As high interest rates constrain consumers' access to traditional mortgage finance options, private credit investors are virtually storming in to fill the demand for financing. For a couple of years, that shift has given non-agency, non-qualified residential mortgages a larger share of the overall residential mortgage-backed securities (RMBS) market. Now market professionals expect 2024 to be a banner year for new securitizations.
Non-agency RMBS represents one of the few opportunities available to investors to generate liquidity at scale, said Dane Smith, president of Verus Mortgage Capital (VMC), a non-QM, non-agency correspondent investor based in Washington, D.C.
Investor demand for non-agency products is hearty, too, which makes the asset class a rewarding prospecting option for non-bank lenders, especially independent mortgage banks (IMBs), Smith said. These residential mortgage loan originators, who traditionally focus on affordable housing QMs instead of riskier non-agency loans, also support future growth. IMBs lend non-agency products to high-quality, non-conventional borrowers who do not qualify for government and agency backed lending programs, he said. They are filling demand for financing as large traditional banks retreat from certain non-agency loans, due to regulatory changes enacted after the bank failures in 2023 and updates of Basel III rules.
Following the 2008-2009 financial crisis, the Basel Committee on Banking Supervision (BCBS) created the bank capital requirements framework (finalized in 2017) known as the Basel III Endgame, which regulators continue to update. Separately, after the 2023 bank crisis, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Federal Reserve jointly released additional requirements for U.S. banks with over $100 billion in assets that went into effect on Oct. 1, 2023. Megabanks must use two capital risk calculations, the standardized Basel III approach and a more sophisticated, bank-specific model, which implement lending restrictions not applicable to small size banks and non-bank lenders.
The trend, Smith says, will create attractive opportunities for private credit investors interested in both whole and securitized loans.
Shift to sustained growth
By yearend 2023 the non-QM sector was the largest non-agency RMBS subsector by issuance volume, representing 40% of the total $31 billion securitized balance, according to Invictus Capital Partners. The non-QM securitization volume reached $2.4 billion in March 2024, up an impressive 113.75%, from nearly $1.2 billion in March 2023, continuing a Q4 2023 market shift.
Earlier in 2023 non-QM interest rates peaked at 9% so the overall origination volume fell by 50%, said Victor Kuznetsov, managing director and co-founder of Imperial Fund, a Hollywood, Fla. based, non-agency mortgage investment firm. Once interest rates stabilized, both the origination and securitization volumes stabilized and the spread compression fell from 190 basis points in 2023, to 150 bps in January 2024, he said.
Unique investors
Several unique RMBS investors played a role in that growth. Verus Mortgage Capital's parent company Invictus Capital Partners, an expanded credit MBS issuer, reported $5.7 billion in non-QM/non-agency RMBS financing in 2023, surpassing J.P. Morgan Chase by $1.8 billion.
After interest rates stabilized in 2023, the Verus Mortgage Capital platform saw a 45% increase in the number of unique investors per securitization as VMC's Q1 2024 acquisitions increased 30% on a year-over-year basis, Smith said. Investors in commercial real estate debt and leveraged loans accounted for that increase.
Unlike the RMBS market, which has effectively adjusted to interest rate increases, he explained, the CMBS and CLO markets are arguably over levered and subject to debt maturity risk.
The high yield and leveraged loan markets face a maturity wall of approximately $175 billion and $300 billion over 2024 and 2025, respectively, according to Mitsubishi UFJ Financial Group, so companies may take advantage of resilient credit markets to pre-fund their maturities.
The property and casualty and life insurance sectors have minimal exposure to residential whole loans, compared to corporate and commercial real estate investments, therefore, high absolute yields, strong credit profiles, and attractive residential whole loan market pricing will persistently bring insurance companies to the sector, Smith said.
Insurance company partnerships with non-agency investors should boost non-QM securitization volumes to $45 billion in 2024, he said.
High rates continue to provide enough of a cushion to margin compression on securitizations and allow lenders to compete on the interest rate, Kuznetsov said, so non-QM lending may double compared to 2023, to about $50 billion, due to consistent demand from good credit, entrepreneurs and investors.
The loan product variable
When interest rates do not change, Kuznetsov says, the credit quality of underlying loans provides the most significant variable in non-QM securitizations.
"We are comfortable with this asset class because we only originate good loans, then service and securitize them."
Imperial's 12 to 24 months banking statements product requires 20 to 52 months of cash reserves, 730-740 FICO score, and 70% LTV, "which even in a bad economic environment should liquidate the property without incurring losses," Kuznetsov said.
Debt service coverage ratio loans with debt obligation to net operating income ratios higher than 1.25x are attracting investors, too. CoreLogic data show the Q4 volume of DSCR loan originations represented a higher share of total non-QM lending, reaching 28.7% in December 2023, and beating the 28.3%, all-time high of February 2022.
Rental property investor purchases account for 25%-30% of all residential home sales, exceeding fix-and-flip investing, said Rick Sharga, president and chief executive officer of C.J. Patrick Company, Trabuco Canyon, Calif.
Technically non-QM serves homebuyers who do not fit into the Consumer Financial Protection Bureau's rules box, he said. Today's DSCR loans substitute the traditional bridge financing borrowers typically use to purchase a property and replace with a conventional loan when tenants move in. And since originators are not capitalized enough to hold collateral on their books, the higher than usual DSCR lending volume will continue to fuel non-QM securitizations, he said.
Rental investor loans are considered riskier than conventional 30-year qualified mortgages, Sharga said, yet securitization portfolios laden with non-QM assets should not experience adverse performance issues in the near future because lenders are not taking on unnecessary risks. The 2023 average non-QM RMBS delinquency rate was just 2.8%, he said, and DSCRs are the best performing non-QM product, according to Fitch Ratings.
