By the Numbers
Lower FICO and larger loans underperform in non-QM MBS
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Delinquencies in subprime and near-prime loans in non-QM MBS continue to outpace non-QM prime loans. One potential concern, particularly for deep credit investors, is the relative performance of larger loans, which, if defaulted, would generate larger nominal losses to thinner subordinate and mezzanine non-QM classes. These larger loans continue to represent a relatively small percentage of the non-QM universe. And many of these loans carry both significant equity, which should drive either prepayments out of late-stage delinquency or limit loss severities on loans that do ultimately liquidate.
Late-stage delinquencies keep climbing, decouple from prime performance
As the impact of Covid fiscal support continues to wane, borrower performance on loans that may have experienced substantial FICO inflation from those policies continue to fall as well. Both the nominal level of serious delinquencies, defined as greater than 60 days past due, and the velocity of those rates continue to decouple from prime loans backing non-QM trusts. Near-prime loans with original FICO scores between 680 and 700 have seen delinquency rates rise to just over 7.25% and have escalated by just over 1.7% over the past six months alone. In contrast, loans to borrowers with credit scores between 740 and 760 are roughly one-third of those of near-prime borrowers, sitting at just over 2.8%, having increased by just over 40 bp over the past six months. An overall upward trajectory in delinquency rates is not particularly surprising given that much of the non-QM universe is not currently callable and delinquencies should rise consistent with a traditional CDR curve. However, lower FICO loans are ramping much faster than prime borrowers (Exhibit 1).
Exhibit 1: Velocity and magnitude of delinquency rates climb in near and subprime loans
Source: Santander US Capital Markets, CoreLogic LP, Observations are based on collateral backing 2019-2023 vintage NQM trusts
Underwriting, occupancy and loan size drive performance
Looking across loan attributes that are driving relative underperformance in near and subprime loans, loans that are primarily underwritten to the borrowers’ LTV ratio along with owner-occupied and larger loans are all exhibiting worse performance than other related cohorts. LTV loans are broadly defined as ‘no ratio’ loans originated by Community Development Financial Institutions (CDFIs), which do not require the originator to underwrite ability-to-repay. It also includes loans where the property’s rental income is not sufficient to cover the monthly mortgage payment (>1.0 DSCR). Both cohorts are underperforming relative to other forms of underwriting, although we have seen some convergence between the performance of lower DSCR loans and limited documentation loans in recent months (Exhibit 2).
Exhibit 2: LTV, limited documentation underwriting underperform
Source: Santander US Capital Markets, CoreLogic LP, Observations are based on collateral backing 2019-2023 vintage NQM trusts
Turning to occupancy, owner-occupied loans are performing substantially worse than both investor loans and second homes. While not controlling for other loan attributes that may be impacting performance, 60+ day delinquency rates on near and subprime owner-occupied loans currently sit at nearly 10%, roughly 30% greater than those of lower FICO investor loans. Lower FICO investors loans are currently just over 7.25% while performance on second homes is markedly better than that of both other cohorts at just over 4.0% based on the most recent remittance.
A look at loan purpose shows, somewhat surprisingly, that delinquency rates for both cashout and rate-and-term refinances are elevated relative to rates on purchase loans. Late-stage delinquencies on both cashout and rate refinances are both hovering around 9.25% for lower FICO borrowers while rates on purchase loans are roughly 100 bp lower. While this somewhat counter-intuitive when thinking about performance through the lens of GSE or government loans, it is likely a function of a large population of purchase loans being comprised of lower original LTV investor loans rather than higher LTV first time home buyers in both the GSE and government cohorts.
Looking finally at loan size shows a fairly stark contrast in performance across loan balance cuts with larger loans underperforming relative to smaller ones. Delinquency rates on loans to lower FICO borrowers with original balances in excess of $800,000 are roughly double those on loans with balances between $200,000 and $400,000 (Exhibit 3). Relatively elevated delinquency rates on higher balance loans should drive weaker price performance on deep subordinate and mezzanine classes of deals backed by these loans given the potential for substantial reduction in credit enhancement if these loans ultimately liquidate. With that said, there are reasons to be constructive on the potential for relatively negligible loss severities on these loans given the fact that fixed costs associated with liquidation will make up a much smaller percentage of a larger loan’s balance and the fact that many of these loans carry both substantial paid-in and mark-to-market equity, which, in many cases should result in a prepayment or no loss abatement after the sale of the property.
Exhibit 3: Larger loans underperform relative to smaller ones
Source: Santander US Capital Markets, CoreLogic LP, Observations are based on collateral backing 2019-2023 vintage NQM trusts
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