By the Numbers
Good economics and a shifting borrower mix in non-QM
Chris Helwig | November 5, 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.
Prospects for growing non-QM issuance next year look favorable, buoyed by a handful of factors. Securitization economics still appear favorable despite recent higher interest rates and wider spreads in some classes. Non-QM loans continue to serve as a valuable source of financing for self-employed borrowers, a group that makes up the majority of loans in a spate of recently issued non-QM deals. The sharp rise in home values and rents should help issuance as well as more investors try to qualify for loans based on property income rather than their own.
Sizing up non-QM securitization economics
Packages of non-QM whole loans appear to be trading with very little interest rate duration lately despite the backup in interest rates. Note rates and prices of non-QM whole loan packages remain somewhat sticky. The market for non-QM loans does not appear to have repriced materially even in the face of higher short-term rates and wider liabilities at the top of the capital structure in non-QM securitizations.
The strong bid for loans likely reflects strong deal economics. A proxy pool with roughly a 4.375% net coupon at price of $105-16 would have a market value of $316.5 million. Using liability prices on the ‘AAA’ through ‘B’ slices of the capital structure of a recently issued transaction, COLT 2021-4, which priced on October 14, the sizes, coupons and prices of the rated classes of a proxy securitization can be derived. From there, the coupon on the excess interest class can be sized at 3.00% based on the principal and interest certificate coupons and valuations can be assigned to the unsold first loss and excess interest classes of the deal to estimate current issuer economics.
A price of $85 on the first loss class implies a roughly 13% yield to the first call date assuming 1 CDR and a 25% loss severity. And once all the principal and interest certificates have been priced, the remaining market value difference between the loans and bonds is assigned to the excess interest class, subsequently determining the price for that class. Based on these assumptions the price for 300 bp of excess interest is $6.16 or just over a 2x coupon multiple. Assuming the pricing speed of 25 CPR for the deal, the yield on the excess interest class would be north of 18% and would still be positive yield to upwards of 35 CPR. While the IO is callable along with the rest of the structure, the sponsor obviously continues to receive cash flow on the retained excess interest. (Exhibit 1)
Exhibit 1: Estimating non-QM securitization economics
Sizing up the shape of supply
The non-QM market has gone through a somewhat substantial change in the wake of the pandemic. Populations of lower FICO and higher LTV loans have fallen and remained somewhat depressed relative to pre-pandemic issuance. Despite the de-risking of the collateral backing these deals, risk premiums over the prime rate remain relatively elevated (Exhibit 2).
Exhibit 2: Risky loans fall while risk premiums remain elevated in non-QM lending
While the populations of higher LTV and lower FICO loans have declined, the populations of alternative documentation loans and loans to self-employed borrowers are up across recent issuance. Credit concerns that self-employed borrowers would be disproportionately hurt by the pandemic appear to have abated as those loans have contributed upwards of 90% of the total collateral backing recent non-QM issuance. The elevated presence of alternative documentation loans is likely consistent with the decline in higher risk loans to borrowers with lower FICOs or higher LTVs as originators would have likely required full documentation to compensate for those risk dimensions previously. (Exhibit 3)
Exhibit 3: Alternative documentation and self-employed borrowers make up most of recent non-QM issuance
Within the population of alternative documentation loans, it appears that the presence of loans underwritten using 12-months of bank statements is steadily increasing across recent issuance. Conversely, shorter duration bank statement loans, which were commonplace prior to the pandemic, have virtually disappeared. Growth in 12-month bank statement loans appears to be at the expense of 24-month bank statement loans, which for the most part have declined across recent issuance (Exhibit 4).
The population of loans backed by investment properties underwritten using the property’s rental income has dipped across non-QM issuance recently. But the expectation is for it to make a greater contribution to net supply of non-QM next year as the sharp rise in home prices will likely make it increasingly difficult for investors to qualify for loans based solely on their personal income. Sponsors of non-QM securitizations may shift their demand from faster paying, more negatively convex owner-occupied loans to more positively convex investor loans, which can carry prepayment penalties. This is likely as a greater percentage if not the entirety of sponsors’ risk retention shifts to interest-only cash flows.
Exhibit 4: 12-month bank statement loans on the rise in recent non-QM issuance