Education needed to boost non-QM lending even with patch's end

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Non-qualified mortgage originations have been on a growth spurt the last two years, growth that has been underpinned by standardization of product terminology and processes that made it easier for market participants to gain a working knowledge of the options available to them.

That growth is poised to accelerate given the expected elimination of the so-called QM patch and the attendant expansion of mortgages that would no longer achieve qualified status. But there is still some work to be done in terms of educating lenders, mortgage brokers, warehouse line providers and consumers if private-label lending is to participate in the opportunity created by the patch's demise.

There are a lot of high hopes for this market, said Perry Rahbar, the CEO of dv01, a data management and analytics company. If the patch expires "it definitely would be transformational for this market," he said. Estimates range from 15% to 33% of current conforming mortgages would fall outside those guidelines without the patch.

Last year "was the inflection point" for non-QM mortgage-backed securities issuance. In 2017, there were $3.7 billion of non-QM MBS; in 2018 that grew to $14 billion, according to Fitch Ratings. Through early June of 2019, non-QM issuance totaled $10.6 billion.

"We've seen a ton of interest from investors who've kind of been sitting on the sidelines for the past 10 years, not really looking at this stuff and really looking to get back in," Rahbar said. It is at the early stages, but "it is an exciting time for this space, for sure."

As non-QM lending "shifts a little bit more from aggregators to conduit originators and consistent flow programs, it naturally just becomes a little bit more homogeneous over time as people's programs grow," Rahbar said.

But, what is holding back third-party originators from doing more non-QM lending is a lack of knowledge about what it entailed.

When non-QM products first came on the market, each investor was doing their own design and that led to a lot of variation. And the result was a lack of understanding on how they worked, said Lisa Schreiber, NewRez senior vice president of correspondent lending.

Those initial investors "were feeling their way through," said Schreiber. "And as those products have been developed over the last six or more years, what we're finding when we look at a lot of the investors, there is a lot of similarity at this point.

"And with similarity, comes the ability for lenders or brokers or originators to understand the product a little bit more easily because they have many similar characteristics throughout the investor community."

All the lenders in the non-QM business are very focused on providing education and training to originators and warehouse lenders (who needed to understand the collateral in order to provide short-term funding for non-QM mortgages) and that is the key to getting more of this product originated.

With education, lenders and investors can properly underwrite and price these loans to compensate for the risk.

"Any time something is outside the box, we are all looking for the compensating factors," said Sadie Gurley, head of diligence services at Digital Risk. "It's what gets you comfortable that this loan is going to perform."

And that is what might be holding some potential participants back, she continued. "We're being cautious about our stamp on these loans because nobody wants the liability going back to them."

What might be a bigger influence on future participation in non-QM are how mortgage interest rate movements affect volume flow.

"We're still seeing a lot of originators — it may change now, as interest rates change, originators products change — when interest rates backed up everybody started looking to move into the non-QM space to gain market share, to get originations," Gurley said. "But now that interest rates have tightened up again and refis are back, right now there's a ton of origination jumbos coming out again. Our clients who started working on 'hey how can I get into non-QM' in the fall when they were looking for something else to do, are still working on that process."

Importantly, there is more technology being created for non-QM lenders to help direct an originator or a borrower to the right product for them, Schreiber said.

That includes making these products easier to find in the product and pricing engines that originators use.

Optimal Blue recently added filters to its PPE that allows users to better isolate non-QM and expanded credit criteria products.

The PPE has always supported non-QM and expanded criteria products, explained Bob Brandt, Optimal Blue's vice president of marketing and alliances. "What we've done is add some pretty detailed filters in our search screens, to be able isolate and adjust pricing for these expanded criteria loans and be able to display them for the 60 investors [that offer them]. Any of our clients can now adopt those programs, adopt those investors and have the price show up on the screen."

Optimal Blue is seeing 2.5 times the demand for these product types than it did 18 months ago.

"One of the challenges that our customers had was that because there weren't specific filters for these expanded criteria and non-QM products, and because they typically had higher interest rates because of the increased risk, they would generally show at the bottom of the list of rate ranked results within our product and pricing engine," said Rick Allen, vice president of business transformation. "So they really weren't seen and quite hard to find because there was no filter to pull them out, they weren't coded differently, they might have a different name."

"As the business grew," Allen continued, "we really had to find a way to make them readily accessible for the customers, to select right away and not have them at the end of the list behind all of the conventional/conforming or government products that would have a better interest rate."

The lack of standardization in the non-QM space created challenges for developing the filters. But the market is slowly moving in that direction but there never will be an entity like a Fannie or Freddie to drive it all, Allen said.

Even though each lender has its own "special sauce" when it comes to non-QM product development, "this was a great first step" toward bringing standardization, added Brandt. And that was seen by Optional Blue in working with some of the non-QM investors to build the product.

Maintaining market share in what was expected to be a rising interest rate environment peaked lender interest in non-QM products. While rates haven't moved as expected, housing finance reform is peaking originator interest in being able offer their clients a diversity of products.

"At the end of the day, the non-QM, expanded criteria market is just another example of that. They want to be able to have an offering that meets the needs of consumers when they're walking in the door that perhaps the guy down the street doesn't have," said Brandt.

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