Regulators move to preserve high debt-to-income agency lending

admin | January 24, 2020

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CFPB Director Kathy Kraninger signaled recently that the bureau will extend rules set to expire in January 2021 allowing Fannie Mae and Freddie Mac to guarantee loans with debt-to-income ratios above the Qualified Mortgage limit of 43%. The bureau plans to eventually eliminate DTI guidelines for a Qualified Mortgage and substitute other standards. The changes should preserve a large share of Fannie Mae and Freddie Mac’s recent business.

In a January 17 letter to Sen. Mark Warner (D-VA), Kraninger noted her intention to extend the rules, known as the QM patch, for “a short period.” The extension could last from six months to 18 months depending on progress toward new underwriting rules. Kraninger also suggested the bureau eventually would change the rule to an “alternative such as a pricing threshold (i.e. the difference between the loan’s annual percentage rate and the average prime offer rate for a comparable transaction).”

In her letter, Kraninger signaled that the bureau would propose an alternative standard no later than May of this year. In addition to removing the DTI cap, the director said the bureau is considering an addition to the rule that would allow loans with clean payment histories to be designated as QM safe harbor loans after some seasoning period.

The extension does not likely come as a surprise to industry participants as the bureau signaled a short extension last July, but the potential elimination of DTI may. High DTI loans have constituted between 25% and 35% of Fannie Mae and Freddie Mac business for the last two years (Exhibit 1). The patch extension and removal of the DTI cap should preserve this part of the agencies’ business, eliminating potential new friction in refinancing existing high-DTI loans and limiting a potential role for private MBS in the market segment.

Exhibit 1: High-DTI loans have made up 25% to 35% of the enterprises’ recent business

Source: Amherst Pierpont Securities

Higher DTI but lower risk

Over the past two years, the GSEs have guaranteed more than $420 billion of loans that exceed the QM DTI cap. Over that period, the enterprises have tightened credit on loans purchased. Average credit scores on high DTI loans guaranteed by the GSEs have risen by roughly 10 points, and SATO has tightened. (Exhibit 2). Additionally, the average LTV on high DTI loans has fallen from approximately 80 earlier this year into the 70s in recent months. The population of high DTI loans purchased by the GSEs has shifted to more loans just above the QM threshold. In 2018, loan DTIs ranging from 43 to 45 made up 31% of high DTI lending. That number grew to 37% last year while loans with DTIs between 45 and 50 fell by 6% year over year. Additionally, the increase in average FICO was more dramatic in higher DTI loans where the average credit score on loans with 45 to 50 DTIs increased by nearly 20 points since the beginning of 2018 and the end of last year.

The move to remove the DTI cap coupled with a tightening of credit on high DTI loans that the GSEs purchase appears to dovetail with FHFA Director Calabria’s apparent intent to maintain revenue at the enterprises while reducing the risk profile of the GSEs guarantee book. While the removal of the cap may be in large part a move to ensure credit availability for borrowers with high debt-to-income ratios, that credit appears it will likely be limited to more pristine borrowers and less so for underserved ones.

Exhibit 2: Credit quality of high DTI loans purchased by the GSEs has improved

Source: Amherst Pierpont Securities

 The alternative to DTI offered by the bureau already exists in the Qualified Mortgage rules. Under the existing framework, any conforming loan with a rate greater than 1.5% over the Average Prime Offered Rate (APOR) is considered a High Priced QM loan. Jumbo loans with rates greater than 2.5% greater than the APOR are also designated as High Priced QM loans. And loans with points and fees greater than 3% of the original balance cannot be designated as Qualified Mortgages. While originators and aggregators do not have control over a borrower’s DTI, they do have control over risk-based pricing. If the bureau were to implement a bright line spread over the prime rate as the QM standard, it may create incentives for market participants to price certain loans inside of that spread to relieve themselves from any risk retention obligations.

Absent a material change in risk-based pricing on high DTI loans from the enterprises, the move undoubtedly hampers the prospects for PLS issuance backed by high DTI loans. That being said, most market participants saw the patch expiring without an extension or change as a very low probability event and that non-QM issuance is more likely to be driven by lending that falls outside the purview of the Qualified Mortgage rules for other reasons, such as documentation. As a result, the more material headwind to growth in non-QM issuance is the fact that those loans need to be manually underwritten and the limited industry expertise associated with underwriting these loans.