By the Numbers
More prime jumbo loans popping up in non-QM trusts
This material is a Marketing Communication and does not constitute Independent Investment Research.
An interesting phenomenon is occurring in the non-agency market, namely the growing presence of loans that would normally be securitized in prime jumbo deals popping up in non-QM trusts. The presence of these loans likely bolsters the credit profile of these trusts but at the cost of worse convexity.
Some observers of the non-QM market might attribute the uptick in average loan sizes of these trusts solely to the measured increase in home prices nationally. However, another factor may be at play. Namely a growing amount of prime jumbo loans being securitized in non-QM trusts, with nearly one fifth of some trusts being stocked with prime jumbo loans.
Sponsors likely have a few incentives that may keep these balances elevated for the foreseeable future. The ability to collateralize non-QM trusts with prime jumbo loans should improve the overall credit profile of the pool, reducing credit enhancement and all-in cost of funds from a larger amount of lower cost ‘AAA’ debt. Jumbo loans tend to be larger than typical non-QM loans, giving aggregators the ability to get to critical mass for a transaction faster, reducing costs associated with warehouse financing and hedging ahead of securitization. Furthermore, it gives sponsors some flexibility on best execution if the loans can fetch a higher price in a non-QM structure than a prime jumbo shifting interest deal.
Gauging concentrations of prime jumbo loans in non-QM trusts
Defining prime jumbo as fully documented loans having original balances of greater than $1 million, only 55 of the roughly 230 trusts issued between January of last year and last month were completely devoid of prime jumbo collateral. On the opposite end of the spectrum, 27 trusts saw jumbo balances exceed 10% of the original pool. And 55 trusts had at least 7.0% jumbo collateral. Unsurprisingly, the largest concentrations of jumbo loans were securitized on dealer shelves that likely maintain both non-QM and jumbo conduits along with Cross Country Mortgage’s shelf, an originator of non-QM, jumbo, conventional conforming and government mortgage loans (Exhibit 1).
Exhibit 1: Dealer shelves exhibit larger concentrations of prime jumbo loans
Source: Santander US Capital Markets, CoreLogic LP
Implications of jumbo ‘creep’ into non-QM
Growing amounts of prime jumbo loans will have implications for both the credit and convexity profile of non-QM trusts. While I have highlighted the relative underperformance of larger loans in non-QM trusts, this phenomenon does not hold up when filtering further by occupancy, underwriting and credit score. Filtering first on documentation shows that large, fully documented loans are performing better than any other cohort when measured by serious delinquency rate. Delinquencies of 60 days or more on large, fully documented loans are just 2.82%. When changing the cohort to loans underwritten using alternative documentation, serious delinquency rates nearly double to 5.42% (Exhibits 2 and 3).
Exhibit 2 & 3: Large, fully documented loans exhibiting strong credit performance
Source: Santander US Capital Markets, CoreLogic LP
Filtering the cohort further to control for prime credit scores shows that while large, fully documented loans do not exhibit the lowest delinquency rates of all cohorts on a relative basis, the absolute level of delinquencies fall substantially, to just 0.96%, after controlling for credit score. By comparison, serious delinquency rates on large prime loans underwritten using alternative documentation are more than triple those of fully documented ones, currently sitting just above 3.0% (Exhibits 4 and 5).
Exhibit 4 & 5: Delinquency rates fall further when controlling for prime credit scores
Source: Santander US Capital Markets, CoreLogic LP
While credit quality looks likely to improve, the presence of large fully documented loans look likely to weaken convexity in non-QM trusts that carry substantial amounts of these loans. However, the magnitude of worsening convexity is going to vary based on the baseline assumption for comparison. At-the-money speeds for large, fully documented loans have tallied 35 CPR over a 2-year observation. By comparison, loans with balances greater than $1 million that were underwritten using alternative documentation have prepaid at 27 CPR. The prepayment S-curve on fully documented, large loans is also substantially steeper than that of alternatively documented ones. Given 50 bp of moneyness, full doc loans pay at 50 CPR while alternative doc ones pay at just 33 CPR (Exhibits 6 and 7).
Exhibit 6 & 7: Prime jumbo loans worsen convexity in non-QM trusts
Source: Santander US Capital Markets, CoreLogicLP
Note: Prepayment S-curves are SATO adjusted over a two-year observation for exclusively owner-occupied loans
Assuming that prime jumbo loans are going into these trusts at the expense of more ‘on the run’ non-QM loans, alternatively documented loans with balances between $400,000 to $600,000, then the convexity propositon worsens. At-the-money speeds on lower balance, alternative documentation loans have tallied 16 CPR, roughly half those of prime jumbo loans. And given 50 bp of incentive, they pay at just 20 CPR compared to 50 CPR for jumbos.
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