The residential mortgage-backed securities (RMBS) market is reeling from an unfavorable interest-rate environment, which is expected to suppress private-label securities offerings for at least the rest of the year, a recent market outlook report concludes.
The private-label securities (PLS) market update from Kroll Bond Rating Agency (KBRA) places the bulk of the blame for the market’s woes on fast-rising mortgage rates, fueled by the Federal Reserve’s inflation-fighting rate bumps. Adding to market tumult, the agency notes, are the uncertainty and inflationary pressures caused by ongoing geopolitical upheaval, including the war in Ukraine.
For the year, KBRA projects RMBS issuance of $112 billion, based on the value of loan pools backing deals. It’s a significant reduction compared to KBRA’s May projection of $131 billion. The revised RMBS issuance figure, according to KBRA, “represents an 8% year-over-year decrease from 2021.”
Still, at $112 billion, the 2022 issuance total would represent the second-highest issuance level on record since the global financial crisis (GFC) some 15 years ago.
“Q1 2022 issuance totaled almost $43 billion, the second highest post-GFC quarter, and was almost two-and-a-half times above Q1 2021,” according to the July KBRA report. “But Q2 2022 closed at nearly $28 billion, or $10 billion below our expectations — with prime down 55% quarter over quarter. Nonprime was down 20% quarter over quarter, while credit risk transfers (CRT) were 14% lower in the same period.”
The report focuses on so-called “RMBS 2.0 deals,” defined as all post-GFC residential mortgage-backed securities issuance in the prime, nonprime (including non-QM) and CRT spaces — the latter typically issued by the government-sponsored enterprises.
KBRA projects PLS issuance in this year’s third quarter will be about $20 billion across the prime, nonprime and CRT segments — down from its May estimate of $29 billion. The decline is attributed to “rising interest rates and an unfavorable spread environment for issuers,” the report states.
“The prime sector saw the sharpest quarter-over-quarter issuance decline, reaching only $9 billion in the second quarter (actual),” the KBRA report continues. “With inflation rates remaining historically elevated, accompanied with prolonged geopolitical uncertainty, we expect RMBS issuance volumes through [the second half of] 2022 to be affected by the unfavorable issuance conditions, as the Federal Reserve continues its efforts to stabilize the economy.”
Compared to 2021, PLS volume in the second and third quarters of 2022 will be down by $20 billion, or 43%; and $21 billion, or 51%, respectively, the report forecasts.
“We expect prime sector issuance to decline in 2022, mainly due to sharp interest rate increases that have decreased overall mortgage production and increased extension risk [a reduction in refinancing],” the report states. It also concludes existing market conditions are likely to decease the “attractiveness of PLS as a financing outlet.”
Keith Lind, CEO of Acra Lending, a leading non-QM lender, said tapping the PLS market as a liquidity channel has been a challenge in 2022 for many lenders — especially for nonbanks trying to digest a lot of lower-rate loans that have essentially been “orphaned by the market.”
During the height of the refi boom and earlier this year, scores of loans were originated at interest rates much lower than current rates, which have risen dramatically in recent months. Many of those lower-rate loans were still winding their way through the securitization pipeline in 2022 because most loans have several months of seasoning before being securitized.
However, the mismatch between those lower-rate mortgages — typically in the 3% range, and more current higher-rate loans, now hovering around 5.5%, — has distorted execution and pricing in the secondary mortgage market. That’s the case even though the lower-rate loans are widely considered well-underwritten, quality loans.
In fact, a recent PLS bond-performance report by KBRA shows the yield for both prime and nonprime PLS issuance, as measured by the weighted average coupon (WAC), fell below conforming mortgage rates, as of June 2022. For the prime sector, the WAC, as of June 2022, stood at 3.36%, according to the KBRA report. That’s down slightly from January’s mark of 3.44%. The WAC for nonprime mortgages, which are deemed riskier credits than prime loans, stood at 5.44% in June, KBRA data show, compared with the January average coupon of 5.87%.
“Investors are not jumping to buy [PLS] bonds backed by [lower-rate] coupons that can’t even cover the coupon [rate investors demand] on the bonds,” Lind, from Acra, explained. He said Acra has aggressively raised its rates this year to avoid getting caught on the wrong side of the interest-rate curve.
“The loan coupon is so low [on some PLS deals] that it can’t even cover the coupon on the bonds and securitization [costs],” Lind said. “So, I think that’s going to be difficult for those wanting to securitize [these lower-rate loans] because they don’t seem to be received very well by investors in the securitization market.”
In its May PLS market-forecast report, KBRA suggested deals backed by reverse mortgages, mortgage-servicing rights, Ginnie Mae early-buyout loans, home equity lines of credit “and other esoteric RMBS transactions” were expected to increase during the remainder of 2022 and into 2023 — “as interest rates rise further.”
The new July report raises the prospect that the PLS market could benefit greatly from the huge run-up in home equity in recent years. Single-family home prices grew at an annualized rate of 19.4 percent in the second quarter of this year, according to Fannie Mae’s most recent Home Price Index report. The Federal Reserve estimates home equity nationwide now is valued at nearly $28 trillion.
Borrowers generally have seen home equity increase in recent years, according to the KBRA report. Tapping that equity via cash-out refinances likely won’t make sense for most homeowners in the current rate environment, given the rates on such loans would be much higher than their existing loans, in most cases. However, the report says “second-lien” mortgages — such as close-end (fixed rate and term) home-equity loans and home-equity lines of Credit (HELOCs) — could be attractive options for equity-rich homeowners.
Since the global financial crisis in 2006-2007, however, there have been only five securitization deals valued in total at $900 million, which used closed-end or HELOC loans as collateral, the report states. Those deals were issued between the first quarter of 2020 and the second quarter of this year.
By contrast, “At least $185 billion in second-lien collateral was securitized pre-GFC across more than 300 private-label securitization (PLS) transactions,” according to the KBRA report. “Whether this past market serves as a useful guide for the potential second-lien market [today] is an open question.
“However, we believe that second liens remain as a potential opportunity for increased PLS issuance, and as a relatively attractive option for borrowers interested in tapping into their home equity. … The PLS market may see an influx of transactions backed by these loans if the spread environment allows.”