Interest rates jumped by more than 2 percentage points over the first quarter of 2021. That bolt-like spike in rates put many mortgage lenders into crisis mode.
Lenders saw the value of agency loans made at lower rates — in the 3% range — in 2021 and early January 2022 drop precipitously over the course of the first quarter. That negatively affected liquidity options in both the loan-trading and securitization markets as higher-rate loans [above 5%] subsequently hit the market. The same rate-spike dynamics hit non-QM lenders as well, with rates for those loans rising a couple points over the period as well, to the 6% to 7% range.
“Loans that before would move at 102 or 103 [above par] all of a sudden were on sale at 99 in January, and that was a really hot trade,” said John Toohig, managing director of whole loan trading at Raymond James in Memphis. “And then in February 99 [the trading price] became 96, and that was still a hot trade.
“Then came March, and rates kind of kept going, and that caught everyone kind of flatfooted. We started to see a pretty precipitous drop [in loan prices for lower-rate notes] down to 90 or 91 [below par].
“… It’s exceedingly unusual to see that deep of a discount on fully performing, relatively young loans,” Toohig added.
Thomas Yoon, president and CEO of non-QM lender Excelerate Capital, added that the housing industry in late 2021 and early 2022 was at the tail end of a historic refinancing boom.
“And when the margins compressed and did so quickly [because of the spike in interest rates], everyone had to react immediately,” he said. “That caused industry layoffs and rightsizing, downsizing, whatever you want to call it.
“That always happens after a refi boom. But the kind of the unique piece of it this time was that interest rates have never risen as quickly as they went up in such a short period of time.”
The good news, according to both Toohig and Yoon, is that in the second quarter of 2022, so far, the extreme rate volatility has abated. Both agree the industry is not completely out of the woods, given interest rates are still much higher than in 2021 and may inch up further in the months ahead as the Federal Reserve continues to fight inflation by raising its benchmark interest rate and shrinking its portfolio of mortgage-backed securities.
Still, a good portion of the lower-rate mortgage paper has worked its way through the system and is being replaced by higher-rate mortgage loans. “The hope is we can put a whole bunch of 5.5% or 5.25% current rate coupons [into the system] so we can get back to [a new normal],” Toohig said.
“There is still a lot of that paper out there. We saw $2 billion of it [trade] last week alone [in late May],” he added. “So, we haven’t completely cleared the deck, but we made a pretty good bite into that In Q1.”
Yoon said he does not anticipate that rates will move upward rapidly going forward like they did over the first quarter of the year because the Fed’s aggressive interest-rate policy and other economic headwinds are “already backed into the market now.”
“And everyone is more keen to the idea that market volatility and higher rates are here to stay for the remainder of this year, so everyone’s everyone is likely prepped better to handle the circumstances in the event that the rates move rapidly,” he added. “We’re a non-QM platform that happens to have all of our agency tickets, but you know, 85% to 90% of our production is non-QM. We’re in an environment where we’re looking to expand and grow, even in the midst of the cycle that we’re in now.
“Non-QM is a counter cyclical product. So, when rates are rising, and the market is compressing, non-QM becomes a more vogue product,” Yoon added.
Non-QM lenders are dealing primarily with purchase loans that require far more intensive underwriting than agency loans and, once funded, must be moved off the balance sheet quickly in many cases to maintain liquidity. That is typically accomplished through whole loan sales or private label securitizations along with hedging — such as the use of third-party forward contracts that allow for bulk loan sales at a future date at a predetermined rate.
Non-QM mortgages include loans that cannot command a government, or “agency,” stamp through Fannie Mae or Freddie Mac. The lenders originating in the non-QM space make use of alternative-income documentation because borrowers cannot rely on conventional payroll records or they otherwise fall outside agency credit guidelines. The pool of non-QM borrowers includes real estate investors, property flippers, foreign nationals, business owners, gig workers and the self-employed, as well as a smaller group of homebuyers facing credit challenges, such as past bankruptcies.
Yoon said the Q1 rate crisis did force Excelerate to furlough some of its staff, “less than 5%,” but he added that most of those furloughed have since returned to work. The company currently employs about 450, he added.
“We did a small rightsizing, probably less than 5% [of our staff], and most of them were furloughed,” Yoon said. “We have since brought back the bulk of those employees, and we’re currently in expansion mode.
“We’ve added several senior leadership managers to our company, and we’re looking to continue the [growth] strategy [being pursued] before the market went nuts on us the first quarter.”
Part of that growth includes Excelerate’s plan to complete its inaugural private-label securities transaction by year’s end.
“We were expecting to do our first securitization, but instead of doing it in the third quarter, it will likely be in the fourth quarter,” Yoon said. “Also, instead of doing two [this year], we will likely only do one, simply because the first-quarter volatility really forced us to push back some of our game plan.
“But in terms of us doing our own securitizations, that hasn’t changed. We’re actively engaged in doing so. Outside of tweaking timelines, our overall vision and outlook hasn’t changed for this year.”
Yoon said Excelerate also is investing in technology to ensure the lender is on the front end of the innovation-adoption bell curve. Among the plans is an effort to develop an automated underwriting app for non-QM loans, he said. The initial version of the program is expected to launch later this year, Yoon added, and it will function more like a loan-pricing and qualification app — showing users who supply basic application information what loan programs they qualify for and at what rates.
“But every phase launch [or new iteration of the app] that we do thereafter will integrate more and more of our AI [artificial intelligence] tech behind it,” Yoon said. “Ultimately it will become a front-end underwriting platform for our proprietary non-QM loans.
“As the non-QM business starts to commoditize more, and get more progressive and advanced, my hope is that our company will be at the forefront of that.”
Yoon added that the new app also will “be built on the backside as blockchain-capable.” He said blockchain technology makes it possible to create smart contracts that can’t be forged and “technically don’t require a title or escrow to validate, which means blockchain can serve as a platform where “you have seller and buyer go into contract through … a smart contract that is stored in the blockchain, and that would potentially be a game changer that could be done with a real estate purchase contract or … notes [securities].”
Blockchain technology links transaction records instantly in an encrypted data chain reproduced across a network of distributed computers, creating a transparent yet indelible and authenticated cyber record, or ledger, that can be accessed securely by authorized parties. Yoon said full industry adoption of the technology is still years away, but it has the potential to transform the mortgage-lending world.
Even though Excelerate’s Yoon sees a brighter future ahead for the mortgage market, particularly for non-QM lenders, that doesn’t mean the new normal is the same as the old normal. A recent forecast report for the private-label securitization market reflects that reality.
“We continue to expect 2022 will close as a record [post-global financial crisis] issuance year, with almost $131 billon in aggregate [prime, non-prime and credit-risk transfer] issuance,” Kroll Bond Rating Agency states in a market-forecast report released last month. “… KBRA expects Q2 2022 to close at approximately $38 billion, and Q3 to decrease further to $29 billion across the prime, non-prime, and credit-risk transfer segments because of rising interest rates and an unfavorable spread environment for issuers.
“… Similar themes could continue through 2023, causing prime issuance to be negatively impacted further. The non-prime [including non-QM] sector’s expected issuance is projected to increase moderately in 2023 as [rate] spreads normalize after rising precipitously [in early 2022].”
In April, as the rate crisis was cresting, Yoon told HousingWire that he was confident non-QM origination volume at Excelerate would still exceed the lender’s 2021 mark of $2.6 billion and would likely “be north of $4 billion.” As of early June, Yoon said he was still certain production this year will eclipse the 2021 mark, but he has tempered his optimism a bit on the upside, indicating that Excelerate’s non-QM production in 2022 “will exceed $2.6 billion but likely [will be] under $4 billion.”
That’s still growth, however.
“There’s no question [lower-rate loans are still] being sold at discounts. That’s firmly true,” Toohig added. “But I think we’ve largely worked through that problem.”