By the Numbers
More broker loans add negative convexity in non-QM MBS
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.
While most non-QM loan originations still flow through correspondent or retail channels, a steadily growing share comes from brokers. Broker loans tend to prepay faster when they become refinanceable and may consequently make the non-QM universe increasingly negatively convex. All else equal, more negative convexity should mean more yield and spread.
A rising share of non-QM broker loans
Over the past year, the percentage of non-QM loans originated through broker channels has more than tripled from 7.2% in the first quarter of 2023 to 24% in the first quarter of this year. The growth in broker loan share has been driven by larger volumes of loans from originators like United Wholesale Mortgage and others that rely on broker networks (Exhibit 1).
Exhibit 1: Broker loans grow in Non-QM originations
Source: Santander US Capital Markets, Inside Mortgage Finance
With conventional loans, broker loans refinance faster
Looking first at the prepayment performance of broker originations relative to correspondent and retail, the conventional MBS market has the most robust observations. Controlling for both loan age and loan size, broker loans with balances between $400,000 and $600,000 prepay faster than other loans—anywhere from 4 CPR to 6.5 CPR faster than correspondent loans and 8 CPR to 14.5 CPR faster than retail loans when in-the-money by up to 100 bp. Similar performance is reflected in lower loan size cohorts as well (Exhibit 2).
Exhibit 2: Broker loans prepay faster in conventional MBS
Source: Santander US Capital Markets, eMBS, Fannie Mae, Freddie ML
Prepayment attributes of non-QM broker loans
Turning to non-QM rather than conventional loans, broker loans in recently issued non-QM securitizations look like they carry comparable prepayment risk to non-QM correspondent loans and elevated prepayment risk relative to non-QM retail loans. Broker loans carry modestly lower average loan sizes than loans originated through correspondent channels hand higher than those originated through retail channels. Retail loans will likely exhibit better convexity due to a combination of channel, lower weighted average loan sizes and greater concentrations of investor loans, which generally carry prepayment penalties (Exhibit 3).
Exhibit 3: Collateral characteristics of broker loans in recent vintage non-QM trusts
Source: Santander US Capital Markets, CoreLogic LP
Focusing specifically on the performance of broker loans in non-QM trusts reflects similar performance to that cohort in conventional MBS. Controlling for owner-occupied, fixed-rate loans, broker loans have prepaid 2.5 CPR to 5 CPR faster than retail and correspondent loans at-the-money and up to 10 CPR faster in-the-money. While correspondent speeds are elevated relative to broker loans when both cohorts refinanced with 25 bp of moneyness, the sample of observations is significantly smaller than other incentive observations and may not be as reliable (Exhibit 4). Somewhat surprisingly, broker loans in non-QM trusts have paid faster than other cohorts when out-of-the-money as well.
Exhibit 4: Comparing S-curves across channels in Non-QM trusts
Source: Santander US Capital Markets, CoreLogic LP
Documentation, debt service coverage ratio and loan size
Looking exclusively at roughly four years of prepayment performance within the cohort of broker loans and assuming 75 bp of refinancing incentive, both full- and limited-documentation loans have exhibited the greatest sensitivity to that incentive, prepaying at 46 CPR while investor debt-service-coverage-ratio loans originated through brokers have prepaid at roughly 33 CPR.
Consistent with agency observations, loan size has historically provided prepayment protection even in faster prepaying broker loans. Assuming 75 bp of incentive, high balance loans with average loan sizes greater than $1 million on average, have prepaid at roughly 58 CPR historically. Broader non-QM cohort level average loan sizes of $400,000 to $600,000 prepaid at 43 CPR while lower loan balance loans with balances between $100,000 to $200,000 have prepaid at roughly 36 CPR.
Implications for credit: somewhere between correspondent and retail
The presence of a greater population of broker loans in non-QM trusts may be a modest credit positive. Aggregate delinquency and modification rates for all cohort channels were broadly consistent through most of 2022 and have subsequently diverged to some degree. Aggregate delinquency and modification rates for broker loans currently sit at 5.5%, in between the lower reading for retail loans which are currently 5.08% and those of correspondent loans which currently sit at 5.91% (Exhibit 5).
Exhibit 5: Non-QM delinquency rates across channels
Source: Santander US Capital Markets, CoreLogic LP Population controlled for minimum of 12 WALA
Given potential differences in credit characteristics across cohorts, the observations are constrained have similar attributes. Controlling for loans between 60 OLTV and 80 OLTV with FICOs between 700 and 760, aggregate delinquency and modification rates for broker loans were 5.34% last month versus 5.14% for retail loans and 5.96% for correspondent loans.
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