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A new form of non-QM loan
admin | June 7, 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. This material does not constitute research.
A recent non-QM securitization has added another type of lending to the market, one that could shape credit and prepayment risk and, consequently, relative value: mortgages made by community development financial institutions.
Nearly half the loans backing Angelo Gordon’s inaugural non-QM securitization GCAT 2019-NQM1 are Community Development Financial Institutions (CDFI) loans. The CDFI Fund was established in 1994 and resides within the Treasury Department. One of the main purposes of the fund is to offer mortgage financing to low-income and first-time homeowners in economically distressed markets. The most meaningful implication for the private MBS market is that these loans fall outside the scope of ability-to-repay rules and consequently do not require a securitization sponsor to retain risk. The GCAT sponsor chose to retain 2.66% risk, according to Morningstar, instead of the 5% retention required on a deal backed fully by non-QM loans. Given their exempt status, the inclusion of CDFI loans in non-QM securitizations may improve overall economics to the issuer, potentially driving a growing amount of these loans in non-QM securitizations going forward.
An increase in the population of CDFI loans could shift both the credit and prepayment profile of non-QM securitizations. A broader mix of underwriting and geographic concentration could shape credit risk, and limited opportunities to refinance could shape convexity. A few notes on each.
- Apart from the lack of issuer risk retention, the exempt status of CDFI loans does not require the originator to meet ability-to-repay standards. These loans could be originated using expanded underwriting guidelines.
- There are fewer than 1,100 certified CDFIs and roughly half of those are banks or credit unions. Many of these institutions also are single-state lenders. A material rise in the population of CDFI loans in non-QM deals could expose investors to significant geographic concentration. In fact, nearly 40% of the collateral backing the GCAT transaction are in New York.
- While investors may potentially be exposed to more underwriting and concentration risk, the loans are likely to have mitigating credit characteristics. The GCAT deal had an average FICO score of 714 and a weighted average original LTV of 66.1.
- Finally, given the limited scope of the program and number of certified lenders, refinancing opportunities for these borrowers will likely be fewer than a more conventional non-QM loan. Given this, investors may look to deals with large populations of CDFI loans to mitigate fast prepays evident in most non-QM deals so far.
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