Diving in on delinquency trends in non-QM
admin | April 16, 2021
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.
Investors in non-QM securitizations have seen a precipitous decline in delinquency rates on loans backing these trusts. But that steady improvement has begun to fade in recent months and, in some cases, tick back up after accounting for both delinquencies and certain types of modifications, Investors should keep a close eye on potential changes to servicer behavior as borrowers exit forbearance and on delinquency trends across different borrower attributes.
Nearly a year removed from peak stresses in the non-QM market, the cohort has seen a pronounced recovery. That recovery has begun to stall, leaving investors to question whether lagging performance is merely a function of borrowers coming to the end of forbearance. Alternatively, current delinquencies could reflect the tail of borrowers experiencing material hardship from pandemic. Recent upticks in delinquency and modification rates in certain sectors of the market may be signaling the latter.
On balance, it’s fair to say that credit performance across non-QM collateral has been resilient relative to other mortgage credit cohorts. Delinquency rates have fallen 55% since peak levels in June last year and currently sit at just over 10% for the cohort, roughly 350 bp higher than those in April last year. Sectors of the market that were areas of concern at the onset of the pandemic, such as loans underwritten with limited documentation or those that used a property’s rental income instead of the borrowers, have fared relatively well when compared to fully underwritten ones.
There are some areas of the market that should garner increased surveillance. There is somewhat material divergence in overall delinquency, modification and roll rates across major non-QM shelves, likely driven by the types of loans backing different sponsors’ trusts as well as some potential recent changes in servicer behavior. One potential cause for concern among non-QM investors is that after accounting for both delinquency and modification rates, some shelves are seeing a modest uptick in those rates in recent months due to increases in capitalization modifications by servicers. An increasing incidence of capitalization modifications may be a function of borrowers exiting forbearance with an inability to repay past due balances. Given this, the servicer may capitalize those arrearages which may result in a loss to the trust (Exhibit 1).
Exhibit 1: Tracking shelf level delinquencies and modifications across non-QM
Looking at month-over-month roll rates across major non-QM shelves shows that relatively stagnant delinquency rates are mainly a function of large populations of loans previously 90 days or more past due remaining seriously delinquent. There is limited variance across shelves. Between 82.3% and 86.9% of loans seriously delinquent in February remained so in March across larger non-QM shelves. While serious delinquency status remained relatively consistent across all major sponsors there were some differences across issuers when looking at cure and prepay rates for loans that transitioned out of serious delinquency.
WAMCO’s ARRW and New Residential’s NRZT shelf saw the highest amounts of seriously delinquent loans roll back to current in March at 8.4% and 8.8% respectively. However, some of these cure rates appear to be primarily fueled by the incidence of capitalization modifications as 1.9% of all loans backing ARRW deals received a capitalization modification in March while 0.2%% of loans backing the NRZT shelf received capitalization modifications. In both instances, these modifications resulted in losses to their respective trusts. While capitalization modifications are somewhat commonplace across the NRZT shelf, more so in called legacy re-securitizations than in non-QM deals, the uptick in those modifications in March are new to the ARRW shelf and may be a harbinger of increased incidence of them going forward across other non-QM shelves as borrowers exit forbearance. Of course, it may be somewhat servicer dependent. And while Pretium’s DRMT shelf had the lowest amount of loans remain in late-stage delinquency, this was fueled by a combination of cures and prepayments as well as the highest concentration of loans that rolled to foreclosure, REO and liquidation. In fact, the DRMT shelf was the only major shelf that had any loans, albeit a very small amount, roll to REO or liquidation (Exhibit 2).
Exhibit 2: Tracking roll rates across seriously delinquent non-QM loans
Looking at performance across loan attributes
While non-QM investors should know how servicers are treating borrowers exiting forbearance, they should also continue to keep an eye on the relative performance of different loan attributes across the sector. One example of this is the relatively strong performance of limited documentation loans, where overall delinquency rates on those loans totaled just 9.2% in March, only 30 bp greater than those of fully documented borrowers. The relatively strong performance on limited documentation loans is likely a function of the presence of compensating credit characteristics, quite often in the form of lower LTV ratios at origination. Another area of relative strength in the non-QM market is the performance of non-owner occupied loans. Delinquency rates on both investor loans and second homes are tracking somewhat substantially below those of owner-occupied ones. Delinquency rates on investor loans and second homes were 9.1% and 8.5% respectively in March while they tallied nearly 12% for owner-occupied borrowers. Within the subset of investor loans, delinquency rates on loans underwritten using the property’s rental income or DSCR are only modestly higher than those traditionally underwritten using the borrowers income. Delinquency rates on DSCR loans stood at roughly 9.5% last month, roughly 110 bp higher than those of traditionally underwritten investor loans. Ultimately the relative resilience of non-QM credit should be a positive for the growth of the asset class going forward however investors may be subject to existing trusts facing some near term losses as borrowers exit forbearance and arrearages accrued during forbearance are passed through to those trusts.