Uncategorized
CFPB policy shift could lift value in high DTI loans
admin | July 26, 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.
The Consumer Financial Protection Bureau announced in recent days it would let special Fannie Mae and Freddie Mac provisions of the Qualified Mortgage rules expire as scheduled on January 10, 2021. Under these provisions, among other things, the GSEs can now securitize loans with debt-to-income ratios above 43%, and these high DTI loans have made up a substantial share of production in recent years. If the provisions do expire, high DTI borrowers should face higher costs for mortgage debt, and the value of MBS pools backed by existing high DTI borrowers should rise.
GSE issuance of high DTI loans has soared
Since inception the Qualified Mortgage rules have included special provisions for loans guaranteed by Fannie Mae and Freddie Mac. Certain loans that otherwise would be considered non-qualified gain qualified status when guaranteed. Perhaps the most significant exemption from the QM rules granted to the GSEs concerns loans with DTIs greater than 43%. These loans gain QM status only when they are guaranteed by the GSEs, and QM status provides lenders with additional protection from lawsuits. Therefore most lenders prefer to securitize these loans with the GSEs, and the share of GSE loans with DTI above 43% has run up rapidly (Exhibit 1).
Exhibit 1: A large share of GSE loans has DTI greater than 43%
Note: TBA-deliverable 30-year pools, excluding specified pools. July issuance is month-to-date. Source: Fannie Mae, Freddie Mac, eMBS, Amherst Pierpont Securities
From 2014 through 2017, high DTI loans comprised 15% to 20% of GSE monthly issuance. In late 2017, the GSEs made changes to the underwriting requirements for these loans. The new policy reduced the documentation requirements for high DTI loans and permitted more compensating factors. GSE issuance of high DTI loans soared to 30% to 35% for most of 2018. The share of issuance has fallen in 2019, likely due to a rise in refinancing and a pick-up in new pool issuance. But high DTI loans still account for over 25% of monthly supply.
Borrowers could face higher rates when the exemption expire
If the current GSE QM exemption expires, lenders will need to price in the additional costs—liquidity, legal, underwriting and other—associated with non-QM loans. This should increase the rate a borrower receives on a new loan. The magnitude of the increase can be estimated from prime non-agency securitizations, which include loans with DTI above and below 43%.
The data suggest a DTI above 43% could lift a borrower’s mortgage rate by 50 bp or more (Exhibit 2). From 2013 to the present, and, more narrowly, in 2018 only, the average securitized prime jumbo loan with DTI above 43% had a higher note rate than loans below 43%. The difference tended to rise with LTV. Last year, for example, loans with a FICO of 760 to 800, an LTV of 50 or lower and a DTI of 43% or below had an average rate of 4.35%; loans with similar FICO and LTV but a DTI above 43% had an average rate of 4.79%–a 44 bp difference. Loans with an a FICO of 760 to 800, an LTV between 70 and 80 and a DTI of 43% or lower had an average rate of 4.51%; similar FICO and LTV loans with a DTI above 43% had an average rate of 5.13%–a 62 bp difference.
Exhibit 2: Prime jumbo loans with a high DTI have higher rates than similar loans with a lower DTI
Note: All loans 760-800 FICO with balances that exceed local market GSE loan limits. This analysis does not control for other factors such as occupancy, documentation, geography and others. Source: Amherst Pierpont Securities
Assuming a 50 bp rise in rates for high DTI loans seems reasonable if the special GSE provisions expire. This should act as an elbow shift that reduces the borrower’s incentive to prepay.
Slower speeds increases the value of these loans
Yield Book’s prepayment model was used to estimate the theoretical pay-up on 100% high DTI pools assuming the GSE provisions expire in January 2021 and refinancing rates for these borrowers rise by 50 bp (Exhibit 2). Three benchmark pools were selected, with coupons of 3.0%, 3.5%, and 4.0%. Each pool is the June 2019 Fannie major pool. Each pool was priced at the TBA OAS using Yield Book in two scenarios—using the baseline model and using a dialed version of the model that incorporates the 50 basis point elbow shift beginning in January 2021. Speeds are identical to the undialed model prior to January 2021. The price difference between the two scenarios gives the theoretical value of slower prepayment speeds.
Exhibit 3: Theoretical payups if High DTI exemptions ends in January 2021
Source: Fannie Mae, Freddie Mac, eMBS, Amherst Pierpont Securities
The analysis assumes that DTI has no influence over current prepayment speeds since the GSEs are issuing such large numbers of high DTI loans. The pay-up is similar for all three pools, with the 3.0% increasing $0-12 and the 4.0% increasing $0-13.
Political obstacles to expiration of GSE provisions
This decision by the CFPB is likely to be strongly opposed by many in the industry. Originators, servicers, realtors, and builders would all be hurt if origination volumes decline. Consumer advocates would like oppose the reduced access to credit. It is also possible that a significant reduction in loan origination could hurt home prices. Because of potential public response, the CFPB announced it intended to seek public comment on revising the QM rules. Revision may mean that some or possibly all of the GSE special exemptions get renewed.
The January 10, 2021 expiration date also adds a wrinkle. It falls between the next presidential election and the date when the next administration gets inaugurated. Even if the next administration and Congress take a different view on this issue, there may be no replacement for the expired provisions until after the next inauguration.
Investors realistically should weight potential gains on 100% high DTI loans by the likelihood that the GSE exemptions would expire. At a small price premium to new pools, however, 100% high DTI could be an inexpensive option on a significant policy change.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2025 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
Important disclaimers for clients in the EU and UK
This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.
This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.
This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.
This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.
