"Coupons on non-QM loans are so high that there’s a lot of spread, which reduces your risk," Angel Oak CEO Sreeni Prabhu says.
Market math: "Coupons on non-QM loans are so high that there’s a lot of spread, which reduces your risk," Angel Oak CEO Sreeni Prabhu says.

There’s no shortage of banks making large mortgages to borrowers with pristine credit and plenty of liquid assets. Yet very few of these loans get bundled into collateral for mortgage bonds, putting them in the hands of capital markets investors.

Contrast this with loans to borrowers with shaky or damaged credit, which many lenders are reluctant to make, but which are far more likely to be securitized.

Overall, mortgage loan originations remained steady in the second quarter, with one- to four-family home originations up 4.5% from the prior quarter, according to the Mortgage Bankers Association.

Yet there were just six securitizations of prime, jumbo mortgages totaling $3.7 billion in the first seven months of the year, according to Fitch Ratings. One player, Two Harbors Investment Corp., has announced plans to exit the market.

The difference, according to Sreeni Prabhu, chief executive and chief investment officer of Angel Oak Capital, is that potential sponsors of prime jumbo mortgage bonds have a tough time competing for loans with banks that want to hold them on their balance sheets.

By comparison, there is much less competition to acquire subprime loans. Banks have no interest in keeping them on their books.  And the higher interest rates on these loans makes timing the market less tricky. Mortgage bonds backed by this kind of collateral can offer an attractive premium, even when prevailing interest rates are rising.

Angel Oak just completed its second securitization of mortgages that do not comply with the Qualified Mortgage rule, attracting interest from a broader array of investors, allowing it to offer lower interest rates than the firm did on its inaugural deal, completed in December 2015.

Prabhu spoke with Asset Securitization Report this week about the economics of nonprime lending, the impact of new disclosure rules, and the benefits of obtaining a credit rating. What follows is an edited transcript.

Did Angel Oak’s first securitization, in December, encourage more non-QM lending, as you hoped it would?

SREENI PRABHU: Two things happened. First, we had to create a brand new underwriting department, hire new loan officers, and re-educate underwriters, brokers and consumers, who don’t know where to go to get these loans. Second, we invested in direct-to-consumer marketing, which is pretty much rolled out. We have 200 people in the mortgage company [and] will probably double that in 2017 … so there are a lot of boots on ground.

We’re comfortable with the mortgage pipeline for this year and next year, and we have capital to deploy. We see originations rising because more people are entering the space, which is a good thing. It’s going to be private-equity-style investors, more than hedge funds, because you’ve got to build origination capability. You can’t just send out rate sheets to other originators. We don’t feel that competition will hurt because the market is at such a young state [that] more marketing is good.

Is the collateral for this deal similar to the first?

The credit quality is not very different, the [average gross] coupon came down slightly, but … that’s just a matter of coupon and the way the portfolio came together. The main theme is that there were more new investors and interest in the deal. All of the existing investors from the first deal looked at this deal, and most participated. Plus, more than 10 new investors looked at the new deal and some of that group participated, as well. It was very well received. The A-1 tranche had a coupon of 3.5%, and last time it was 4.5%. The A-2 was 4.94%, and last time it was 5.75%. That’s all in, everything priced at par. It shows the strength of this deal. It’s also important for us to consistently [come to market]; no one wants to do all that work and not have new deals coming to market. We know that if we can be a consistent issuer, it will create more lending.

There’s quite a contrast between the prime jumbo sector, where sponsors are pulling out of the market, and subprime, which is attracting new entrants. Are the economics of subprime securitization so much better?

Two things are happening in prime jumbo.

The first is the warehouse [arbitrage]. The spread for anybody providing a facility is thin, [and] you have to make sure you can turn loans over faster. You’re taking more of an interest rate risk than you are with non-QM loans. Coupons on non-QM loans are so high that there’s a lot of spread, which reduces your risk. You can time a securitization better.

Second, even if you want to originate [prime jumbo] loans, banks are coming out in front of you, so if you offer [an interest rate of] 3.5%, a bank will come in at 3 ¼ [for the same borrower]. It’s tough to compete with banks whose balance sheet funding is close to zero.

How high are coupons for non-QM loans?

Coupons are anywhere from 5.5% to 9%. In our first deal, the average gross coupon was 7 ¼, and in this second one it was 6.85%. There’s a blend between borrowers who are really good credits but just [can’t get a QM loan] and borrowers who are good credits but in times of stress lost their job and walked away from a house. Those borrowers get coupons of between 7% and 9% … which is a much better alternative than a subprime auto loan or credit card. We’re not doing hard money lending at 15%. People [with non-QM loans] are rebuilding credit and then refinancing.

How high is the prepayment rate for non-QM loans; is it higher than for QM?

In prime jumbo, refinancing is purely rate driven; rates can drop 50 basis points and people will refinance. Non-QM is not purely rate driven, and the cost of originating loans is still expensive. The refi will be there, and part of that we want, but it’s not approaching the rate of prime jumbo securitization.

Have so-called TRID mortgage-lending disclosures been a concern in the non-QM market?

TRID has been an issue for the entire industry, but it’s more around just making documents work. We went through the process with loan files and documents. … It may have slowed us [coming to market], but I don’t think so.

Are you planning to do rated deals? Are credit rating agencies willing to provide ratings on non-QM deals?

They are; a month ago one of our competitors did a rated deal. Two things are necessary: you have to get a rating for the mortgage company and the securitization itself, and our mortgage company is a newer one. We thought it would take a little more time [so we didn’t get this deal rated]. We hope to get the next deal rated. That would probably bring funding costs down by 50 to 70 basis points on the A-1 tranche.

We have enough collateral to do consistent deals, three or five, depending on timing … and liquidity. We have a lot of investors look for just whole loans; they’re either going directly to a mortgage company or coming to us to buy a package. We’ll do all of the above, but we like risk and like to keep it. In general, we don’t want to sell a whole loan package, but we’re always looking at liquidity.

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