Most large banks expect the Federal Reserve to start cutting rates in 2024. According to a recent survey by Bloomberg, 13 of the 18 banks surveyed expect the Fed to start cutting rates by the end of 2024, citing concerns about a potential recession as the reason for their expectations.
The housing market is facing a number of more immediate challenges, most notably current monetary policy. Federal Reserve Chairman Jerome Powell recently said that the housing market is showing signs of "picking back up", despite recent "softening", suggesting that a rate cut is not imminent. This thinking only compounds the industry's fundamental challenges, including rising interest rates, high inflation, and supply chain disruptions. They have led to a decline in home sales and a slowdown in the pace of home price appreciation.
The Federal Reserve should consider shifting to interest rate reductions, which would be a great boon for fixed income issuers.
We believe the Fed has raised rates too high, too quickly, without taking the appropriate time to observe the effects that such drastic changes will have on our economy. Additionally, the Fed will soon realize that it has made the possibility of rate cuts in the short to medium term an almost certainty due to the overzealous nature of current rate hikes and how they negatively impacting the U.S. economy, and might continue to do so.
Instead, the Federal Reserve should consider shifting to interest rate reductions, which would be a great boon for fixed income issuers. As interest rates decrease, so do prices of fixed income instruments. For fixed-income investors and issuers with callable securities this price appreciation in a lower rate environment could mean significant gains for shrewd players, especially those who participate in private label RMBS like non-QM.
The merits of non-QM assets
So here's why non-QM is the light at the end of the RMBS tunnel. Typically we would be bracing ourselves for higher delinquencies, as large companies begin to sporadically lay off workers. This isn't a major concern for the non-QM market, however, because non-QM borrowers tend to be self-employed and not beholden to the typical W2 paycheck cycle. This helps shelter the non-QM sector from the usual fallout of economic contractions.
Borrowers in the non-QM sector have more equity in their homes, making them less likely to default and walk away from their investments. This is why non-QM lenders like A&D Mortgage consider things like property values and loan-to-value ratios when determining risk. The non-QM sector pays special attention to home appraisals so that in the event of borrower default, A&D can repossess and sell real estate assets for more than (or equal to) the outstanding loan amount due. If A&D Mortgage has concerns about any aspect of the appraisal that undermines the property's market value opinion, A&D will run appraisal compliance automated valuation model (AVM), and reserves the right to reject the appraised value.
For fixed income investors and issuers with callable securities ... price appreciation in a lower rate environment could mean significant gains for shrewd players.
Non-QM borrowers usually put down 10%-30% on a new mortgage, surpassing the 5%-20% from conventional mortgage borrowers. This offers more equity "cushion" for credit investors.
Further, non-QMs are less sensitive to higher rates, partially because of a borrower base that includes self-employed individuals like entrepreneurs, small business owners, and real estate investors who are purchasing properties to rent out to tenants. Higher interest rates make home affordability very difficult for people on fixed salaries, but demand remains high among investors with buy-to-let strategies who earn income on the home's long-term price appreciation as well as monthly rental income.
Overall, non-QM RMBS provides an avenue for investors seeking exposure to mortgage-backed securities that deviate from the qualified mortgage standards. In return for the additional risk borne by non-QM RMBS investors due to the "non-qualifying" nature of the loans and bespoke income verification (Income is typically verified via 12 to 24 months of bank statements, the amount of cash available to pay down the debt, known as Debt Service Coverage Ratios (DSCR) ratios or businesses' statements of profit and loss.) investors receive a higher return than with conventional or "agency" MBS. Non-QM remains a great way to achieve exposure to the mortgage market without giving up significant yield that riskier credit assets entail.
