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   ARTICLE   |   From Scotsman Guide Residential Edition   |   March 2017

The New Prime Jumbo

Think big when expanding credit to deserving borrowers

The New Prime Jumbo

From a mortgage investor’s perspective, the past seven years have not been very exciting. Mortgage loan performance has been nothing but stellar for prime jumbo loans originated post crisis.  In post-crisis securitizations of newly originated prime jumbo-mortgage loans, there are less than 0.1 percent of mortgage loans that have ever been 60 days or more delinquent, according to a report from Kroll Bond Rating Agency Inc.

Unfortunately, this incredibly stable and vanilla housing-investment market continues to leave many Americans behind. Too many credit-worthy borrowers are missing a great opportunity to spread their wings and lock in interest rates at what are still historic lows. But what can be done?

Borrowers are not the only ones missing out in the current market. The unprecedented performance of post-crisis jumbo-mortgage loans suggests there are many more prudent mortgage-credit opportunities that originators, mortgage companies and investors are missing out on.

An Urban Institute report from this past December — Housing Finance at a Glance: A Monthly Chartbook — includes some prescient insights about where the market currently stands from a historical perspective. Based on the report’s credit-availability chart, if one were to assume the period from 2001 to 2004 represents a “normal” lending environment, where lenders and mortgage investors were willing to take reasonable amounts of credit risk, then it is safe to say we are currently nowhere near a normal market today.

Stifled jumbo market

Looking at post-crisis jumbo private-label securitizations to date shows how tight the standards have become. At origination, the weighted-average loan-to-value (LTV) of a jumbo loan is approximately 67 percent, the weighted-average FICO credit-report score is approximately 768, and the weighted-average debt-to-income ratio is around 31 percent, according to this past November’s Kroll Transaction Comparison file.

It’s more than obvious that people who fall just below the current extremely high standard could still be excellent borrowers. Yet there have not been many options for these consumers and, if we are being honest, nor has there been adequate interest or motivation from the industry to serve them.

Although we are almost a decade removed from the financial crisis, the wounds to the banking sector are still fresh in the eyes of bank management and regulators. Accounting and regulatory standards, along with the extremely high costs associated with servicing delinquent mortgage loans, have further incentivized banks to lend to only the very best borrowers.

In addition, because of both domestic and international post-crisis fiscal policies, bank balance sheets have ballooned, leaving them with an insatiable appetite for the asset classes they prefer, which includes super-prime jumbo loans. It is little wonder, then, that big banks, with their large stores of deposits, have come to dominate the prime jumbo market.

In fact, while the nation’s biggest banks are losing their share of mortgage origination volume, they are actually increasing their share of the jumbo market by marketing to affluent borrowers with miniscule risk of defaulting. Three banks — J.P. Morgan Chase, Wells Fargo and Bank of America — accounted for more than two-fifths of all jumbo-loan volume in the first half of 2016. The result is smaller lenders and investors are going head to head with competitors that have a seemingly insurmountable advantage.

Less-than-perfect borrowers

This scenario where big banks dominate the super-prime jumbo market actually creates a significant opportunity for smaller originators with the vision to see these dynamics and to expand their jumbo mortgage offerings. Rather than compete head to head with banks in the super-prime segment of the market — with limited margins and limited potential for expansion — small and mid-sized mortgage companies would be better served by focusing on mortgage products that fall just outside the realm of what is being offered by big banks.

One of the most obvious products originators can leverage is expanded-credit jumbo-mortgage loans. Many prudent mortgage loans can be made to borrowers with credit attributes outside of the restrictive statistics noted earlier.

Consider high-earning borrowers with FICO scores in the high 600s, for example. Perhaps a disputed medical bill has taken a borrower’s score down a notch. Other borrowers might be carrying a lot of credit because they run a business or are self-employed. These borrowers often have more than sufficient income to make mortgage payments, typically pay their debts on time and have considerable savings.

Despite the presence of healthy investor appetite, relatively few originators are taking advantage of expanded-jumbo products. 

By the sum of these factors, a prudent originator would look at such borrowers as a “safe” lending risk. There is no good reason why they should be left sitting on the sidelines. Nor should prudent borrowers be forced to sacrifice their hard-earned savings or unnecessarily delay a home purchase to come up with a 20 percent downpayment because they live in San Francisco — or another area with limited or no affordable-housing options.

What these borrowers need are more realistic and practical jumbo-mortgage options. Such programs allow a few less-than-perfect characteristics, can be offered through QM and non-QM programs, and can be obtained at 90 percent LTV with no mortgage insurance — assuming a borrower has satisfactory assets and income. These programs can serve borrowers who need loans and are willing to pay a commensurate interest rate to reflect their credit risk profile or product needs, allowing originators and investors to be compensated in a prudent and fair manner.

For originators, expanded prime-jumbo products hold tremendous benefits. As higher interest rates begin to erode refinance volumes, expanded jumbo programs represent new avenues of business growth — especially for those in high-priced markets. Plus they give originators a competitive advantage against the tight grip that large banks have in the super-prime jumbo market.

Perfect timing

Very few “bad” loans are sold in today’s market. The Dodd-Frank Act and various regulations implemented since the crisis have created a full-documentation-loan world that is effectively shielding the industry from slipping into the risky behaviors that created so much havoc a decade ago. The ability-to-repay rules have set new standards for prudent lending that further reduce the likelihood of default — plus technologies and processes exist today that can clearly and confidently document a borrower’s ability to pay a mortgage debt.

Thousands of high-income borrowers in America who would love to buy homes or refinance their current mortgages think they cannot because of misconceptions they have about their ability to qualify. Despite the presence of healthy investor appetite, relatively few originators are taking advantage of expanded-jumbo products.

This could change in the very near future, however, thanks to the emergence of programs created specifically for the less-than-perfect borrower that also can provide private-market investors with the transparency, insight and confidence they seek.

In a market starved for yield, it seems the industry is missing an obvious opportunity by allowing the jumbo sector to be perceived as unavailable to borrowers with less-than-perfect credit. The industry does these borrowers a great disservice by not expanding the credit box to match what is allowed under current regulations.

As an unprecedented refinance wave finally draws to a close, now is the time to turn to underserved areas of the market. The demand from borrowers and investors alike is undeniable. The only thing left to do is to act.


 


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