September 19, 2016
Subprime v. Non-Prime
The Kroll Bond Rating Agency has issued an RMBS Research report, Credit Evolution: Non-Prime Isn’t Yesterday’s Subprime. It opens,
Following the private label RMBS market’s peak in 2007 and the ensuing credit crisis, non-agency securitizations of newly originated collateral have focused almost exclusively on prime jumbo loans. This is not surprising given the poor performance of loosely underwritten residential mortgage loans that characterized certain vintages leading up to the crisis. While legacy prime, in absolute terms, performed better than Alt-A and subprime collateral, it was apparent that origination practices had a significant impact on subsequent loan performance across product types.
Many consumers were caught in the ensuing waves of defaults, which marred their borrowing records in a manner that has either barred them from accessing housing credit, or at best made it extremely challenging to obtain a home loan. Others that managed to meet their obligations have been unable to qualify for new loans in the post-crisis era due to tighter credit standards that have been influenced by regulation.
The private label securitization market has not met the needs of these consumers for a number of reasons, including, but not limited to, reputational concerns in the aftermath of the crisis, regulatory costs, investor appetite, and the time needed for borrowers to repair their credit. The tide appears to be turning quickly, however, and Kroll Bond Rating Agency (KBRA) has observed the re-emergence of more than a dozen non-prime mortgage origination programs that intend to use securitization as a funding source. Of these, KBRA is aware of at least four securitization sponsors that have accessed the PLS market across nine issuances, two of which include rated offerings.
Thus far, KBRA has observed that today’s non-prime programs are not a simple rebranding of pre-crisis subprime origination, nor do they signal a return to the documentation excesses associated with “liar loans”. While the asset class is meant to serve those with less pristine credit, and can even have characteristics reminiscent of legacy Alt-A, it is expansive, and underwriting practices have been heavily influenced by today’s consumer-focused regulatory environment and government-sponsored entity (GSE) origination guidelines. In evaluating these new non-prime programs, KBRA believes market participants should consider the following factors:
■ Loans originated under sound compliance with Ability-To-Repay (ATR) rules should outperform 2005-2007 vintage loans with similar credit parameters, including LTV and borrower FICO scores. The ATR rules have resulted in strengthened underwriting, which should bode well for originations across the MBS space. This is particularly true of non-prime loans, where differences in origination practices can have a greater influence on future loan performance.
■ Loans that fail to adhere to GSE guidelines regarding the seasoning of credit dispositions (e.g. bankruptcy, foreclosure, etc.) on a borrower’s credit history should be viewed as having increased credit risk relative to those with similar credit profiles that lack recent disposition activity. This relationship likely depends on, among other things, equity position, current FICO score, and the likelihood that any life events relating to the prior credit issue remain unresolved.
■ Alternative documentation programs need to viewed with skepticism as they relate to the ATR rules, particularly those that serve borrowers with sub-prime credit histories. Although many programs will meet technical requirements for income verification, it is also important to demonstrate good faith in determining a borrower’s ability-to-repay. Failure to do so may not only result in poor credit performance, but increased risk of assignee liability.
■ Investor programs underwritten with reliance on expected rental income and limited documentation may pose more risk relative to fully documented investor loans where the borrower’s income and debt profile are considered, all else equal. (1, footnotes omitted)
I think KBRS is documenting a positive trend: looser credit for those with less-than-prime credit is overdue. I also think that KBRS’ concerns about the development of the non-prime market should be heeded — ensuring that borrowers have the ability to repay their mortgages should be job No. 1 for originators (although it seems ridiculous that one would have to say that). We want a mortgage market that serves everyone who is capable of making their mortgage payments for the long term. These developments in the non-prime market are most welcome and a bit overdue.| Permalink