[vc_row][vc_column][vc_column_text]Using RS Edge Data to Quantify the Impact of the QM Patch Expiration
A 2014 Consumer Financial Protection Bureau (CFPB) rule established that mortgages purchased by the GSEs (Fannie Mae or Freddie Mac) can be considered “qualified” even if their debt-to-income ratio (DTI) exceeds 43 percent. This provision is known as the “qualified mortgage (QM) patch” or sometimes the “GSE patch.” It has become one of the most important holdouts of the Dodd-Frank Act and an important facilitator of U.S. lending activity under looser credit standards. The CFPB implemented the patch to encourage lenders to make loans that do not meet QM requirements, but are still “responsibly underwritten.” Because all GSE loans must pass the strict standards for conforming mortgages, they are presumed to be reasonably underwritten–notwithstanding sometimes having DTI ratios higher than 43 percent.
The QM patch is set to expire on January 10, 2021. This phaseout has spawned concern over the impact both on mortgage originators and potentially on borrowers when the patch is no longer available and GSEs are less apt to purchase loans with higher DTI ratios.
We performed an analysis of GSE loan data housed in RiskSpan’s RS Edge platform to quantify this potential impact.
The Good News:
The slowdown in purchases of high-DTI loans is already occurring, which could partially mitigate the impact of the expiration of the patch.
We used RS Edge to analyze the percentage of QM loans to which the patch applies today. From 2016 through the beginning of 2019, Fannie and Freddie sharply increased their purchases of loans with DTI ratios greater than 43 percent, with these loans accounting for over 34 percent of Fannie’s purchases as recently as February 2019 and over 30 percent of Freddie’s purchases in November 2018 (see Figure 1).
Figure 1: % of GSE Acquisitions with DTI > 43 (2016 – 2019)
Our data shows, however, that Fannie and Freddie have already begun to wind down purchases of these loans. By the end of 2019, only about 23 percent of GSE loans purchased had DTI greater than 43 percent. This is illustrated more clearly in Figure 2, below.
Figure 2: % of GSE Acquisitions with DTI > 43 (2019 only)
As discussed in the December 2019 Wall Street Journal article “Fannie Mae and Freddie Mac Curb Some Loans as Regulator Reins in Risk,” the wind-down could be related to the GSE’s general efforts to hold stronger portfolios as they aim to climb out of conservatorship. However, our data suggests an equally plausible explanation for the slowdown Borrowers generally exhibit a greater willingness to stretch their incomes to buy a house than to refinance, so purchase loans are more likely than refinancings to feature higher DTI ratios. Figure 3 illustrates this phenomenon.
Figure 3: Most High-DTI Loans Back Home Purchases
The Bad News:
The bad news, of course, is that one-fifth of Freddie and Fannie loans purchased with DTI>43% is still significant. Over 900,000 mortgages purchased by the GSEs in 2019 were of the High-DTI variety, accounting for over $240 billion in UPB.
In theory, these 900,000 borrowers will no longer have a way of being slotted into QM loans after the patch expires next year. While this could be good news for the non-QM market, which would potentially be poised to capture this new business, it may not be the best news for these borrowers, who likely do not fancy paying the higher interest rates generally associated with non-QM lending.
Figure 4: % of DTI>43 Loans Sold to GSEs by Originator
We will be closely monitoring the situation and continuing to offer tools that will help to quantify the potential impact of the expiration.
 Consumer Financial Protection Bureau, July 25, 2019.[/vc_column_text][/vc_column][/vc_row]
Today, Fannie Mae and Freddie Mac begin issuing the long-awaited Uniform Mortgage-Backed Security (UMBS). The Federal Housing Finance Administration (FHFA) conceived of this new standard in its 2012 “A Strategic Plan for Enterprise Conservatorships,” which marked the start of the Single Security Initiative (the history of which is laid out in the graphic below).
RiskSpan produces FHFA’s quarterly performance reports, most recently published Wednesday, May 29, which will support the agency’s oversight of the UMBS. The FHFA uses this report to monitor prepayment performance of passthroughs issued by Fannie and Freddie. These reports provide market participants with additional transparency on prepayment behavior alignment. They also allow the FHFA to monitor and address differences in conditional prepayments rates (CPR) between the two issuers and to align programs, policies, and practices that affect the cash flows of “To-Be-Announced” (TBA)-eligible Mortgage-Backed Securities (MBS).
The importance of RiskSpan’s contributions to the FHFA’s efforts are highlighted in Bloomberg’s May 30 article, “A $4 Trillion Plan Could Make or Break Dreams of U.S. Homebuyers”.
In our last CRT Deal Monitor post, we touched on a trend we have noticed- that the number of loans being originated with less-than-standard MI coverage has been increasing. This is a trend we will be covering in a series of blog posts. The following analysis provides a historical view of the performance of loans with less than standard MI coverage, like those being originated through the Fannie Mae HomeReady and Freddie Mac HomePossible programs. Fannie Mae CAS Deals contain a steadily growing percent of UPB in the HomeReady program. While Freddie Mac does not currently include a HomePossible indicator we suspect the same trend is occurring. In the coming months Freddie Mac will add this disclosure enhancement and we will investigate.
Historical data indicates that these HomeReady loans perform just as well, if not better, than similar loans not in an affordability program (see appendix for the cohort definitions). However, this trend appears to be shifting as newer vintages with standard MI have experienced less (albeit slightly) losses than their HomeReady counterparts, though there is significantly less performance history available. The table below shows the cumulative default rate for each vintage segmented by LTV cutoffs for the HomeReady Program.
The plots below present a profile of Fannie Mae HomeReady and Standard MI cohorts via the distributions of UPB, LTV, FICO, and DTI dating back to 1999. The cohorts are similar, though the Standard MI cohort does present a slightly better credit profile. The Standard MI cohort contains more loans with <= 95% LTV, slightly higher FICOs, slightly lower DTIs, and higher average loan sizes.
All plots in this post are interactive:
- Click and drag in any of the plots to zoom on a region.
- Isolate groups by double clicking on the legend entries, and single click to add groups back in.
Cohort Characteristics Plots: To compare performance through time each cohort has been grouped by Vintage. The plot below shows the cumulative default rate based on months from origination for each Vintage MI cohort. Based on the data, the older HomeReady population has experienced a lower overall default rate vs. the same vintage with Standard MI. This effect is exaggerated for vintages originated immediately preceding the crisis and is observed consistently through 2011.
Unsurprisingly, since the Low MI cohorts experienced a lower overall default rate, they also experienced a lower cumulative net loss which is displayed for each vintage on hover. Select a single vintage from the dropdown menu or isolate vintage(s) by clicking the lines or legend.
Cumulative Default Rate Plot: Since the HomeReady population is characterized by having less than standard MI, we should expect this population to have a higher loss severity. This relationship is seen in the data and is most prominent from the 2005 vintage onward. With the exception of the 2011 vintage, the gap between severity for Low and Standard MI has grown stronger through time.
Cumulative Severity Plot: In the next installment of this series we will cover specific loss characteristics for the HomeReady and Standard MI populations, and discuss the impact of Borrower Area Median Income, which is an eligibility requirement for the HomeReady population.
Cohort Selection Criteria:
For this analysis, the historical performance of two cohorts ‘Low MI’ and ‘Standard MI’ were pulled from RiskSpan’s Edge Platform from the Fannie Mae Loan Performance Dataset. The cohorts contain approximately 800,000 and 2,1M loans respectively. The cohorts were established based on the current MI coverage requirements set by Fannie Mae, and were limited to loans with LTV > 90.1%. The matrix below shows MI coverage requirements for the HomeReady (Low MI) cohort and Standard MI cohort.
Cohort 1 – Low MI Coverage:
Cohort 2 – Standard MI Coverage:
VQI held steady for the September at 99.31 compared to 99.43 in August. There was a small increase in proportion of loans made made for cash-out refinance. However, there was a slight reduction in loans made to Investors which offset the increase. VQI below 100 indicates stricter underwriting standards compared to January 2003.
RiskSpan introduced the VQI in 2015 as a way of quantifying the underwriting environment of a particular vintage of mortgage originations. The idea is to provide credit modelers a way of controlling for a particular vintage’s underwriting standards, which tend to shift over time.
The VQI is a function of the average number of risk layers associated with a loan originated during a given month. It is computed using the loan-level historical data released by the GSEs in support of their Credit Risk Transfer initiatives (CRT data). The value is then normalized such that January 1, 2003 has an index value of 100. The peak of the index, a value of 139 in December 2007, indicates that loans issued in that month had an average risk layer factor 39% greater (i.e., loans issued that month were 39% riskier) than loan originated during 2003. In other words, lower VQI values indicate tighter underwriting standards (and vice-versa).
Build-Up of VQI
The following chart illustrates how each of the following risk layers contributes to the overall VQI:
- Loans with low credit scores (FICO scores below 660)
- Loans with high loan-to-value ratios (over 80 percent)
- Loans with subordinate liens
- Loans with only one borrower
- Cash-out refinance loans
- Loans secured by multi-unit properties
- Loans secured by investment properties
- Loans with high debt-to-income ratios (over 45%)
- Loans underwritten based on reduced documentation
- Adjustable rate loans
The following graphs illustrate how each of the VQI components have evolved over time.
Analytical and Data Assumptions
- Issuance Data for Fannie Mae and Freddie Mac.
- Loans originated more than three months prior to issuance are excluded because the index is meant to reflect current market conditions.
- Loans likely to have been originated through the HARP program, as identified by LTV, MI coverage percentage, and loan purpose are also excluded. These loans do not represent credit availability in the market, as they likely would not have been originated today if not for the existence of HARP.
- Freddie Mac data goes back to December 2005. Fannie Mae data only goes back to December 2014.
- Certain Freddie Mac data fields were missing prior to June 2008.
GSE historical loan performance data release in support of GSE Risk Transfer activities was used to help back-fill data where it was missing.
Note: The analysis in this blog post was developed using RiskSpan’s Edge Platform. The RiskSpan Edge Platform is a module-based data management, modeling, and predictive analytics software platform for loans and fixed-income securities. Click here to learn more.