By the Numbers
Cashouts and high DTIs represent layered risk in non-QM
This material is a Marketing Communication and does not constitute Independent Investment Research.
Given discernible and growing differences in performance across different cohorts of non-QM collateral, the presence of layered risk should be increasingly relevant for mortgage credit investors, particularly for those that invest further down the capital structure. Much of the layered risk looks to be in both cash out refinances, which have remained elevated across vintages, as well earlier vintage trusts, which carry elevated levels of higher DTI loans and more loans with affordability features. Cash out refinancings with high DTIs appear to be a fairly prominent layered risk.
Analyzing layered risk is nothing new to investors in mortgage credit. The presence of a single weaker borrower attribute can, in isolation, signal weakened performance. The presence of multiple risk layers often amplify that underperformance. Until recently, delinquencies across the universe of non-QM remained low and concerns around layered risk were muted. As delinquencies have steadily risen, investors have become more acutely focused on elevated concentrations of lower FICO loans, higher LTV and DTI loans, as well as cash out refinances and loans with affordability features, and particularly tails of pools with loans that exhibit more than one of these features.
Canvassing the universe for layered risks
The non-QM universe in aggregate is first screened for populations of ‘riskier’ loans. The taxonomy is defined as (i) loans with original LTVs or CLTVs of 80 or greater, (ii) loans with original credit scores of 680 or less, (iii) cash out refinances, (iv) loans with original DTIs of 40 or more and (v) loans that have some type of non-traditional amortization feature such as an ARM, IO or maturity of greater than 30 years (Exhibit 1).
Exhibit 1: Capturing primary risk layers across the non-QM universe
Source: Santander US Capital Markets, CoreLogic LP
The presence of riskier loans with weaker primary credit characteristics, namely LTV and FICO, are fairly scarce as they represent between 11% and 12% of the securitized balance of the non-QM universe. High LTV loans, which comprised anywhere from 6% to 11% of pre-Covid pools, are securitized with little to no frequency and low FICO loans generally made up 1% to 2% of securitized balances in recent quarters.
Pre-Covid non-QM vintages were marked by elevated levels of adjustable-rate loans, cash out refinances and high DTI loans. Non-QM borrowers have increasingly reached for fixed-rate financing in recent years, likely since it is far more difficult to qualify at the fully indexed rate today than when benchmark rates were upwards of 300 bp lower than today. As a result, the presence of affordability products has dwindled. Over two thirds of non-QM loans securitized in 2019 exhibited some type of affordability feature. That number has fallen to just 14% of loans securitized this year.
Conversely the presence of both cash out refinancings and high DTI loans have remained elevated. Cashout refinancings have consistently comprised roughly 30% of non-QM securitized volume over the past six years. The prominence of cashouts in non-QM trusts has been fueled in large part by both rapid and substantial home price appreciation. That appreciation has, in turn, provided investors with significant returns on properties purchased over the past six years. Those investors have subsequently reached for a cashout loan to harvest gains, reinvest those gains into equity for another investment, or both. The slowdown in home price appreciation may prove to be a headwind to elevated cashout originations going forward though. High DTI loans, which peaked at roughly 40% of total volume in 2019 have fallen somewhat, to just over 27% of loans securitized this year (Exhibit 2). The prominence of high DTI loans in earlier vintage trusts is in no way surprising given that prior to the end of 2020, the QM standard was DTI-based, with any loan where the borrower’s front-end DTI was in excess of 43% was considered non-QM irrespective of any additional underwriting or credit attributes.
Exhibit 2: Tracking the progression of risk layers across vintages
Source: Santander US Capital Markets, CoreLogic LP
However, the same rapid and substantial home price appreciation that has provided a tailwind to cashout originations has stretched borrowers’ budgets both in the form of higher DTIs for owner-occupied and traditionally underwritten investor loans as well as lower DSCR ratios for investor loans underwritten using the property’s rental income. When combining the two risk dimensions, over 8% of cashout refinances have DTIs greater than 40%. The 2019 and 2020 vintages have the highest levels, exceeding 13% of the collateral in those deals (Exhibit 3).
Exhibit 3: Cashouts and high DTIs combine to create elevated layered risk
Source: Santander US Capital Markets, CoreLogic LP
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