non-qm risks & rewards -...

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Principles of Mortgage Banking ll

Non-QM Risks & Rewards

Ben Niles, Master CMB, CMP

Housing Advocate for Responsible Lending

Proprietary information, do not distribute or use

without permission of MBBA-NH.

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Principles of Mortgage Banking ll:


1) Non-QM Loans: Thinking Outside the Box

2) QRM

3) Reasons Why Lenders May Not Make Non-QM Loans

4) Reasons Why Lenders Should Make Non-QM Loans

5) Non-QM Risks: Regulatory to Legal to Financial

6) Loan Purchase Agreement Reps & Warrants

7) Non-QM: “A Paper” vs “Sub-Prime”

8) Non-QM Lending & Forecast

9) Non-QM Sub-Prime: Then vs Now



Agenda

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10) Non-QM Securitization

11) Alt Doc Loans

12) Foreclosure Rates by Loan Attributes

13) Managing Non-QM Risks

14) Sins of the Past & Historical Losses

15) Non-QM Lending Policy for the Self-Employed

16) Credit Risk Factors to Consider

17) Non-QM Loan Scenarios



Agenda

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1) I-O’s as Non-QM?

2) Neg Am: Remember Option ARMs?

3) Balloon Payments: Magnified the Real Estate Cash in the Great Depression.

4) Terms > 30 Years: 35, 40, 50 Years?

5) HPML’s: Higher Rates &/or Fees.

6) 3% Points & Fees Cap vs Risk Based Pricing of Points into the Rate.

7) Rebuttable Presumption.

8) Failing QM: DTI > 43%, Low FICO’s (poor credit), or Reduced Doc Loans?



Non-QM Loans: Thinking Outside The Box

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1) QRM = QM (CFPB). ATR- must use 3rd party income documentation for DTI.

2) QRM mandates 5% Risk Retention, “skin in the game”, for all Non-QM Loans.

3) Portfolio Lenders: retain 100% of the risk (voluntarily)

4) Private MBS Issuers: 5% risk retention- all Non-QM Loans.

5) Common Non-QM Products Today:

a) I-O’s

b) Near-prime: (Sub-Prime, Deep-Subprime, No FICO).

b) Bank Statement Loans (1 month, 6 months, 12 months, or 24 months)

d) Foreign Nationals & ITIN Loans





QRM

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1) Reputational Risk: $$$ Unknown- due to no damaging headlines to date.

2) Regulatory Risk: $$$ Unknown- due to no enforcement actions to date.

3) Legal Risk: $$$ Unknown- due to no mega lawsuits to date.

4) Financial Risk: $100,000-$200,000/conforming loan, no lawsuits/ buybacks to date.

5) Misrep/Fraud Risk: Unquantifiable.



5 Reasons Why Lenders May Not Make Non-QM Loans

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1) Lenders who avoid non-qualified loans are passing up on a profitable boost to

their business. Risks are small for borrowers with high FICO scores and a low

LTV.

2) You can make more money- 100-200 BP more, says Jeffrey Lemieux, SVP

Correspondent & Wholesale Lending at Bayview Asset Management.

3) You can boost origination. $20 - $100 Billion of originations or more are in play.

(Some estimates are as high as $300 Billion annually based on demand).



5 Reasons Why Lenders Should Make Non-QM Loans

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4) You can limit your liability. How you document your loan file & establish ATR is key.

5) The Government wants you to do Non-QM loans. Decreases the GSE share of the

total market.

National Mortgage News, 10/3/14, Mark Fogarty



5 Reasons Why Lenders Should Make Non-QM Loans

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6) Reach out to the Underserved Segment of the home buying market.

7) Provide home financing for the Local Self-employed Buyers.

8) Provide home financing for Foreign Nationals (permanent resident aliens).

9) Provide financing alternatives to the FHA.

10) Increase your profitable low-risk portfolio products.



5 More Reasons Why Lenders Should Make Non-QM Loans

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Reputational Risk: Impacts customer market, 3rd counterparty relationships.

Regulatory Risk: Cease & Desist, heavy fines.

Fair Lending, Predatory Lending, UDAAP.

Your Regulator has the “upper hand”.

Legal Risk: Cost to defend lawsuit- borrower & counterparties.

Plaintiff legal fees with negotiated settlements & lost suits.

Financial Risk: $100,000 - $200,000 per loan.



Risks of Non-QM

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1) State Department of Banking (DOB’s).

2) State Attorney Generals: all 50 individually or jointly with the Feds.

3) US Department of Justice.

4) CFPB is Prosecutor, Judge, & Jury.

5) $$ Millions & $$$ Billions in Fines. Another form of taxation?



Regulatory & Legal Risks

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1) Fraud Statutes: Income Misrep on SIVA, SISA, & NINA Loans

2) Fair Lending- Disparate Treatment: marketing, pricing & underwriting.

3) Predatory Lending: product & pricing.

4) QM/ATR: Rebuttable Presumption & Income Documentation.

5) UDAAP: advertising & marketing practices.



Regulations That Put Non-QM Lenders at Risk

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1) ATR – Rebuttable Presumption

DTI > 43% & how did you document the income?

Forecasted Income- New Doctors starting a practice.

- Self-employed < 3 years.

- borrowers paid on commission.

- self-employed set-backs in recessions.

If a mortgagor defaults with a down payment of 20-40%,

will they sell to avoid foreclosure?



Risks: Basis for Litigation & Regulatory Action

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2) UDAAP: Unfair, Deceptive, Abusive Practices

The borrower will say “I was deceived” or “I did not understand”

Difficult for Lenders/Servicers to defend or disprove.

3) Predatory Lending: High Interest Rates on Sub-Prime Loans

6-10% in a 4.5% rate environment?

Do Borrowers of the Bad Credit Club have a good cause for action?




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4) Fair Lending: Social-Economic Demographics Issue

Minority/Emigrant Borrowers have:

- less education

- language barriers

- lower FICO sores (thin credit, high balances, or no credit).

- less financial understanding

- may be desperate for a loan (consolidation loan)

- may be stretching too far (DTI) for the dream of homeownership

Regulators & Plaintiff Bar will apply the “disparate impact” theory.Proprietary information, do not distribute or use



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Penalty for Violating QM:

1) 3 Years Financing Charges.

2) All Fees Paid at Closing.

3) Legal Fees.

4) Regulatory Fines (unspecified- no limit?).

Industry Estimate of Cost of Violation:

1) $100,000 on Average Loan.

2) $200,000++ on Jumbo Loans.

The Big Unknown: No Judicial Case-law or Precedent or CFPB Enforcement.



Non-QM Financial Risks

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“Each Mortgage Loan at the time it was made complied with all applicable

local, state, and federal laws, including, without limitation, usury, equal credit,

opportunity, disclosure and recording laws, and predatory and abusive

lending laws applicable to the originating lender;”

common R&W language from the 2006 era



Loan Purchase Agreement (LPA) Seller Reps & Warrants

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“All federal and state laws, rules and regulations applicable to the Loans have been complied with, including but not limited to: the Real Estate Settlement Procedures Act, the Appraisal Independence Rules, the Flood Disaster Protection Act, the Federal Consumer Credit Protection Act including the Truth-in-Lending and Equal Credit Opportunity Acts, Anti-Money Laundering and all applicable statutes or regulations governing fraud, lack of consideration, unconscionability, consumer credit transactions, predatory and abusive lending or interest charges.”

Plaza Home Mortgage, Inc.10/11/2016





Loan Purchase Agreement (LPA) Seller Reps & Warrants

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1) Ask yourself: Can I make this broad R&W?

2) Am I backing this R&W for the life of the loan?

3) What are my risks when Lending & Servicing or Selling Non-QM Loans:

a) Near-Prime loans? Deep Sub-Prime loans?

b) Bank Statement loans?

c) SIVA & SISA Loans?

d) Asset Based Loans? Collateral Loans?

e) Foreign National & ITIN loans?



Loan Purchase Agreement (LPA) Seller Reps & Warrant Risks

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Depositories: 95% are holding Non-QM loans in portfolio.

Mortgage Brokers: 95% are still mostly “wait & see”; on the sidelines.

Mortgage Bankers: 70% are on the sidelines due to alt doc legacy loan losses.

Private Equity Firms: holding loans (REITs) on their balance sheet or issuing PMBS.

PMBS issuance is mostly nonprime. Alt Doc/No Doc is mixed in with nonprime in a

many PMBS pools. Alt Doc is slowly increasing.



Non-QM Lending Today

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Top 4 Reasons Loans are Non-QM:

1) Exceeded 43% DTI Threshold

2) Balloon Payment

3) I-O Feature

4) Exceeded 3% Points & Fees Cap

Also, Low, very low, or no FICO; Alt Doc, & No Doc (Hard Money Lending).



Non-QM Lending: From ATR to Alt Doc/No Doc

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Liquidity is the key.

Risk Retention slows growth of the PMBS market for Non-QM loans.

MBA: estimated $70B of Non-QM securitization for 2015.

$54.1 billion Non-QM PMBS issued in 2014

-vs $61.6 billion in 2015.

-vs $1.19 trillion in 2005

Most PMBS were re-securitization of old loans.

Most Jumbo loans are kept in portfolio.



Non-QM Securitization Volume

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Nonprime PMBS issuance only $1B in 2016 & $4B in 2017 vs $814B in 2006.

Forecast for 2018 is $20B, mostly Alt A Reduced Doc, ie- bank statement loans.

Subprime now is mostly FHA loans.

Weak Investor appetite due to a lack of regulatory clarity, legal precedents, &

case law forces most originators & aggregators to hold these loans

on their balance sheets. REITs looking for 100-200 BP higher yields.

“Legislative, regulatory, & market changes will limit nonprime RMBS to a

very small share of the total U.S. Market.” Fitch Managing Director Grant Bailey.Proprietary information, do not distribute or use


Nonprime Lending Forecasts

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Angel Oaks Mortgage Solutions: issued $210 million Non-QM PMBS, with a Senior

Tranche rated AAA & over-subscribed, in Dec’ 17 & $550 million in all of 2017.

“We have zero interest in giving a loan to a borrower that they cannot repay. There

is no way to win that scenario- and we proved that in 2008-2009.”

“We think 2018 really is going to be the year when volume of non-qm loans starts to

catapult.”

“We created the bank statement program that analyzes the borrower’s personal

cash flow and/or business cash flow to determine their ability to repay.”

Tom Hutchens, SVP Sales & Marketing Proprietary information, do not distribute or use


Explosive Growth in Non-QM PMBS Predicted for 2018.

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The Subprime Market: Then and Now

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2006 2016

- Average credit score: 580 - Average Credit Score: 660

- Loans were made without requiring - Most loans require min 20% down payment

a down payment

- Income was undocumented - Income must be fully documented

- Volume: $600 billion - Volume: $250 million & growing

- Limited oversight & regulation - Tighter regulation & ATR (ability to repay)

requirements

Tom Hutchens, SVP, Angel Oaks Mortgage Solutions



1) Non-QM is not intended to fill the Sub-Prime Niche.

2) Sub-Prime is the same as 30 years ago- poor credit borrowers.

We simply have a easier way to identify it - FICO Scores.

3) Existing Lenders & new players are again pushing the credit envelop.

4) Believe it or not, Stated Income, SISA, & NINA programs coming are back.



Near-Prime: the new name for Sub-Prime

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1st Time: 1980’s, “Liar Loans” were 1st offered by Fannie & Freddie.

Called “No VOE/No VOD” loans. Imploded in 1990-91 Recession.- defense, hi-tech,

& construction sectors all crashed at the same time.

So much for industry diversification!

2nd Time: 2000-2007, SIVA, SISA, NINA offered by all of the PMBS Issuers on Wall

Street. Real estate values have not fallen nation-wide since the Great Depression.

Geographic diversification & appreciation will keep foreclosure losses manageable.

Just ask S&P, Moodys, & Fitch!

The common thread is 90-99% of these loans contained 1 or more material

misrepresentations. Result: $$$ Billions in fines & repurchases. Proprietary information, do not distribute or use


Sins of the Past

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3rd Time is a Charm: 2016 Return of Stated Income Loans.

Products: Alternative Documentation Loans, Portfolio Programs, Alternative-Income

Verification Loans, Bank Statement Loans, Asset-Based Loans, No Ratio Loans,

Foreign Borrower Loans, ITIN Loans. Also “Near Prime” & “Deep Subprime”.

Lenders: Mortgage companies, private equity firms, a few banks, & the new Fintech

lenders.

The CFPB, DOJ, AG’s, and the Plaintiff Bar will have the last word!



Low/No Doc is back for the 3rd Time in 30 Years

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Historical Foreclosure Losses

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Foreclosure Loss Severity Averaged 43%- MBAA

Foreclosure Loss Severity Averaged 34% & peaked at 40% for 60-80% LTV for

1999 – 2013 Originations.**

Foreclosure Loss Severity Peaked at 46% for 60-80% LTV & < 700 FICO for 2007

Originations. **

** Urban Institute Study based on Freddie Mac Data



Use Non-QM niches to meet your customer needs:

I-O’s: Yes, well qualified borrowers with significant incentive income.

ATR: self-employed, new doctors.

Reduced doc programs: How do you manage the Risks?

Can some of these products be for your CRA program?

Develop sound credit policies for each Non-QM product/program.

Hold these loans in the bank’s portfolio.

Establish a loan loss reserve.



Your Business Model: Banks

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Where the Rubber Meets the Road

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Bank Statement or Stated Income Loans: R&W’s puts “the Lender on the hook”.

- IRS Small Business Tax Gap of $125 Billion Annually (taxes never paid).

- Why does your borrower refuse to provide their 1040’s?

a) do they not make the income stated on their 1003?

b) do they under-report their income to avoid taxes (“the gap”)?

c) has their business profits grown, but not yet for a 2 yr history?





Foreclosure Risks- By Loan To Value

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Foreclosure Rates by Down Payment:

Down Payment: Foreclosure Rates:

30% 0.2%

20% 1.3%

15% 2.4%

10% 3.3%

5% 4.0%

3% 4.7%

Source: MGIC





Foreclosure Risks- By Loan Attributes

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Incremental Foreclosure Risk by Loan Attribute:

Negatively amortizing ARM 3-4 times

Reduced Documentation 3 times

Subprime credit 2-3 times

Non-owner occupied 2-3 times

Amortizing ARM 1.5-2 times

Over 45% total debt to income 1.5 times

Cash-out refinance 1.5 times

Source: MGIC





Subprime Defined by Federal Reserve Bank of St Louis

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Credit Score LTV

< 80% 80-90% > 90%

680 or Higher Prime Near-prime Subprime

581-659 Near-prime Near-prime Subprime

</= 580 Sunbrime Subprime Subprime



1) Use your Credit Policy to define “A” Paper:

a) FICO Floor- 660, 680, 690?

2) LTV/FICO/Reserves Policy?

3) 2 Units, 3-4 Units, 2nd Homes, & NOO risk parameters?

4) Address “layering of risk” & U/W methodology.



Near Prime Credit Policy

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How do we manage the risk of foreclosure losses on Alt Doc Bank Statement Loans for Self-Employed Borrowers?

Credit Risk Factors to include in the Credit Policy:● Property Location- State(s)?● Occupancy: Owner-occupied Primary Residence?● Property Type: Single Family Detached, Condo, or Co-op?● Loan Purpose: Purchase or No Cash-out Refinance?● Maximum LTV/CLTV: 50, 55, 60, 65, 70, 75, or 80?● Minimum FICO: 660, 680, 700, 720, or 740?● Maximum DTI: 36, 38, 43, 45, 50?

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How do we manage the risk of foreclosure losses on Alt Doc Bank Statement Loans for Self-Employed Borrowers?

Credit Risk Factors to include in your Credit Policy:● Minimum Reserves: 3, 6, 9, or 12 months?● Mortgage Term: Maximum 20, 25, or 30 years?● Product Type: Fixed Rate, or Intermediate ARM (10/1)?● Number of Months of Bank Statements: 1, 6, 12, or 24?● Points priced into the interest rate for risk components: 0,1, 2, 3, 4?● Origination Channel: Retail?● Portfolio Loan or Held For Sale?

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Non-QM Loan Scenarios





Scenario #1: Max 65% LTV/CLTV, , Min 700 FICO, Max 36% DTI, 6 MonthsReserves, 24 months Bank Statements, 30 Year FixedRate, OO, SFD, Purchase or NCO Refi, -0- Points, Retail, PortfolioLoan.

Scenario #2: Max 55% LTV/CLTV, Min 720 FICO, Max 38% DTI, 9 Months Reserves,12 Months Bank Statements, 30;Year Fixed Rate, OO, SFD, Purchase,or NCO Refi, -0- Points, Retail, Portfolio Loan.

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Non-QM Loan Scenario





Scenario # 3: Max LTV/CLTV = 75%, Min FICO = 740, Max DTI = 36%, 12 MonthsReserves, 24 Months Bank Statements, 25 Year Fixed Rate, OO, SFD,Purchase or NCO Refi, 4 – 5 points, Retail, Portfolio Loan.Or no points & Interest Rate is increased by 100 BP (DVO1 = 4:1) or 125 BP (DVO1 = 5:1)

Cardinal Rule: Do not “Layer Risks”

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QM Question





Who was denied a loan for failing QM/ATR in 2015?(Hint: A high level ex-government official…. )

Why was he/she denied a loan on their residence?

Would you deny that loan & why?

Or on what terms would you approve that loan?

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QM Question



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1) The CFPB ruled that QRM=QM and you must use 3rd party documentation to verify income for ATR. (T/F)

2) Bank statements are a good way to verify income on Stated Income loans. (T/F)

2) Safe bank Interest-only loans are QM loans. (T/F)

3) The std Seller Reps & Warrants for Non-QM loans should be customized to the products being sold. (T/F)

4) The Non-QM lineup of products will help me to replace lost refi volume in 2017. (T/F)

5) a good way for Lenders to manage the risks on Non-QM lending by brokering the loans. (T/F)

6) You can manage the Subprime risks by setting a max LTV/CLTV or 75-80% & a FICO floor of 580-620. T/F

QM Question



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7) Stated income loans will have an incremental foreclosure rate of 3 times full doc. (T/F)

8) Many self-employed taxpayers under-report their income and avoid $125 Billion a year in Federal Taxes. (T/F)

9) On a Stated Income loan, the borrower most likely either does not make the stated income, or makes it but under-reports to the IRS to avoid paying their full taxes. (T/F)

10) Non-QM lending is being held back by a lack of regulatory enforcement actions, no case law to date. (T/F)

11) For the risk-adverse Lender, the FHA product is a good substitute for Non-QM Subprime. (T/F)

12) Non-QM loans can be more efficiently serviced the same as Fannie/Freddie loans. (T/F)

Principles of Mortgage Banking ll


Just remember, you will have to answer to your Investors, Regulators, and

Attorneys tomorrow for the choices you made today.

Choose Wisely

Study the past if you would define the future. Confucius

Ben Niles: [email protected] 603-305-0590 (C)



Questions?

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