This week, the spotlight shines on the still-contentious issue of the Qualified Mortgage (QM), and our expert on the subject is Michael Kime, chief operating officer of W.J. Bradley, headquartered in Centennial, Colo.
Q: How difficult was it preparing for QM and what has this done to your business mix?
Michael Kime: It’s fair to say that preparing for QM was a substantial effort. I don’t know that I would call it difficult exactly, but we certainly invested significant resources in the effort. Thanks to a lot of hard work and an effective organizational effort, we were able to complete our implementation ahead of schedule and were fully operational before January 2014.
Rather than focusing on QM explicitly, we decided that we must perfect our ability to document and defend Ability-to-Repay (ATR), as QM is a safe-harbor. We believe that we must always be able to defend ATR whether a loan appears to be a QM loan or not. Frankly, the more precisely we are able to manufacture loans and ensure ATR compliance, the less risk we face.
As far as business mix – our production has largely mirrored the broader market. The impact of QM has appeared to be somewhat minimal so far, largely because of the GSE exemption. More than 85% of the market is GSE- and GNMA-eligible. That is changing and we believe that we are well positioned to offer a broader product mix due in part to our QM preparation.
Q: Will you be doing Non-QM or Non-prime loans? If so, what kind?
Michael Kime: This is a loaded question. To answer directly, yes, we are working to develop a product to target “prime” credit borrowers with transactions that fall outside the safe harbor of QM. We are not currently considering originating nonprime (a.k.a. subprime) loans. We are and will continue to be very mindful to make responsible loans to responsible consumers for make-sense transactions.
That said, we believe that the GSE and government product offerings do not fully meet the needs of all consumers in the markets we serve. It is both our responsibility and an opportunity to pursue the ability to offer non-QM loans. We are working with select capital partners and plan to provide liquidity to those borrowers who may fall outside of QM eligibility.
A significant focus for us, currently, is creating the opportunity to originate loans for “prime” credit borrowers with “off-the-run” (non-typical) transactions or circumstances. A clarification: we will not be making interest-only ARMs to borrowers with 620 FICO scores and no reserves, a part-time job and DTI of 50%. However, there are deals that reasonable people would agree make sense that are not QM. Our job in this climate is to design that product and to find those customers.
Q: Are there investors interested in Non-QM? If so what kind of loans and do you think the pool will expand?
Michael Kime: Sure there are interested investors – and the number is growing. Here’s the rub – most investors are not originating firms. It is the duty of the originator to ensure that the loans provide consumers with a net-tangible benefit and that the terms and structure are not predatory.
Originators must be able to effectively navigate the regulations and be prepared to answer for their actions. There is a lot of capital looking for yield and originators could be lured down a tricky path if unprepared.
We initially believed that banks and institutional lenders would avoid non-QM loans. But making interest-only loans to high net-worth customers to be held on a balance sheet makes sense. The fact that interest-only loans are non-QM is not reason enough to lose a customer.
However, beyond on-balance sheet / portfolio executions no one really knows how non-QM loans will trade. The securitization market is inefficient and it is anyone’s guess how the rating agencies will price ATR risk. Furthermore, while there may be some that might get comfortable with how non-QM secured bonds will price, the question of pricing the I/O (the servicing and excess servicing portions of the note rate) is open ended. This means that an investor planning a securitization who is willing to pay much above PAR for a non-QM loan is taking significant execution risk.
All of this is a long way of saying: yes, there are investors. But the pool of investors will only expand once some deals get done and the question of pricing ATR and I/O can be answered. Until then, it will be a niche market likely dominated by a small group.
Q: Is there enough volume in Non-QM or nonprime to offset the sharp decline in volume that the industry is experiencing?
Michael Kime: There is always enough volume if the product and the price are right. The issue is not “are there enough deals?” but rather: can a product be designed and priced at a level where it’s attractive and useful to consumers? Production is created in the capital markets not in the primary markets. I’m quite sure that if there were liquidity for a 30-year fixed rate loan at 3% that there would be plenty of loans to fill the volume gap.
However, that’s not really what you’re asking. While we believe that there is a significant volume of responsible non-QM loans to be done, they are “off-the-run.” Therefore, they will not fill the gap. The U.S. mortgage market in 2014 will be about $1 trillion. There will not be enough liquidity or originations to add hundreds of billions of non-QM to that number.
W.J. Bradley is online at http://www.mortgagecapital.wjbradley.com.