By the Numbers
Analyzing recent credit trends in non-QM
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.
Delinquency rates in non-QM MBS, while still relatively benign, have begun to tick up in recent months. Cohorts underwritten primarily using the property’s loan-to-value ratio continue to underperform relative to other cohorts. Delinquency rates are elevated in higher balance loans as well, potentially introducing increased risk to deeper subordinate classes of deals with higher concentrations of large loans. Higher LTV loans have seen a recent spike in serious delinquency rates as well. The numbers point to best value in MBS with larger concentrations of investor loans, particularly those with smaller tail populations of lower DSCR loans.
Greater than 60-day delinquency rates across recent non-QM vintages plateaued around 3.00% for most of the second quarter but have begun to rise again in recent months. Roll rates from early to later stage delinquencies remain relatively rangebound over the past two years of observations although rolls from the 60-day bucket remain elevated relative to rolls from the 30-day bucket (Exhibit 1).
Exhibit 1: Cohort level delinquency and roll rates across non-QM
Source: Santander US Capital Markets, CoreLogic LP Note Analysis inclusive of 2019-2023 vintages.
Breaking the non-QM universe into high level cohorts based on underwriting shows that loans that rely primarily on borrower equity or a combination of borrower equity and the property’s rental income are underperforming relative to other forms of underwriting. Greater than 60-day past due “No ratio” loans that do not employ a borrower’s income as part of the underwriting decision are currently sitting above 6.0% for loans issued by Community Development Financial Institutions (CDFI). That compares to roughly 3.5% for DSCR underwritten loans where the property’s income does not fully support the monthly mortgage payment (Exhibit2).
In addition to LTV underwritten loans, limited documentation loans are exhibiting elevated delinquency rates relative to other cohorts. Within limited documentation loans, loans to foreign borrowers and those underwritten using P&L statements are performing worse than other forms of alternative documentation loans. Rates of 60+ day delinquency for loans to foreign borrowers were slightly less than 6.0% last month while roughly 5.2% of P&L underwritten loans were greater than 60 days delinquent. Conversely, full-documentation loans are performing materially better than the broader cohort. 60+ day delinquency rates on W-2 underwritten loans have actually seen serious delinquency rates decline in recent months peaking at roughly 2.25% in the first quarter of this year and falling to roughly 1.65% last month.
Exhibit 2: Non-QM delinquency rates by underwriting
Source: Santander US Capital Markets, CoreLogic LP Note Analysis inclusive of 2019-2023 vintages.
In addition to certain underwriting characteristics, loan size is impacting credit performance across the non-QM cohort as well. Loans with original balances in excess of $800,000 are exhibiting elevated serious delinquency rates relative to smaller balance ones (Exhibit 3). Within larger balance loans, higher delinquency rates are being driven by CDFI loans and those to foreign borrowers. Elevated delinquency rates in higher balance loans should impact valuations on subordinate tranches of deals backed by CDFI loans or those with larger concentrations of loans to foreign nationals as liquidations of large loans may more rapidly erode credit enhancement in these deals.
Exhibit 3: Higher balance loans are performing worse
Source: Santander US Capital Markets, CoreLogic LP Note Analysis inclusive of 2019-2023 vintages.
More traditional credit metrics such as FICO and LTV are weighing on Non-QM performance as well. Lower FICO loans, which admittedly make up relatively small contributions to the overall cohort, Loans with original FICO scores between 660 and 680 are currently above 7.5% more than double that of cohort level averages. Weaker performance in near prime Non-QM loans may be largely a function of upward FICO drift driven by pandemic related forbearance and fiscal policies which facilitated broad-based credit curing, particularly among consumers with lower credit scores (Exhibit 4). Current delinquency rates on lower FICO loans are roughly seven times greater than those of borrowers with credit scores of 780 or greater.
Exhibit 4: Large dispersion in borrower performance across FICO bands
Source: Santander US Capital Markets, CoreLogic LP Note Analysis inclusive of 2019-2023 vintages.
Looking across LTV bands there is a fairly stark dispersion in borrower performance around loans with greater or less than an original 80 LTV. Delinquency rates on loans with LTVs of 80 or greater are roughly double those of lower LTV loans. Substantially higher delinquency rates on high LTV loans may be driving the dispersion in performance between owner-occupied and investor loans. Owner occupied loans generally carry higher original LTVs than investor loans, particularly those underwritten using a Debt Service Coverage Ratio.
Current 60-plus delinquency rates on owner-occupied loans sit at just over 4.00%, roughly 125 bps greater than those of investor loans and nearly double those of second homes securitized in Non-QM trusts. However, that gap narrows materially once controlling for LTV. Looking exclusively at loans with original LTVs between 70 and 80, the gap in delinquency rates narrows from roughly 125 bp to just 50 bp with owner-occupied loans still exhibiting marginally worse performance.
Investment Implications
Credit performance across various cohorts of non-QM likely lends itself to investors skewing exposure towards deals with larger concentrations of investor loans, particularly those with smaller tail populations of lower DSCR loans. The combination of greater amounts of hard credit enhancement, generally larger amounts of excess spread and lower balance, lower LTV loans in deals backed by investor collateral should outperform given any downturn in consumer credit performance. These loans offer the additional benefit of additional prepayment protection given the presence of prepayment penalties on these loans.
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