Fitch: Subprime lending is re-emerging

The Scotsman Guide - Victor Whitman - 30 January 2017

The long-defunct securities market for subprime U.S. home loans has begun to re-emerge, according to Fitch Ratings. 

In the past 18 months, 10 “non-prime” securities deals totaling $1 billion were offered to investors by five issuers, the rating agency said. Meanwhile, lenders have been roughly doubling the volume of subprime home loans each year, according to the rating agency. Subprime originations have risen from near zero in 2013 to just under $3 billion in 2016, of which a percentage were securitized and the rest remained in portfolio.

Subprime loans and the risky securities backed by them were blamed in large part for the U.S. housing crisis a decade ago, and the subprime market largely evaporated after 2008.

Policy analysts, like the Urban Institute, however, say a healthy subprime market is needed so that lower-income borrowers have access to mortgages. Lenders typically won’t offer subprime loans unless they can be sold to end investors.  

Many times lower-income borrowers also don’t fit the mold set down by the guidelines in government loan programs. According to the Urban Institute, there also is a risk that the government could scale back its guarantee programs, making it harder for marginal borrowers to obtain a mortgage.

Laurie Goodman, co-director of the Urban Institute’s Housing Finance Policy Center, said subprime lending may get a boost if interest rates continue to rise, because lenders may be more inclined to go outside the standards of so-called qualified mortgages (QM), which have largely defined what kind of loan products are acceptable in today's marketplace.  

“They may look for that marginal borrower, those borrowers who are being served less well, because they don’t have this huge pipeline of refinancing,” Goodman told Scotsman Guide News. “You could see more non-QM lending, and some of that would end up in securitization, but it is still not a lot. It is not like you are going to go back to where you were in 2001 even.”  

The entire universe of private-label securities — which includes those underpinned by prime, subprime and Alt-A (Alternative-A paper) home loans — accounted for $13.7 billion in issuance volume in 2015, as opposed to $240 billion in 2001 and more than $1 trillion at the peak in 2005, the Urban Institute reported. 

Fitch expects subprime residential originations to double again in 2017, but does not expect another boom in subprime lending. The volume of subprime loans should be kept in check by the emergence of government regulators, like the Consumer Financial Protection Bureau, and rules that assured the dominance of standard QM loans, Fitch said. 

Most of the old subprime products, like interest-only loans, teaser-rate loans and no-documentation loans have disappeared. Subprime loans originated over the past two years have an average FICO credit score of 697, whereas the FICO score averaged 623 over the 10-year period through 2008, Fitch said. Other factors, like the borrowers' average debt-to-income ratios, suggest that today's subprime loans carry less risk than those originated before 2008. 

“The origination volume has roughly doubled in each of the last couple of years based on Fitch’s estimate, but volume is still very small,” said Grant Bailey, managing director of Fitch’s RMBS group, during a recent presentation.

“Even if the volume doubled again, it would represent well less than 1 percent of the precrisis volume,” Bailey said. 

The performance of subprime loans in newly issued securities has been good, Bailey said. Long-term, Fitch expects a higher percentage of under-stress subprime loans to default than prime loans, and it is doubtful that securities backed by subprime loans will achieve a AAA rating. 

Bailey also noted that the subprime sector “will be under intense scrutiny” as it evolves over the next few years.