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August 16, 2019  

Non-QM Prepayments Turning Off Buysiders

Bond buyers are losing patience with high prepayment levels among securitized home loans that don’t meet the Consumer Financial Protection Bureau’s “qualified-mortgage” guidelines.

While the early payment rate among non-qualified loans has broadly subsided this year, the reduction wasn’t as large as many investors hoped. And indications are that the figure could grow in the coming months.

The upshot: Only bonds from a few issuers with low prepayment levels are attracting strong demand, leading to less-optimal conditions for most others. Perhaps 10-12 investors currently buy the bulk of new offerings.

Investors tend to dislike high prepayment levels among securitized mortgages because the incoming cashflows could lead to earlier-than-scheduled principal distributions, which in turn could force the bondholders into unanticipated redeployments of capital. Typically, the senior portions of non-qualified loan deals have lives of two or three years.

What’s more, early payments can erode deals’ credit cushions by diminishing the amount of excess collateral in the asset pools. While it’s typical for prepayments to be higher for non-qualified mortgages than than other types of non-agency loans, “it’s getting to the point where I may have to stop investing in the bonds altogether if they don’t slow down,” a portfolio manager at a large insurance company said.

According to S&P, overall constant prepayment rates, or CPRs, for non-qualified loans have remained around 28% since June. In March, they were at 35%. The CPR expresses prepayments as an average annual percentage of a deal’s current asset balance. For qualified jumbo loans, that figure typically has been 5-15%.

Why is it so much higher for non-qualified mortgages? Many borrowers in the category have experienced recent foreclosures or other events that hurt their credit histories, and are using the loans temporarily before refinancing. Their motivation to refinance additionally is bolstered by higher interest rates — typically 5-13%.

By comparison, the national average fixed rate for a 30-year prime-quality mortgage was 3.9% this week, according to Bankrate. And with that figure falling, indications are that prepayments among non-qualified loans could grow in the near term as even more borrowers refinance. “Non-QM is a credit-cure product. The question is will it ever break from that mold,” another buysider said.

Buy-side resistance could limit what has been explosive growth in securitizations of non-qualified mortgages. So far in 2019, 35 issues totaling $14.4 billion have priced, versus 13 deals for $5.1 billion a year ago, according to Asset-Backed Alert’s ABS Database.