As part of its takeaways series, DBRS Morningstar is publishing several write-ups about pertinent topics discussed at SFVegas, an industry conference for the structured finance/asset-backed securities (ABS) sector. DBRS Morningstar’s Corina Gonzalez, Senior Vice President, U.S. RMBS, moderated a panel on Tuesday afternoon about U.S. nonperforming loans (NPLs) and reperforming loans (RPLs).
The Coronavirus Disease (COVID-19) pandemic was a big credit event for the NPL and RPL market, according to JD Ballard, Vice President, RMBS Trading, at Nomura. Pools saw their delinquency rate climb up to 15% from 3% in a matter of months. However, the collateral has managed to perform well throughout the pandemic. Ballard noted that 87% of the RPLs that were in forbearance during the pandemic have now recovered, and 58% of those did not even require modifications. In addition, fewer than 1% of delinquent RPLs were liquidated with a loss. However, credit widening and recession fears have increased loss expectations; Ballard has seen investors bump up their loss expectations. For example, he said an RPL pool with a 12-month clean payment history and a 50% loan-to-value ratio (LTV) may now have a loss expectation of 100 to 120 basis points (bps), up from 70 bps.
One of the biggest challenges for the U.S. NPL and RPL market is the lack of inventory. There are fewer of these loans than there were following the 2007–08 housing crisis, when many borrowers couldn’t afford their mortgages and defaulted. “It’s been a tough market if you’re an NPL buyer,” said Bill Byrnel, Founder and Chief Executive Officer of First Lien Capital. He noted that his company has gotten most of its portfolio from competitors in the space.
However, there is an area of opportunity in the space: scratch-and-dent loans. Also known as agency kickout loans, these loans typically fall out of the government-sponsored enterprise (GSE) pools for technical reasons, per Scott Swerdloff, Partner at Dentons. Ballard said investors view these loans as second-tier collateral. They’re difficult for people to wrap their head around. Ballard noted that 40% of these loans are debt-to-income ratio miscalculations, which is less scary than appraisal problems, and the LTVs are all below 80%. Another reason these loans might fall out of the GSE pools is that the valuation tool used at origination was not exactly what the GSEs were looking for, according to Swerdloff.
Both Ballard and Swerdloff discussed how these loans have performed well, but the scratch-and-dent name still adds some stigma to them. Investors tend to avoid mortgages they believe are risky.
Looking ahead, the panelists were unsure about the outlook for NPLs and RPLs, especially when it comes to inventory.
Written by Caitlin Veno
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