Value Opportunities in Private-Label Investor Loan Deals The supply of investor loan collateral in private securitizations has surged in 2021 and projects to remain high (more on this below). To gain an informational edge while selecting bonds among this new issuance, traders and investors have asked RiskSpan for data and tools to dissect the performance of investor Read More.. September 28, 2021 The supply of investor loan collateral in private securitizations has surged in 2021 and projects to remain high (more on this below). To gain an informational edge while selecting bonds among this new issuance, traders and investors have asked RiskSpan for data and tools to dissect the performance of investor loans. Below, we first show the performance of investor loans compared to owner-occupied loans, and then offer a glimpse into a few relative value opportunities using our data and analytics platform, Edge. As background, the increase of investor loan collateral in PLS was spurred by a new FHFA policy, recently suspended, that capped GSE acquisitions of investor and second home loans at 7% of seller volume. This cap forced originators to explore private-label securitization which, while operationally more burdensome than GSE execution, has been more profitable because it bypasses the GSEs’ high loan-level pricing adjustments. Now that this difficult but rewarding PLS path has been more widely traveled, we expect it to become more efficient and to remain popular, even with the GSE channel reopening. Subsector Performance Comparison: Investor Vs. Owner-Occupied Loans Investor Loans Promise Longer Collection of Above-Market Rates Compared to owner-occupants, investors have historically paid above-market mortgage rates for longer periods before refinancing. Figure 1 shows the prepayment rates of investors vs. owner-occupants as a function of refinance incentive (the borrower’s note rate minus the prevailing mortgage rate). As their flatter “s-curve” shows, the rise in investor prepayments as refinance incentive increases is much more subdued than for owner-occupants. Crucially, this relationship is not fully explained by higher risk-based pricing premiums on investor loans. Figure 2 shows the same comparison as Figure 1 but only for loans with spreads at origination (SATO) between 50 and 75 bps. The categorical difference between owner-occupied and investor prepay speeds is partially reduced but clearly remains. We also tried controlling for property type, but the difference persists. The relative slowness of investors may result from investors spreading their attention across many elements of their P&L besides interest expense, from higher underwriting obstacles for a rental income-driven loan, and/or from lenders limiting allocation of credit to the investor type. While we plot these graphs over a five-year lookback period to balance desires for recency and sample size, this relationship holds over shorter and longer performance periods as well. Figure 1: The Investor Loans S-Curve is Significantly Flatter Than the Owner-Occupied Curve Investor s-curve vs. owner-occupied s-curve. Includes prime credit, no prepayment penalty, original loan size $200K-$400K, ages 6-48 months for the past 5yr period performance. Source: CoreLogic’s Private-Label RMBS Collateral Dataset, RiskSpan. Note: because the increase in private-label investor loan volume is coming from Agency cutbacks, the historical performance of investor loans within both Agency and private-label datasets are relevant to private-label investor loan future performance. In this analysis we show private-label data because it straightforwardly parses voluntary prepays vs. defaults, which of course is a critical distinction for PL RMBS investors. Nonetheless, where applicable, we have run the analyses in both datasets, each of which corroborates the performance patterns we show. Figure 2: Even Controlling for SATO, The Investor vs. Owner-Occupied S-Curve Difference Persists Same as Figure 1 but includes only loans with SATO between 50-75 bps Source: CoreLogic, RiskSpan Investor Loans Pose Comparable Baseline Risk, Greater Downside Risk to Credit Investors Credit performance of investor loans has been worse than owner-occupied loans during crises, which justifies a pricing premium. During benign periods, investor loans have defaulted at similar or lower rates than owner-occupied loans – presumably due to more conservative LTVs, FICOs and DTIs among the investor loan type – and have therefore been profitable for credit investors during these periods. See Figure 3. Figure 3: Investor Loans Have Defaulted at Greater Rates During Crises and Similar Rates in Other Periods vs. Owner-Occupied Loans Default rates over time, investor loans vs. owner-occupied. Includes prime credit, ages 12-360 months. Source: CoreLogic, RiskSpan Relative Value Opportunities Within Investor Loans California Quicker to Refinance California has the largest share of U.S. investor mortgages, as it does with all residential mortgages. California borrowers, both investors and owner-occupieds, have exhibited a steeper response to refinance incentives than have borrowers in other states. Figure 4 shows the comparison focusing on investors. While historical home price appreciation has enabled refinances in California, it has done the same in many states. Therefore, the speed differences point to a more active refinance market in California. All else equal, then, RMBS investors will prefer less California collateral. Figure 4: California Prepays Significantly Faster In the Money Investor s-curves bucketed by geography (California vs. Other). Includes prime credit, no prepayment penalty, original loan size $200k-$400k, ages 6-48 months for the past 3yr performance period. Source: CoreLogic, RiskSpan For AAA Investors, Limited-Doc Investor Loans May Offer a Two-Sided Benefit: They Buoy Premium Bonds, and a Small Sample Suggests They Lift Discount Bonds, Too Limited-doc investor loans offer senior tranche holders the chance to earn above-market rates for longer than full-doc investor loans, a relative edge for premium bonds (Figure 5). This is intuitive; we would expect limited-doc borrowers to face greater obstacles to refinancing. This difference holds even controlling for spread at origination. Based on a smaller sample, limited-doc investor loans have also turned over more (see greater prepay rates in the negative refinance incentive bucket). This may result from a correlation between limited documentation and more rapid flipping into the rising HPI environment we have had nationally throughout the past seven years. If so, this would mean that limited-doc investor loans also help discount bonds, relative to full-doc investor loans, accelerate repayments at par. Because limited-doc investor loans are rare in the RMBS 2.0 era, we widened the performance period to the past seven years to get some sample in each of the refinance incentive buckets. Nonetheless, with all the filters we have put on to isolate the effect of documentation type, there are only a few hundred limited-doc investor loans in the negative refinance incentive buckets. Figure 5: Limited-Doc Investor Loans Have Prepaid Slower In-The-Money and Faster Out-of-the-Money Investor s-curves bucketed by doc type. Includes prime credit, no prepayment penalty, original loan size $400K-$800K, ages 6-48 months, SATO 25-125bps for the past 7yr performance period. Source: CoreLogic, RiskSpan Size Affects Refi Behavior – But Not How You Think An assumption carried over from Agency performance is that rate-driven prepays get likelier as loan size increases. This pattern holds across conforming loan sizes, but then reverses and refinance response gets flatter again as balances cross $800K. This is true for investor and owner-occupied loans in both Agency and private-label loan data, though of course the number of loans above $800K in the Agency data is small. Figure 6 shows this pattern for private-label investor loans. As shown, in-the-money prepayments are slowest among loans below $200K, as we would expect. But despite their much higher motivation to refinance, loans above $800K have similar S-curves to loans of just $200K-$400K. The SATO is generally a few basis points higher for these largest loans, but this does not explain away the speed differences. Figure 7 shows the same comparison as Figure 6 except only for loans with SATO between 50-75 bps. Except for a slightly choppier graph because of the reduced sample size, the same rank-ordering is evident. Nor does controlling for property type or geography remove the speed differences. The largest loans, we conclude, have fewer credit alternatives and/or face more stringent underwriting hurdles than smaller loans, hampering their refi rates. Rate refinances are fastest among the mid-sized loans between $400K-$600K and $600K-$800K. That these last two groups have similar S-curves – despite the greater dollar motivation to refinance for the $600K-$800Kgroup – suggests that the countervailing effect of lower ability to find refinancing outlets is already kicking in for the $600K-$800K size range. All of this means that high-balance collateral should be more attractive to investors than some traditional prepayment models will appreciate. Figure 6: The Largest Investor Loans Refinance Slower Than Medium-Sized Investor s-curves bucketed by loan size. Includes prime credit, no prepayment penalty, ages 6-48 months for the past 5yr performance period. Source: CoreLogic, RiskSpan Figure 7: Controlling For SATO, Largest Investor Loans Still Refinance Slower Than Medium-Sized Same as Figure 4 but includes only loans with SATO between 50-75 bps Source: CoreLogic, RiskSpan Preliminarily, Chimera Has Lowest Stressed Delinquencies of Top Investor Shelves For junior-tranche, credit-exposed investors in the COVID era, 60-day-plus delinquencies have been significantly rarer on Chimera’s shelf than on other top investor shelves. The observable credit mixes of the three shelves appear similar. We ran this analysis with only full-doc loans and from only one state (California), and the rank-ordering of delinquency rates by shelves remains the same. Further to this point, note that the spread at origination of Chimera’s shelf is nearly as high as Flagstar’s. All of this suggests there is something not directly observable about Chimera’s shelf that has generated better credit performance during this stressed period. We caution that differences in servicer reporting of COVID forbearances can distort delinquency data, so we will continue to monitor this performance as our data updates each month. Figure 8: Chimera Posts Lowest COVID Delinquencies, with Nearly Highest SATO of Top Investor Shelves Investor DQ60+ rates over time, bucketed by shelf. Includes prime credit, ages 12-60 months. Source: CoreLogic, RiskSpan The Greater Default Risk of Low-Doc Investor Loans Lasts About 10 Years Low-doc investors default more frequently than full-doc investors, but only during the first roughly 120 months of loan age. Around this age, the default rates converge. For loans seasoned beyond this age, full-doc loans begin to default slightly more frequently than low-doc loans, likely due to a survivorship bias. This suggests that credit investors are wise to require a price discount for new issuance with low-doc collateral. For deals with heavily seasoned collateral, junior-tranche investors may counterintuitively prefer low-doc collateral — certainly if they can earn an extra risk premium for it, as it would seem they are not actually bearing any extra credit risk. Figure 9: Low-Doc Investor Loans Default More Frequently Than Full-Doc Until Loan Age = 120 Investor default rates over time, bucketed by doc type. Includes prime credit, RMBS 2.0 era, for the past 7yr performance period. Source: CoreLogic, RiskSpan Summary Investor loans face higher barriers to refinance than owner-occupied, offering RMBS investors the opportunity to earn higher coupons for longer periods. For junior tranche investors, the credit performance of investor loans has been similar to owner-occupied loans during benign economic periods and worse during stressed times. California borrowers respond more quickly to refinance incentives than borrowers from other states; investors will prefer less California collateral. Limited-doc investor loans offer AAA investors a double benefit: slower refinances in the money, extending premium bonds; and faster turnover out of the money, limiting extension risk. Low loan balances are attractive for their slow refinance response – as are non-conforming (high) loan balances above $800K. Traditional prepay models may miss this latter dynamic. For credit investors, Chimera’s delinquency rates have been significantly better during the pandemic than other investor shelves. We will continue to monitor this as different ways of reporting COVID forbearances may confound such comparisons. For credit investors, limited-doc investor loans default at higher rates than full-doc loans for about the first ten years of loan age; after this point the two perform very similarly, with limited-doc loans defaulting at slightly lower rates among these seasoned loans, likely due to survivor biases. Contact Us Contact us if you are interested in seeing variations on this theme. Using Edge, we can examine any loan characteristic and generate an S-curve, aging curve, or time series.