Moody’s: Default Risk of Non-QM RMBS Driven by Underwriting


It’s no secret that investors have been eating up mortgage securities backed by non-QM loans, similar to how Wall St. ate up subprime mortgages back in the early 2000s.

There’s simply more yield relative to other investments, especially in a world with bond yields inching toward or hitting record lows.

And while subprime and non-QM aren’t the same, there are unique risks involved in the purchase of non-QM residential mortgage-backed securities (RMBS).

These concerns need to be addressed as the market for non-QM RMBS grows from hundreds of millions to billions in annual volume.

Non-QM Loan Underwriting Guidelines Can Be Quite Different

In a new announcement, Moody’s Investors Service notes that variations in underwriting criteria for non-QM loan programs poses risk to the underlying securities.

They highlight the fact that non-QM loans can be extended to both prime and non-prime borrowers, such as those with poor credit or those with excellent credit.

And some borrowers could just be “near misses” from qualifying for a Fannie Mae- or Freddie Mac-backed loan, while others might only be able to provide reduced documentation.

Reduced doc loans seem to be a point of contention given the fact that lender requirements can range from just one month of bank statements to as many as 24 months.

“Bank statement underwriting standards vary across originators along several dimensions, such as the number of bank statements used, the source of the statements, and how revenue and expenses are identified,” said Moody’s Vice President Lima Ekram.

There are also investor loans, which rely upon the property’s actual cash flow as opposed to the borrower’s financial strength.

All of this variance can breed uncertainty when investors attempt to determine the default risk of the RMBS.

Using Technology to Mitigate Risk in Non-QM Securitizations

However, Moody’s doesn’t seem to be sounding the alarm on non-QM securities. Rather, they’re just pointing out the wide range of underwriting approaches being employed by lenders.

While they do acknowledge that there have been some securitizations of non-QM mortgages with weak underwriting variations, there are readily available tools to lessen risk.

“The use of technology in risk modeling and oversight can mitigate the risk of higher loan defaults from alternative documentation programs,” Ekram added.

Additionally, regulations (Ability-to-Repay rule), appraiser independence, transparency of third party loan reviews, and robust lender controls may improve investor confidence and strengthen loan quality.

Ultimately, Moody’s is pointing out the obvious for a new breed of mortgage securities that haven’t been around a very long time, yet continue to grow in popularity.

The takeaway is to ensure procedures and protections are in place to avoid non-QM becoming the next subprime crisis.

(photo: Derek Gavey)

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