INSIGHTS

Post-crisis mortgage regulation created two classes of mortgage loans, “qualified mortgages” and “non-qualified mortgages,” based on certain loan characteristics including income verification and debt to income ratios.

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Key Conclusions / Implications

• While originators of both loan types certify the borrower’s ability to repay, lenders have full safe harbor if the loan conforms to all qualified mortgage (“QM”) standards and has a borrowing rate within 150bp of the Prime rate.[1]
  • Not surprisingly, in a risk averse post-crisis lending environment, lenders issued a disproportionate share of QM loans to avoid litigation risk and credit loss (the GSEs and Ginnie Mae purchase and wrap most QM loans).
  • From 2014-2019, nearly 80% of all mortgages were conventional conforming or FHA/VA loans, which all carry the QM designation and therefore fall within the safe harbor.[2]

• These regulations, while well intended, had the unforeseen consequence of limiting credit to tens of millions of creditworthy borrowers whose incomes and credit profiles do not conform with the strict QM guidelines.
  • Primary non-qualified mortgage (“non-QM”) borrower types include self-employed borrowers or those with alternative incomes, expanded or near-prime credit borrowers with recent credit events, and investor loans to single-family rental owners.
  • Non-QM lending has expanded quickly to provide credit to these underserved cohorts, especially self-employed borrowers.
  • According to a Zelman analysis, from 2017-2019 over 30% of non-QM loans were classified non-QM because they did not satisfy the Appendix Q documentation rules related to underwriting income, employment, and liabilities.[3]
  • Importantly, non-QM lending is unlike subprime lending, and features higher FICO scores, lower LTVs, and improved post-crisis documentation and underwriting. Non-QM underwriting is more like early Alt-A lending.[4]

• Likely near-term changes to federal mortgage finance policy are designed to ‘level the playing field’ between government lending and private markets.
  • There are two likely sources of near-term mortgage finance reform which would impact non-QM lending, both of which we believe would increase the role for private capital in mortgage lending.
  • First, the Treasury Housing Reform Plan directed FHFA to examine and potentially reduce its role in lending to “non-core” loans including investor loans, jumbo prime, second homes, and cash out refinancings to “Limi[t] certain GSE activities for which Government support is not necessary or justified.”[5]
  • The Urban Institute estimates that 34% of GSE production in 2019 was in high balance loans, cash-out refinancings, investor loans, and second homes.[6]
  • Second, the CFPB has announced plans to allow the temporary QM exemption for loans with a DTI above 43% (known as the “QM Patch”) to expire in January 2021 or soon after if an extension is needed.[7]
  • According to the CFPB, the Patch allowed the GSEs to purchase $234bn of mortgages in 2018 which would not have been permitted under the original guidelines.[8]

• The non-QM market has grown quickly, with $35bn of origination in 2019 or 1.7% of all originations, up from $7bn or 0.4% in 2017.[9]
  • For historical context, pre-crisis non-jumbo expanded prime lending totaled $247bn per year from 2000-2003, or 11% of originations, illustrating the potential growth as non-QM lending channels expand.

Non-QM securitizations increased to more than $20bn in 2019 from $9bn in 2018 and $3bn in 2017, illustrating the financing market support for non-QM expansion.[11]

[1] Urban Institute, “ What, If Anything, Should Replace the QM GSE Patch?”, August 2018.  https://files.consumerfinance.gov/f/documents/201603_cfpb_atr-and-qm-comparison-chart.pdf

[2] Inside Mortgage Finance data, “Mortgage Originations by Product,” data through 2Q’19

[3] Zelman and Associates, “A Deep Dive on Non-QM Lending,” October 1, 2019.

[4] Morgan Stanley, “Non-QM: We’re Not in Legacy Anymore,” October 11, 2019.

[5] U.S. Department of the Treasury, “Housing Reform Plan,” September 5, 2019.

[6] Urban Institute, “The Trump Administration’s Perplexing Plans for Fannie and Freddie,” October 2019.

[7] Bureau of Consumer Financial Protection, “Advance notice of proposed rulemaking”, July 25, 2019. JP Morgan, “QM patch to expire—but will QM change?”, July 2019.

[8] Ibid.

[9] Nomura Securitized Product Research, As of December 31, 2018.  Total origination actuals and forecasts from the Mortgage Bankers Association through November 20, 2019.

[10] Inside Mortgage Finance data, “Mortgage Originations by Product,” data through 2Q’19.

[11] Bank of America, “Securitized Products Strategy, Securitization Weekly”, November 4, 2019.