2018 Compliance Conference Non-QM Risks &...

Presented by

2018 Compliance Conference

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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1) Non-QM Loans: Lending Outside the Box

2) Non-QM Forecasts

3) Reasons Why Lenders Should Make Non-QM Loans

4) Non-QM Risks

5) Loan Purchase Agreement Reps & Warrants

6) Non-QM Sub-Prime: Then & Now

8) Subprime Defined

9) Credit Scorers

10) FICO vs VantageScore



Agenda

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11) Historical Losses

12) New England Loss Severity

13) Foreclosure Rates & Risks

14) Your Business Model

14) Rubber Meets the Road

15) Managing Non-QM Risks

16) Risk Based Pricing

17) Where the Rubber Meets the Road

17) Non-QM Credit Policy

18) Self-Employed Credit Policy

19) Loan Pricing


without permission of MBA-NH.

Agenda

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1) I-O’s

2) Balloon Mortgages.

3) DTI > 43%

4) HPML’s: Higher Rates &/or Fees.

5) Rebuttable Presumption.

6) Subprime

8) Alt Doc/Reduced Doc



Non-QM Loans: Lending Outside The Box

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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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Forecast for 2018: $20B, mostly Subprime & Bank Statement Loans.

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

Subprime: most subprime loans now end up as FHA loans.

Strong Investor Demand despite lack of regulatory & legal precedents & case law.

Rating Agencies are back in the game with AA & AAA Ratings on PMBS.

Subprime- Majority of PMBS issuance. Alt Doc- Mixed in with Subprime pools.

Aggregators & Investors 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.



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



Explosive Growth in Non-QM PMBS Predicted for 2018.

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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).

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.



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 Orders, Consent Agreements, & Fines.

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

Plaintiff legal fees with negotiated settlements & lost suits.

Class action lawsuits. $ Millions to settle.

Financial Risk: $100,000 - $200,000 per loan to $$ Millions for Class Actions.



Risks of Non-QM

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

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

3) US Department of Justice.

4) CFPB

5) Plaintiff Bar



Regulatory & Legal Risks

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

1) AML on SISA & NINA loans. Foreign Nationals?

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

4) Predatory Lending: product & pricing.

5) QM/ATR: Rebuttable Presumption (3 C’s).

6) UDAAP: advertising & marketing practices, including Social Media.



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 or sue the Lender?



Risks: Basis for Litigation & Regulatory Action

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2) UDAAP: Unfair, Deceptive, Abusive Practices

What is the Borrower’s & Plaintiff Attorney defense or position?

May be difficult for Lenders/Servicers to defend.

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

PMBS issuers are pricing in 200 BP profit.

Loan Attributes.




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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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ATR Penalty: Non-QM Loans:

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.

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) How long am I backing this R&W?

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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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 Sales & Marketing

Angel Oaks Mortgage Solutions




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 Subprime Subprime Subprime

760 - 850: Great725 -759: Very Good660 - 724: Good560 - 659: Not Good300 - 559: Bad




DCU Credit Score Categories

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Wikipedia

641-680 A-Minus<640 Subprime




FICO vs Vantage Score

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State FICO VantageScore

CT 675 698

MA 685 706

ME 670 697

NH 686 712

RI 670 691

VT 685 713

National Average 695 699




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




New England Loss Severity 1999-2013 Origination Years*

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State Loss Severity

CT 30%

MA 29%

ME 32%

NH 30%

RI 40%

VT 27%

* Urban Institute Study February 2015




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




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?


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.

Do Not Layer Risks

Hold these loans in the bank’s portfolio.

Establish a loan loss reserve.



Your Business Model: Banks

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Review Purchase & Sale Agreement (PSA) Carefully.

Understand Your Liability for the Reps & Warrants You Make.

Evaluate Your Wholesale Partner.

Do Not Layer Risk Attributes, ie- High LTV/CLTV, Low FICO, Alt Doc (Bank

Statements) .

Establish a Loan Loss Reserve.



Your Business Model: Non-Depositories

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Risk Based Pricing: Non-QM Loans

Pricing Factors: a) FICO/LTV Matrx: 0.5% - 3% (incl A-Minus & Subprime).

b) NOO Matrix: 2.125% - 4.125%, < 75% - >80% LTV’s.

c) 2 Units: 1%, 3-4 Units: 1% - 2%.

d) Condo: 0.75%, > 75% LTV.

e) Mfg Home: 0.5%.

d) C-O Refi Matrix: 37.5 BP to 312.5 BP by LTV.

e) ARM: 25 BP > 90% LTV.

Freddie Mac Exhibit 19 Credit Fees

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Loan Pricing Using DVO1



DVO1 = discounted value of 1 BP of yield.

DVO1 = 4, 100 BP higher interest rate is equivalent to charging 4 points. 200 BP higher interest rate is equivalent to charging 8 points.

FNMA/Freddie Mac Buyup Ratio: a good proxy for the DVO1.

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Choose Your Loss Severity

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Severity Source

43% MBA National Average.

34%* National Average, Urban Institute Study, February 2015.

30%* New England Average (RI = 40%), Urban Institute Study.

* Freddie Mac Data, 1999-2013 Origination Years.




Non-QM Pledge: Thou Shall Not Layer Risks

If you push on a Credit Lever and increase risk,

you need to pull back other Credit Levers to offset that risk.

Hint: Think of the 3 C’s Risk Attributes: Credit, Capacity, & Collateral

FICO/LTV

DTI

Also Documentation Level

If you can not offset the increased Risk, you must price it into the

interest rate or add mortgage insurance (if available).

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Put on Your Risk Management Hat: Bank Statement Program

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Loan Attribute Credit Policy Value- Circle One

FICO Floor: 670, 680, 690, 700, 710, 720, 730, 740

LTV/CLTV Max: 60, 65, 70, 75, 80

Months Reserves: 3, 6, 9, 12, 15, 18

Months Bank Statements: 1, 3, 6, 9, 12, 18, 24

U/W Ratios: 28/36, 33/38, 33/40, 36/43, 43/43, 43/50

Mortgage Type: Fixed Rate, ARM- 1/1, 3/3, 5/5

Hybrid ARM or I-O ARM 5/1, 7/1, 10/1

Mortgage Term: 20, 25, 30 Yr

Origination Channel: Retail, Correspondent, Broker

Funding: Portfolio, Sold- Servicing Released




Put on Your Risk Management Hat: Sub-Prime Program

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Loan Attribute Credit Policy Value- Circle one

FICO Floor: 500, 550, 600, 610, 620, 630. 640. 650. 660

LTV/CLTV Max: 60, 65, 70, 75, 80

Months Reserves: 3, 6, 9, 12, 15, 18

Months Bank Statements: 1, 3, 6, 9, 12, 18, 24

U/W Ratios: 28/36, 33/38, 33/40, 36/43, 43/43, 43/50

Mortgage Type: Fixed Rate, ARM- 1/1, 3/3, 5/5

Hybrid ARM or I-O ARM 5/1, 7/1, 10/1

Mortgage Term: 20, 25, 30 Yr

Origination Channel: Retail, Correspondent, Broker

Funding: Portfolio, Sold- Servicing Released

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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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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mailto:[email protected]

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