By the Numbers
Delinquencies continue to rise 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.
Serious delinquencies on loans in non-QM MBS rose again in March. While FICO and LTV continue to predict higher delinquencies, loan size and DSCR ratios also are starting to signal weaker credit. Substantial paid-in and mark-to-market borrower equity in the financed properties should insulate MBS investors from losses, particularly on seasoned collateral. But elevated delinquency rates can translate to lower valuations on underlying collateral pools, potentially increasing extension risk in deals with more delinquent loans.
The population of loans in non-QM trusts more than 60 days past due ticked up again in the March remittance cycle. Across the entire cohort, serious delinquencies increased by 15 bp to just over 4.0%. Focusing on the 2019 through 2023 pre-and post-Covid vintages shows both an even more pronounced monthly increase and higher nominal delinquency rate. Those vintages saw a 25 bp month-over-month increase, with serious delinquency rates now approaching 5.0% (Exhibit 1).
Exhibit 1: Serious delinquency rates continue to increase
Source: Santander US Capital Markets, CoreLogic LP
A look at delinquencies across FICO and LTV bands
Differences in delinquency rates across FICO bands are stark, with a dispersion of nearly 9.0% between the best and worst performing cohorts. Loan with ‘near prime’ original FICOs between 660 and 700 are performing markedly worse than both the broader cohort and worse than higher FICO loans. Loans with original FICOs between 660 and 680 not only exhibit the highest nominal delinquency rates, but those delinquencies are also increasing with much greater velocity than other credits, rising by over 200 bp over the past six months (Exhibit 2). Underperformance in near prime credits may be, to some degree, attributable to FICO inflation, a product of Covid-era forbearance and fiscal stimulus policies.
Exhibit 2: Near prime credits performing worse than broader non-QM cohort
Source: Santander US Capital Markets, CoreLogic LP
Loans with original LTVs above 80% look to be a source of concern for non-QM investors as well. Serious delinquency rates for these loans were between 6.08% and 7.38% last month with 80%-90% LTV loans showing higher delinquency rates than loans with LTVs greater than 90% (Exhibit 3). Better performance in the higher LTV cohort is likely primarily due to more pronounced compensating credit characteristics on these loans, likely in the form of substantially higher amounts of liquid reserves, lower debt-to-income ratios and higher FICO scores. More recent vintage non-QM trusts seem to be largely insulated from poorer performance in high LTV loans, as the tail of high LTV loans in these deals has been decreasing over time. Late 2019 and early 2020 vintage deals appear to be most exposed as upwards of 10% of the collateral contributed to these trusts had original LTVs greater than 90%. In contrast, deals issued since 2023 saw the percentage of high LTV loans securitized drop to between 2% to 4%.
Exhibit 3: High LTV non-QM collateral underperforms
Source: Santander US Capital Markets, CoreLogic LP
Analyzing secondary credit characteristics
Certain secondary credit characteristics are showing signs of relatively elevated delinquency rates as well. Looking across the universe of non-QM collateral, delinquency rates on owner-occupied loans are trending well above those of both investor loans and second homes. Greater than 60-day delinquencies on owner-occupied loans stood at 4.6% in March. Delinquency rates on investor loans were roughly a point lower at 3.5%. Second homes have been the best performing cohort, with serious delinquencies of just 2.4% as of the most recent remittance. Looking at performance on the various forms of non-QM underwriting shows that asset depletion loans, which rely primarily on a borrower’s demonstrable liquid assets rather than a combination of assets and income to repay the loan are faring better than all other forms of non-QM underwriting, while ‘no ratio’ loans, underwritten exclusively by CDFIs, and becoming less prevalent in non-QM deals, are the worst performing cohort(Exhibit 4).
Exhibit 4: Performance varies across different forms of non-QM underwriting
Source: Santander US Capital Markets, CoreLogic LP
While investor loans are broadly outperforming owner-occupied ones, there is some noticeable divergence in performance based on the loans’ debt service coverage ratio. Bifurcating the universe of loans underwritten to a DSCR to those with a DSCR of less than 1.0 and those underwritten to 1.0 or greater shows that delinquency rates on lower debt service coverage loans were roughly 180 bp higher than those of loans with higher coverage ratios in March. Controlling for a subset of loans with original LTVs of 60% to 70% for both cohorts showed a similar dispersion.
Another secondary credit characteristic that has shown elevated delinquency rates is loan size, with larger loans underperforming relative to smaller ones. Serious delinquency rates on loans with original balances greater than $1 million spiked to 6.6% last month while loans with balances between $800,000 and $1 million came in at 5.6% (Exhibit 5). Balances between $400,000 and $600,000, reflecting the average loan size of the majority of non-QM trusts, tallied 4.4% in March.
Exhibit 5: Larger loans exhibit higher delinquency rates in non-QM trusts
Source: Santander US Capital Markets, CoreLogic LP
Digging in on higher balance loans, elevated delinquency rates appear to be driven by certain states in the Southeast and Southwest. Delinquencies on large loans in Texas, Georgia and Florida are currently elevated relative to those of other states that make up a meaningful amount of collateral backing non-QM trusts. In contrast, delinquency rates on California-based loans remain muted, totaling 3.9% in March, the lowest of all states analyzed.
While it seems reasonable to surmise weaker performance in states like Texas and Florida may be driven by investor loans where home price depreciation and correlated reductions in rental income have impaired cash flow, that does not appear to be the case. Splitting these cohorts by occupancy shows that serious delinquency rates for high balance investor loans in Texas totaled 5.4% while those of owner-occupied loans were nearly 400 bp higher at 9.2%. A similar pattern is discernible in Georgia where delinquencies totaled 5.9% for investor loans and 8.8% for owner occupied ones in March. Given this, elevated delinquency rates appear to attributable to higher household debt burdens on large loans more so than a downturn in rental income.
Large losses unlikely, but extension risk may be on the rise
It seems unlikely that elevated delinquency rates will translate to meaningful losses across non-QM trusts. The combination of existing stores of both paid-in and mark-to-market equity and tight housing supply should afford distressed homeowners or investors the ability to sell their homes rather than face foreclosure and subsequent liquidation. However, higher delinquency rates could increase extension risk on pools with large concentrations of seriously delinquent loans for a couple of reasons. First, by calling trusts with seriously delinquent loans sponsors would likely curtail leverage provided by the securitization as these loans would not be able to re-securitized in a new non-QM deal. Secondly, non-performing loan prices drag down the weighted average price of the collateral backing the trust, which could, in turn, push the par call out-of-the-money and create substantial friction to the sponsor’s decision to exercise the call.
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