The Consumer Financial Protection Bureau (CFPB) recently issued a notice regarding the possible extension of the mandatory July 1, 2021, adoption date it had set for the amendments to the Ability-to-Repay/Qualified Mortgage (QM) Rule (the new QM rule) announced on Dec. 10, 2020. According to the Feb. 23 notice, certain elements of the rule, such as the seasoning component, may be revised and/or subject to new rulemaking. We understand that the March 1, 2021, optional early adoption date for the new QM rule remains intact. While parts of the new QM rule may change, and it is not clear how many market participants will choose to implement it based on the early adoption date, below we answer some frequently asked questions based on our assessment of the new rule in its proposed form.
Frequently Asked Questions
What is most notable about the new QM rule?
We believe a resolution to the Government-Sponsored Enterprise (GSE) Patch (the temporary QM patch) will be the new QM rule's greatest impact on U.S. mortgage markets. The new rule reflects two main changes to the current rule: the move away from a debt-to-income (DTI) ratio threshold to a spread over the Average Prime Offer Rate (APOR), which designates a loan as QM (specifically, a spread less than 225 basis points [bps]), and the removal of Appendix-Q, which is the current template for calculating income and debt.
In recent years, there has been some concern over which entities would fund mortgages with DTI ratios above 43% if the GSEs (Fannie Mae and Freddie Mac) no longer acquire these loans. The GSEs finance more than half of the roughly $10 trillion U.S. residential mortgage market, and loans with DTI ratios over 43% can make up about one-quarter of the GSE financed amounts. Other market participants, such as the Federal Housing Administration (FHA) and non-agency origination channels, could fund these loans if the temporary QM patch were to expire and the 43% limit remained intact. However, those channels are not deep enough to absorb the entire demand, and FHA and non-agency loan pricing may not be as advantageous for consumers.
The move away from the DTI ratio limit would alleviate some of these concerns because, under the new rule, the loans would not automatically become non-QM if the DTI ratio exceeds 43%. Further, because the move to a pricing metric (spread over APOR) is expected to result in uninterrupted GSE mortgage financing, credit risk transfer (CRT) issuance should also continue at the current pace or accelerate, given the strong mortgage origination (approximately $4 trillion) expected this year.
We forecast CRT issuance of approximately $20 billion this year, and around $2 billion has been issued to date. Given the potential extension of the mandatory July 1, 2021, adoption date, we believe the temporary QM patch (which the CFPB anticipates will remain in effect until the new mandatory compliance date) should leave GSE loan acquisitions relatively uninterrupted (for more details, see our general non-agency issuance forecast "U.S. Residential Mortgage And Housing Outlook: Positive Momentum Carries Into 2021," published Jan. 22, 2021).
How could the "seasoning" element of the new QM rule affect non-agency RMBS?
Mortgage loans could attain QM safe harbor status under the new QM rule if they are seasoned at least 36 months and meet certain other conditions, such as performance requirements. However, loans held in a securitization (as opposed to in a portfolio) would not count toward the 36-month seasoning period. Therefore, we would expect the "seasoned QM" component of the new rule to have a minimal impact on non-agency securitizations, especially given our understanding that the 36-month limit doesn't start until the new rule is in effect. Moreover, only first-lien, fixed-rate, fully amortizing loans with terms no more than 30-years (and other conditions) are eligible to become seasoned QM loans. This further dilutes any effect on securitization, especially in the near term. In addition, the CFPB's Feb. 23 notice indicates that the agency could revise the seasoned QM rule. Depending on the proposed amendments, this could change the impact that the new rule's seasoning component has on U.S. RMBS.
Which loan type in non-QM RMBS securitizations would be most affected?
Securitized collateral pools of nonprime, non-QM loans have typically contained either non-QM or exempt loans. Exempt loans are investor property loans (e.g., debt service coverage ratio [DSCR] loans), and their "exempt" status is primarily due to their business-purpose nature. These loans make up a meaningful portion of securitized non-QM pools, even though they are not considered non-QM. Our aggregated issuance data for the non-QM securitizations rated by S&P Global Ratings (approximately $35 billion), which predominantly include 2018–2020 issuances, reveal that exempt investor property loans represent approximately one-third of these loans, with the remainder being mostly alternative income documentation loans (e.g., bank statement loans).
As shown in chart 1 below, about half of the portfolio designated as non-QM under the current rule is due to either alternative income documentation (mostly bank statement loans) or other Appendix Q fall-outs and instances where DTI ratio over 43% was the sole factor causing the non-QM designation. These loans could have been designated as QM had they been originated under the new rule. However, the two factors that would ultimately determine whether the QM designation is met are the loan annual percentage rate (APR) over APOR spread and the originator designating the Truth in Lending Act (TILA) status as such.
About 15% of the loans in the reviewed population were non-QM, primarily due to points and fees over 3%, loan terms over 30 years, or interest-only (IO) payment features. These loans would have retained their non-QM status under the new rule. Although DTI ratio over 43% has been an important non-QM market theme, our analysis indicates that only 5%-10% of the portfolio was designated as non-QM solely due to DTI ratio over 43%. That is, a meaningful portion of loans with DTI ratio over 43% may have other features (e.g., IO payments and loan term over 30 years) that would also result in a non-QM designation.
How much of the securitized non-QM market could become QM due to the removal of Appendix-Q and the DTI ratio limit?
Under the new QM rule, loans that do not meet Appendix-Q could potentially attain QM safe harbor or rebuttable presumption status for purposes of income and liability assessment. Therefore, we analyzed the distribution of interest rates on historical non-QM loans that were non-QM solely due to DTI ratio over 43% and/or Appendix-Q fall-outs (including alternative income documentation loans) to identify how many would have mortgage APRs less than 225 bps over APOR (we used the loan interest rate as a proxy for the APR).
While chart 1 indicates that roughly half of the securitized loans in the reviewed population fall within a non-QM designation solely due to alternative income documentation, other Appendix-Q fall-outs, and/or DTI ratio over 43%, chart 2 shows that approximately two-thirds of those loans had spreads over APOR of less than 225 bps, with roughly one-third below 150 bps.
Assuming interest rate spreads over APOR remain unchanged, this suggests that approximately one-third of a typical non-QM securitization pool could be considered QM (although mostly rebuttable presumption) under the new rule. This assumes the mortgagor's income and liability underwritings fulfill the rebuttable presumption standard associated with the new rule.
How would the removal of Appendix-Q affect our credit views for loan-level income documentation underwriting?
The new QM rule removes Appendix-Q and provides for a QM safe harbor or rebuttable presumption designation, assuming other attributes are met and depending on the procedures followed for underwriting items, such as income, liabilities, and residual income. Although certain alternative income programs may now attain QM rebuttable presumption status instead of automatically falling into a non-QM designation, we don't intend to change our approach to modeling the likelihood of default as it relates to income underwriting in our credit analysis for those loans.
When assessing alternative income documentation loans, we typically increase the likelihood of default by 1.75x, 2.00x, or 2.25x, depending on the duration of the income documentation. The TILA status under the new rule could be more favorable for these loans. However, our assessment of these loans' performance still indicates inferior behavior compared to loans that meet the Appendix-Q standards or the methods that would be applicable (e.g., Fannie Mae and Freddie Mac) for attaining safe harbor status under the new rule. The change in TILA status would impact our loss given default (LGD) assessment. (For more information on our adjustment factors for alternative income loans, see "Key Factors For Assessing U.S. Non-Qualified Mortgage Bank Statement Loans," published April 10, 2019.
What is the credit impact on non-QM RMBS collateral pools?
To assess the new QM rule's impact on our credit analysis, we analyzed a hypothetical $300 million non-QM pool with a weighted average FICO score of approximately 700 and a combined loan-to-value (CLTV) ratio of approximately 73%. The average loan balance for the hypothetical pool, which we believe is representative of the average non-prime non-QM securitization, was $400,000. We also assumed the pool contains 50% alternative income documentation loans, 25% loans with DTI ratio over 43% and/or other Appendix-Q fall-outs as the sole driver of non-QM designation, and 25% ATR Exempt investor property DSCR loans. Table 1 shows an analysis of scenarios in which a portion of the pool would have a TILA status of QM rebuttable presumption under the new rule instead of a non-QM designation.
The TILA designation in our credit analysis does not directly affect our likelihood of default assessment (i.e., foreclosure frequency). But it does impact the LGD (i.e., loss severity), based on whether the loan's TILA status is QM safe harbor (for which no adjustments are made), QM rebuttable presumption, or non-QM. We estimate the likelihood of default, LGD, and loss coverage (estimated losses) at various rating levels and TILA designations (see table 1) as follows:
- Scenario 1 assumes an "as-is" TILA status (under the existing rule).
- Scenario 2 assumes that 50% of the pool changes to QM rebuttable presumption from non-QM.
- Scenario 3 assumes that 75% of the pool (all alternative income documentation, other Appendix-Q fall-outs, and DTI ratio over 43% loans) have a TILA status of QM rebuttable presumption instead of non-QM.
While the estimated losses are progressively lower under Scenarios 2 and 3 due to more loan TILA statuses moving to QM rebuttable presumption from non-QM, the change relates only to LGD because the TILA status does not directly affect our likelihood of default assessment.
|Hypothetical Non-QM Pool Under Various TILA Designations|
|Scenario 1: "as-is" hypothetical pool||Scenario 2: 50% QM rebuttable presumption||Scenario 3: 75% QM rebuttable presumption|
|Rating category||Loss coverage (%)||Foreclosure frequency (%)||Loss severity (%)||Loss coverage (%)||Foreclosure Frequency (%)||Loss severity (%)||Loss coverage (%)||Foreclosure Frequency (%)||Loss severity (%)|
What is the expected impact on non-QM loan interest rates?
Loans converting to a QM status under the new QM rule could influence mortgage loan pricing. Non-QM loans have historically carried an average interest rate premium of roughly 200 bps over the Freddie Mac survey rate (see "Factors Affecting Non-QM Mortgage Interest Rate Spreads," published Feb. 20, 2020). Although that spread has tightened over the past few years (controlling for credit attributes) because the non-QM origination and securitization markets have gained acceptance, there is some evidence that a portion of this rate premium is due to regulatory concerns that may be associated with non-QM status. We believe a pricing-based QM rule qualification that removes or reduces the regulatory concerns could over time lower the interest rates offered to borrowers and correspondingly the DTI ratio.
Chart 3 shows the historical spread of non-QM interest rates over APOR for a part of the non-QM population. The average spread and its variance have generally tightened in recent years, likely due to a move towards standardization, greater acceptance of the non-QM product, and more competition in non-QM loan origination. Spread variance, which had been within a narrow band, has increased since the first half of 2020, likely due to origination activity declining amid the COVID-19 pandemic. The new rule could result in more spread compression due to the (likely) embedded rate spread associated with the TILA status, coupled with a move to a pricing test instead of DTI ratio under the new rule. In particular, using an APR over APOR threshold instead of a DTI ratio (and the likelihood of alternative income documentation loans gaining QM status) could result in spreads for loans that would otherwise be 225 bps or more over APOR tightening such that QM status is achieved.
When will the new QM rule go into effect?
The new QM rule has an optional adoption date for applications taken on and after March 1, 2021, and a mandatory adoption date for applications taken on and after July 1, 2021, subject to the extension indicated in CFPB's Feb. 23 notice. We believe most of the U.S. mortgage market will adopt the new rule on or around the final mandatory adoption date. However, some segments, such as non-QM, could benefit from early adoption. This would likely include a QM TILA status for loans that would otherwise be non-QM due to DTI ratio over 43% and/or alternative income documentation. Either way, we believe the new rule's impact on U.S. RMBS will lag its adoption date due to the interval between the loan application, loan closing or origination, and securitization dates. That is, loans affected by the new rule will likely appear in U.S. RMBS securitizations 60–90 days, on average, after the effective adoption date.
Some market participants have been considering making changes regarding the TILA designation and reporting under the new rule. These changes include the use and implementation of different or alternate selections of income and liability underwriting methods to attain safe harbor status (e.g., Fannie Mae and Freddie Mac) with the removal of Appendix-Q. We will continue to monitor ongoing updates regarding the new rule, including any changes to the optional or mandatory adoption dates, and assess how it integrates with our methodologies and assumptions for rating U.S. RMBS.
S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
This report does not constitute a rating action.
|Analytical Contacts:||Jeremy Schneider, New York + 1 (212) 438 5230;|
|Kapil Jain, CFA, New York + 1 (212) 438 2340;|
|Sujoy Saha, New York + 1 (212) 438 3902;|
|Zhan Zhai, New York (1) 212-438-1970;|
|Research Contact:||Tom Schopflocher, New York + 1 (212) 438 6722;|
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: email@example.com.