By the Numbers
Signs of stress in large loans
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.
Larger loans in non-QM MBS have always been a source of risk for investors in private-label bonds, mainly because historically they have been far more negatively convex than smaller loans. A curious and somewhat counterintuitive trend has begun to form where larger non-QM loans are exhibiting elevated serious delinquencies compared to smaller loans. A granular analysis suggests that growing strains on household budgets may be the root cause given elevated delinquency rates on second homes in New York and primary residences in Florida.
In the run-up to the Global Financial Crisis, conventional wisdom said that large loans bore less credit risk than smaller ones as larger loans generally went to more affluent borrowers who could afford bigger homes and heftier downpayments. Smaller loans were also problematic since fixed costs of foreclosure and liquidation would represent a higher loss severity on default. Fast forward to today and there is a discernible difference between large and small loans with more large loans rolling into serious delinquency (Exhibit 1).
Exhibit 1: Larger loans exhibit elevated delinquencies in non-QM trusts
Source: Santander US Capital Markets, CoreLogic LP
Vintage and occupancy trends
Stratifying the universe of non-QM trusts by loan balance to isolate performance of loans with original balances of $800,000 or more and then further cutting this cohort by vintage and occupancy shows that more seasoned trusts are significant contributors to elevated delinquencies. This is especially notable for 2019 and 2020 vintages and not surprising as these loans are further up the seasoning curve. They should exhibit higher balances of delinquent loans than less seasoned trusts. However, the 2023 vintage appears to be somewhat of an aberration as delinquency rates are ramping with greater velocity than other post-COVID vintages (Exhibit 2).
Exhibit 2: 2023 vintage high balance loans rolling delinquent faster than other cohorts
Source: Santander US Capital Markets, CoreLogic LP
Underperformance in the 2023 vintage does not appear, at least on the surface, to be a function of materially looser underwriting standards. While the credit box did loosen modestly coming out of the pandemic, with average LTV rising by one to two points and average FICOs decreasing by roughly 10 points versus the absolute tights in underwriting, they by no means signal a meaningful deterioration in underwriting. Additionally, while anecdotal, talks with many originators suggested that they began to tighten underwriting standards through 2023, either pricing loans with layered risks such as high LTV loans to lower FICO borrowers more punitively, or removing the offerings from their pricing grids altogether as primary mortgage rates rose.
Exhibit 3: Underwriting remained strong in 2023 vintage despite weaker performance
Source: Santander US Capital Markets, CoreLogic LP
While difficult to know with certainty what might be driving this underperformance it seems plausible that large balance borrowers in the 2023 cohort may have ‘bought the house and not the rate’ with an eye towards being able to refinance that loan at some point in the not-too-distant future, thereby bringing down household debt burdens substantially. Persistently elevated mortgage rates, coupled with rising non-fixed costs such as taxes and insurance seem likely to be putting pressure on a segment of larger balance borrowers.
A look at occupancy trends
When cutting higher balance loans at the cohort level by occupancy, both owner-occupied and investor loans are showing comparable delinquency levels with second homes performing markedly better than both primary residences and investor loans. Delinquencies on primary residences and investor high balance loans have converged over the past year after delinquency rates on higher balance investor loans surged at the start of last year (Exhibit 4). However, this trend is not uniform across states that are currently flashing elevated delinquency rates.
Exhibit 4: Delinquency rates on high balance primary residence and investor loans converge
Source: Santander US Capital Markets, CoreLogic LP
Geography matters
When cut by geography, there are notable differences in the performance of larger balance loans across states. The start of the year marked the beginning of a significant divergence in credit performance across states that make up substantial swaths of non-QM collateral. Delinquencies in Florida and New York surged and currently sit at the highest readings of meaningful non-QM geographies. Delinquency rates in loans in Georgia have surged in recent months as well. Conversely, delinquency rates on large loans in New Jersey have fallen substantially. While readings in California and Texas remain relatively benign (Exhibit 4).
Exhibit 5: Delinquency rates rising in large loans in New York and Florida
Source: Santander US Capital Markets, CoreLogic LP
Signs of stress in New York second homes
Evidence that persistently elevated rates and rising non-fixed costs of homeownership may be putting strains on larger loan borrowers in non-QM trusts can be seen when drilling down into the state with the highest delinquency rate, New York.
In New York, delinquency rates on second homes are significantly higher than those of both primary residences and investment properties, contrary to the broader trend for the non-QM universe where second homes exhibit markedly better credit performance than the other two exposures. Serious delinquency rates on second homes in New York surged to as high as 11% earlier this year, 5.6% higher than primary residences and 4.2% higher than investor loans in the same period. Second homes in New York are by no means a meaningful cohort in the broader non-QM universe. However, the trend may be illustrative of strained household budgets and potentially continued stress on larger primary residence and second home borrowers within the sector.
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