack are unchanged to slightly tighter since the beginning of the year.
Exhibit 6: Prime jumbo AAA super senior pass-through spreads