Move over Fannie, the non-QM loan is in the fast lane

Rising rates and an expanding gig economy are fueling the growth of the ‘non-prime’ private-label market 

HW+ mortgage rates desk

In the world of mortgage-financing, there exists a product line defined by what it is not — non-qualified mortgage (non-QM), non-prime, non-agency or an alternative-documentation loan. 

In the secondary market, these non-QM loans are in demand this year and are expected to continue propelling the growth of private-label securitizations in the year ahead, according to Dane Smith, president of Verus Mortgage Capital.

“We expect total [private-label] issuance for 2021 to be approximately $25 billion,” said Smith, referring to the non-QM private-label securitization market. “In 2022, we forecast issuance to grow to over $40 billion.”

Through November of this year, Verus has sponsored 10 non-QM private-label securitizations valued at more than $5 billion, according to a review of bond-rating reports,

Even if the non-QM private-label market grows to $40 billion next year, that is still only a fraction of the market’s loan-origination potential. Manish Valecha, head of client solutions at Angel Oak Capital, part of Angel Oak Companies, says the non-QM market “as a percentage of the overall market is about 10% to 12% in a normalized environment” — adding that was the size of the non-QM market in the early 2000s, prior to the global financial crisis.

“That implies a market size [today] somewhere between $175 billion to maybe $200 billion,” he said. “We just see tremendous opportunity.”

Angel Oak, through its affiliates, both originates and securitizes non-QM loans. So far this year, the company has brought seven non-QM private-label deals to market valued at nearly $2.5 billion, according to bond-rating reports. 

A datasheet prepared by Kroll Bond Rating Agency that includes most, but not all, private-label deal activity through mid-November of this year shows a total of 68 non-QM securitization deals involving loans pools valued in aggregate at more than $21 billion. That’s up from 54 deals valued at nearly $18 billion for all of 2020 — a year disrupted by the emergence of the pandemic.

The universe of non-QM single-family mortgage products is broad and difficult to define in a few words, but the definition matters because a huge slice of the borrowers in this non-QM category represent the heartbeat of the U.S. economy. Within its sweep are the self-employed as well as entrepreneurs who buy single-family investment properties — and who can’t qualify for a mortgage using traditional documentation, such as payroll income. As a result, they must rely on alternative documentation, including bank statements, assets or, in the case of rental properties, debt-service coverage ratios. 

“If you look in the last 15 to 20 years, the self-employed portion of the country has been increasing every year,” said Keith Lind, executive chairman and president of Acra Lending (formerly known as Citadel Servicing). “The pandemic has only accelerated that, with more people self-employed or wanting to be entrepreneurs. That’s a huge tailwind [for the non-QM market.]

That sweet spot includes the gig economy, which represents anywhere between 11% to a third of the U.S. workforce, depending on the source of the analysis. 

Lind says Acra and other non-QM lenders are positioned well to tap into that demand and the secondary market created in its wake. He said Acra did one small non-QM loan securitization this year, valued at about $51 million, but next year he said the company is primed to do more deals and is “exploring [its] options in the securitization market.” 

Non-QM mortgages also go to a slice of borrowers facing credit challenges — such as a recent bankruptcy or slightly out-of-bounds credit scores. The loans may include interest-only, 40-year terms or other creative financing features often designed to lower monthly payments on the front-end of the mortgage — often with an eye toward refinancing or selling the property in the short-term future.

It’s important to note, however, that non-QM (or non-prime) mortgages are not the same as subprime loans, which were the high-risk, poorly underwritten — often involving minimal or no documentation — mortgages that helped spark the housing-market crash some 15 years ago. Today’s non-QM/non-prime loans are underwritten to much higher credit, income and asset standards and involve a range of buyers beyond individuals with credit dings — and even those loans must meet federal Ability to Repay rules. The pool of nonprime borrowers also includes real estate investors, property flippers, foreign nationals and business owners.

Non-QM mortgages, Lind said, include everything that cannot command a government, or “agency,” guarantee through Fannie Mae, Freddie Mac or via another government-backed loan program offered by agencies such as the Federal Housing Administration or Department of Veterans Affairs. It’s a wide and growing segment of the mortgage-finance market that is expected to grow as rising home prices, changing job dynamics and upward-sloping interest rates push more borrowers outside the agency envelope.

There are some mortgages, however, that fall in a grey area outside the agency space but also do not fit neatly into the non-QM category, such as prime jumbo loans — which otherwise meet agency lending guidelines except for their size. Also in that grey area are certain investment-property and second-home mortgages to individuals (versus to partnerships or corporate entities) that do qualify for agency guarantees — but were excluded from a Fannie Mae and Freddie Mac stamp for much of this year because of volume caps since suspended.

In fact, jumbo-loan securitizations have represented the tip of the spear in the private-label market in 2021, with private-label deal volume at $44 billion through October of this year, according to a report by loan-aggregator MAXEX. The pace of jumbo-loan securitizations in 2021 has been driven, to a large degree, by loan refinancing, however, and rising rates are expected to chill the market in 2022.

“As rates start to rise, the supply of [jumbo] loans will decrease and we will likely see less securitization volume,” the MAXEX report states.

The opposite is the case for the non-QM market, though, given a rising-rate environment, absent sharp spikes and volatility, creates opportunity for that market, both in terms of loan originations and securitizations.

“Think about all the mortgage brokers [this year] that didn’t care about non-QM and are focusing on agency and jumbo products because it is the low-hanging fruit,” Lind said. “Well, guess what? If rates go up a little bit, they will have to find new products to focus on.” 

Lind added that a “50- or 75-basis-point move” upward in rates starts to shift the market away from refinancing jumbo and agency loans and toward a greater array of purchase-loan products, such as non-QM.

“I think that’s one of the biggest tailwinds, the fact that you will have more brokers focusing on the [non-QM] product,” Lind said.

Not everything is a tailwind in the market, however. Smith of Verus Mortgage said while he believes the prospects for the non-QM market are quite strong in the year ahead, “we do see the potential for volatility in the face of the Federal Reserve’s tapering [reduction of bond purchases] and changes in interest-rate policy.”

“Despite the potential for increased volatility on the horizon,” he added, “we believe the market is mature enough to digest higher issuance effectively and continue its growth.” 

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