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Tracking credit performance in non-QM

| September 20, 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.

Performance on loans backing non-QM MBS has been relatively pristine so far, marked by fast prepayments and low default rates. The confluence of rising home prices, low interest rates and a steady grind tighter in risk-based pricing have provided a strong tailwind to performance. Issuer calls also have helped as seriously delinquent loans have been called at par by issuers, insulating investors from potential losses. In fact, the overwhelming majority of seriously delinquent loans leaving non-QM trusts have generated no losses either because of a par call or a sufficient cushion of borrower equity.

Non-QM shows strong credit performance

Over the past two years, only 390 loans totaling $165 million in principal have gone into serious delinquency, foreclosure or have liquidated. Of these loans, roughly 75% are in some late stage of delinquency or foreclosure with the remainder having liquidated. This translates to very low delinquency rates across non-QM trusts with many trusts exhibiting no late-stage delinquencies at all.

Exhibit 1: Delinquency and default rates across the universe of non-QM trusts

Source: Bloomberg, Amherst Pierpont Securities

Tracking transitions

 The majority of early- or late-stage delinquencies in the last two years have either prepaid or been called.  An overwhelming majority of loans that were current or 30-days past due have prepaid or been called. Just over one quarter of loans that have gone 60-days delinquent, calculated using the MBA methodology, have rolled back to current, with roughly two-thirds having prepaid or been called. Of loans 90-days or more past due, roughly 20% have prepaid and more than half of them have been called. Across the entire universe of non-QM loans one fifth of all loans have been called and over half have prepaid. (Exhibit 2)

Exhibit 2: Two-year transition matrix of non-QM loans by delinquency status

Source: Amherst Insight Labs, Amherst Pierpont Securities

Sizing up severities

Of the roughly $ 41 million in seriously delinquent loans leaving non-QM trusts, nearly $40 million have not generated a loss to the trust, a phenomenon we have observed in the legacy market and dubbed a no-loss liquidation. Drilling into these loans, $31 million were 90+ MBA delinquent when they left their various trusts while an additional $8.4 million were either in foreclosure or REO. Just over $16 million of seriously delinquent loans that abated were a result of issuer calls and had a mark-market LTV of 77. An additional $23 million of loans defaulted and liquidated without generating a loss to the trust. These loans had roughly 30 points of borrower equity when they left their respective trusts, ostensibly enough to more than cover any foreclosure discount and associated liquidation costs.  (Exhibit 3)

Exhibit 3: Issuer calls and borrower equity cushion against losses on delinquent loans

Source: Amherst Insight Labs, Amherst Pierpont Securities

Characteristics of delinquencies

Characteristics of delinquent loans in non-QM trusts generally exhibit characteristics consistent with riskier loans with the exception of occupancy where owner occupied homes make up a disproportionately larger amount of delinquencies than investor loans or second homes. Lower delinquencies on investor homes appear to be a function of compensating credit characteristics as delinquent owner occupied loans has higher LTVs and lower FICOs than other occupancy types. Limited documentation loans make up a disproportionately large amount of total delinquencies, with LTVs roughly in line with delinquent full documentation loans with modestly higher, albeit subprime FICO scores. (Exhibit 4)

Exhibit 4: Profile of non-QM delinquencies by documentation and occupancy

Source: Amherst Insight Labs, Amherst Pierpont Securities

While credit performance to date has been pristine, these loans have yet to be tested against the backdrop of lower home prices and a weakening economy. Certain types of non-QM loans like no income loans written against the debt service coverage ratio of an investor property have little to no performance history into a downturn in home prices and may likely pose increased risk to investors if the economy stalls or home prices decline.

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