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March 22, 2019  

QM Impasse Threatens Agency Pullback

Mortgage-finance professionals are growing concerned that originators of non-qualified loans won’t have the capacity for an anticipated uptick in business.

At issue are the Trump Administration’s efforts to reduce the footprints of Fannie Mae and Freddie Mac, possibly by eliminating a measure that enables the agencies to buy and securitize loans that don’t meet the Consumer Financial Protection Bureau’s “qualified-mortgage” standards. Should that so-called QM Patch be removed, the expectation is that huge amounts of borrowers would turn to private-label lenders.

But many large institutional investors are unwilling to buy non-agency bonds backed by such receivables, citing weak representations and warranties. And with lenders refusing to strengthen those conditions, industry professionals believe they may lack the funding to step in for Fannie and Freddie.

The worry, in part, is that the Federal Housing Finance Agency might respond by holding off on a rollback of the QM Patch.

Indeed, major buyers of senior mortgage bonds including DoubleLine, MetLife, Neuberger Berman and Pimco have been balking at most non-qualified loan deals while telling issuers that they could be wooed with stronger representation-and-warranty frameworks, and better enforcement of those protections. So-called reps and warrants also have been a focus of the Structured Finance Industry Group’s “RMBS 3.0” initiative, which seeks to create uniformity across mortgage securitizations.

“Investors in the current non-qualified loan market are comfortable with the yield they are getting amid this good economic environment,” said Eric Kaplan, who leads the Milken Institute’s mortgage-finance program in Washington. “But the institutional investors needed to grow this market are demanding more protections.”

Sales of new non-qualified mortgage bonds are expected to grow to more than $20 billion in 2019, from $8.7 billion in 2018, amid increased output from established issuers including Angel Oak Mortgage, Deephaven Mortgage, Caliber Home Loans and Verus Mortgage. This year’s pipeline also includes first-time offerings from AIG, Goldman Sachs and Reliant Bank — with industry players predicting that supply could grow to $40 billion by 2021.

But some see that as a ceiling created by current demand, noting that far more volume would be needed to fund the non-qualified loans that currently flow to Fannie and Freddie. The upshot is a growing sense that the stalemate between issuers and investors represents something of a crisis. “If you put this into context with GSE reform, then there is a tipping point,” one source said. “In order for this non-QM market to grow past $40 billion to a much larger size, you need to get bigger investors to buy in. But that’s going to be a challenge with the current rep and warranty protections.”

Fannie and Freddie currently can buy mortgages whose borrowers have debt-to-income ratios of up to 50%, exceeding the 43% cap for qualified accounts. The QM Patch, meanwhile, spares the agencies from complying with the Dodd-Frank Act’s risk-retention rule when securitizing those accounts until 2021.

Mark Calabria, who is awaiting confirmation as FHFA chairman, is eyeing an earlier end to that exemption as part of a broader push to scale back agency lending.

Large investors have cited a number of shortcomings in the representations and warranties for today’s non-qualified loan securitizations, including a lack of automatic reviews and the absence of mechanisms that would force issuers into binding arbitration. They also are concerned about the financial wherewithal of issuers to cover losses on receivables that fail to meet the stated standards. “We agree there are weaknesses,” Fitch managing director Suzanne Mistretta said. “The frameworks have shortcomings, but we account for those in our loss expectations.”

Speaking on panels at the “SFIG Vegas 2019” in Las Vegas, representatives of several large investors including MetLife and Neuberger Berman expressed frustrations over protections for holders of non-qualified mortgage bonds. SFIG said it continues to work on matters of concern to buysiders.