The mortgage market is facing a crisis today, and it’s being fueled by fast-rising interest rates.
The rate escalation started at the beginning of this year and is continuing to play out. It’s a crisis that one industry executive describes as “a situation where we have to get the pig through the belly of the python.”
The mortgage industry, really the entire economy, is coping with fast-rising inflation further aggravated by jammed-up supply chains, the escalating war in Ukraine, and the related, expanding sanctions that are whipsawing the global economy. That economic environment has led to spiking interest rates driven by a hawkish Federal Reserve policy and free-market forces — with rates up more than 1.5 percentage points since the beginning of the year and still rising.
For the sector of the mortgage market engaged in non-QM lending, the volatile rate environment is a particular challenge. 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 most 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 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.
Some non-QM lenders have parent companies in the private equity space or have affiliates organized as real estate investment trust, and some even have affiliated real estate mortgage investment conduits (REMICs). Those entities can help to buy or warehouse loans for their non-QM lending affiliates for a time to deal with a liquidity challenge. But regardless, they all face the same problem: coping with rates rising at a faster clip than the market has seen in decades.
“You got to pay the piper if you’re stuck with bad loans,” said Keith Lind, CEO of non-QM lender Acra Lending. “You have to sell at some point.”
What this rate crisis means for lenders in the non-QM space is that the loans they made at the start of the year at a lower coupon were worth less in the whole-loan or private label securitization market than the loans they funded a month or even a week later at a higher coupon rate.
“We haven’t seen rates move like this in 40 years,” Lind said. “The problem in the market right now is there’s all these distressed loan portfolios out there [composed of lower-rate loans].”
Thomas Yoon, president and CEO of Excelerate Capital, another non-QM lender, offered this anecdote to illustrate what his company and his fellow non-QM lenders are facing:
“On January 3 of this year, we put out a bulk loan offering of $150 million, and we found that that it was worth more than 50% less than what it was just a week or two earlier. …It was slightly above par [in early January] and just a few weeks earlier, I’m talking in the fourth quarter, we could have probably executed north of 103 [above par]. So, overnight, the bottom dropped out on us.”
Non-QM executives who agreed to answer questions from HousingWire about the current rate crisis stressed that the future remains uncertain. However, finally, well into April now, higher-rate loans are starting to find their way into the pipeline, some executives said, which should help lenders execute on loan trades and securitizations at better margins going forward.
Still, if rates keep rising at the same pace as during the first quarter of the year, the crisis will persist — meaning there will likely be consolidation in the non-QM space because some non-QM lenders likely will not survive the challenges.
Specifically, according to the executives who spoke with HousingWire, those most likely to drop out of the market if conditions don’t improve are the thinly capitalized smaller players or some of the larger agency lenders who only recently began to dabble in the non-QM space.
“It’s not that easy to originate [non-QM] loans, and now there’s this market risk,” said Tom Hutchens, executive vice president of production at Angel Oak Mortgage Solutions, part of non-QM-driven Angel Oak Cos. “The performance and the pricing are not guaranteed by anybody, and even hedging takes a different level of expertise.
“So, all those factors point to those two groups [the thinly capitalized and the lenders dipping their toes into the non-QM waters] that would be the most likely to maybe look in a different direction perhaps. But I do think those that can succeed during this time are going to have a leg up and be able to capture more market share.”
Like other mortgage executives interviewed, Yoon said it’s not possible to accurately predict the future course of interest rates, “so we’re kind of at this point where there is great uncertainty.” But he added that some of his sources in the market remain optimistic, even holding out the possibility that there might be a non-QM rally in the second half of the year if rate spreads stabilize.
Lind, on the other hand, though hoping for the best, is preparing for the worse, adding that his background on Wall Street has taught him that financial markets “tend to overcompensate.” That doesn’t bode well for an end to rate volatility during a time of rising inflation, a global economy under stress and a hawkish Federal Reserve with a quiver full of rate increases ready to be unleashed in the months ahead.
“That’s my fear,” Lind said. “And if that happens, it’s going to be very, very tough sledding. And you know, it’s going to make it very difficult to be to be in the space, whether you’re an agency or non-agency lender.”
Yoon added that regardless of what the future holds, one thing seems certain. We are now in a new normal.
“Financial markets are always working into the future,” he said. “And the new normal is that we’re not going to be as fat as we were last year.
“But so long as there’s price discovery and consistency [in the rate environment], as far as being able to originate non-QM and being able to run a profitable model, it’s still very viable. It’s just that we have to be OK with the fact that it’s no longer what it was before.”
HousingWire queried more than half a dozen non-QM lenders with a series of questions about the spiraling rate crisis now plaguing the housing market. Executives at six of the lenders replied, either by granting in-person interviews or via written responses. Following is a snapshot of their responses in relation to critical elements of the crisis in play. [Not all the executives responded to every question and declined comment in some cases.]
The Fed only raised rates once [so far]. The free market has driven rates to where they are. …My fear is that the market is going to overcompensate, and rates are going to keep moving up. That’s when things can get very volatile and be very painful for a lot of lenders. …Now we’re funding close to a mid-6 [percent] coupon rate, and the loans we’re locking are at 7.5 [percent], but we’re not going to fund those for another 30 days because there’s a lag from when a loan gets submitted to when it gets funded. We took the view to just take rates up really fast — Acra Lending’s Keith Lind
We do materially hedge our interest rate risk, but it is certainly difficult to hedge the combination of interest rates, mortgage extension [due to reduced refinancing] and spread-widening that originators and aggregators have had to contend with during 2022. — David Pelka, head of RMBS business and a principal at non-QM lender CarVal Investors
We see non-QM growing through the remainder of this year and into next. … Thenon-QM space has historically been a purchase-money heavy space, something we continue to see strong interest around even in a rising-rate environment. — John Keratsis, president and CEO of non-QM lender Deephaven Mortgage
“We’re not afraid to originate loans because [rates] might go up in the next month. That isn’t ourmindset at all. …I don’t I don’t think anybody’s thrown in the towel and said we’re just going to sit on the sidelines until the market settles down. This just might be the new market. — Angel Oak’s Tom Hutchens
We reacted immediately. We sold loans at par or even below because we had blocked pipelines. …The market was moving faster than you could actually change the rate in the first month and a half of this year. Our strategy was really simple. We shot our rates up a lot, anticipating where the bogey was, because we didn’t have the luxury of a parent company to carry us [and] let us ride this out. We had no idea what the market was doing at that time. No one did. It was free falling for a period of time. So that’s the strategy that we took. … Our core non-QM programs today are at a 6.5 % rate. — Excelerate Capital’s Thomas Yoon
We much prefer to focus our efforts on maximizing production during any changing rate environment. We’re confident that the non-QM sector — and Sprout in particular — will not only ride out the turbulence but outperform expected growth rates. — Shea Pallante, president of non-QM lender Sprout Mortgage
So that everyone is clear, and our customers are clear, there was no way we were not honoring rate locks. …[There was some confusion over our policy that] started with us actually trying to get a handle on old loans in our pipeline because we had loans that had been locked for, let’s say 45 days, but had no activity. So, we were trying to fully understand how many more of these legacy locks there were that had no activity, where the loan was going nowhere. And all that just kind of happened very quickly, with a lot of moving parts. But I think it’s all clear now. As of today, we offer 30-day locks, and we’re good with that. And as soon as the market levels off, then we’ll be able to look at offering extensions on those locks. — Angel Oak’s Tom Hutchens
We didn’t adjust our rate-lock period. We did adjust our extension period. We have it at 15 days as a maximum. In a rising rate environment, we don’t want extensions to continue to extend month over month. …With a 30-day lock, you can extend it up to 15 days, so you get 45 days. In a normal market, you could pay to extend it [further], but not in this market. — Excelerate Capital’s Thomas Yoon
“It’s something we’re constantly looking at. We do a 45-day lock. If you can’t get it done in 45 days, there’s different fees that we’re asking people to pay. It’s something that we’re constantly looking at. But there’s no excuses, right? Here’s what we need, [so] get us the information we need, right? We’re not looking to extend locks. It would be great if we didn’t have to do any extensions at all, and just fund the loan in a normal timeframe. — Acra Lending’s Keith Lind
SECURITIZATION & LOAN SALES
I can’t speak broadly for the industry, but we’ve acquired in excess of $500 million between loan trades and forward commitments in the last two weeks. Given our recent launch of Mill City Loans [a REMIC], we don’t have legacy coupon exposure. The securitization market is functioning, but execution is still challenging. It seems like holders of loans are doing a mix of [loan] sales, expected securitizations and locking in forward flows [future contracts] to manage through this difficult time. — CarVal Investors’ David Pelka
At Deephaven, we are very focused on our pipeline risk management, especially the associated interest rate risk. We are not a portfolio lender; however, we have established multiple exit strategies which lead into both securitization as well as whole-loan outlets. This focus on development of multiple outlets has positioned us well to adapt to evolving market conditions and not tie ourselves to a single execution strategy. …Our view is that securitization volume in Q1 was likely front-loaded to a degree as issuers generally reacted quickly to the changing interest rate/spread environment.… Overall, while volumes may be lower than where they would have been without the selloff in rates, we expect new origination volume to remain strong and that will translate into PLS [private-label securities] issuance over the course of 2022 that matches or exceeds that of 2021. — Deephaven Mortgage’s John Keratsis
Investors bids [for whole loans] were going from 104 to 103 to 102 [with par at 100]. We sold $260 million [in loans that were at a 4.5% coupon] in early February, and we got 101 for it. So, we’ve been selling loans as fast as we can. We were probably breaking even, but for me that was good because it was a big chunk of loans. … It wasn’t a month later that all these [lenders] were hung with these loans they couldn’t sell, and the bid for the same loans that we had [sold at 101] was 97 to 98.… We’re in the moving business not the storage business. People in the storage business, or who thought they were, they’re the ones that are stuck with bad loans. …I do think more and more lenders are originating at the right coupon, now. We’re starting to see [non-QM rates] well into the sixes or sevens [6% to 7% range]. — Acra Lending’s Keith Lind
We did some tactical layoffs. …I think it’s deemed a layoff if it’s 10% of your employee count, and it was it was much less than that [with around 30 or 40 people let go]. …But we didn’t make a deep knife cut and have a major layoff. …I don’t feel comfortable just growing the business until we have stable price discovery. So, when the market stabilizes, and we’re able to execute with some consistency, then we’ll go back to our strategy and start to build out again. But until then, we’re in a holding pattern. I think we’re a little north of 400 employees now. — Excelerate Capital’s Thomas Yoon
We had our biggest month in non-QM in history in March. So, we’re not we’re not paring back our staff, and we’re still hiring. It’s still a volatile market, so it’s hard to really give you a projection for all of 2022, but we haven’t stopped our hiring that we had planned for the year at this point. [Angel Oak Cos. employs about 900 people, with its lending operations accounting for the bulk of that workforce, at 766 employees, according to company officials.] — Angel Oak’s Tom Hutchens
We took our headcount [down slightly]. We were at 450, and we’re at about 400 now. So, we’re down about 50, and we’re taking a pause for now [on expanding] just to see what happens. We’re still hiring strategically for certain areas if it’s an area that we’re looking to grow. We’re looking for salespeople and specific accounting and tech positions, so we’re still hiring, but overall we’re really taking a look at everything that’s going on and making sure that we have the best people in place to be successful. — Acra Lending’s Keith Lind
[CarVal, Deephaven and Sprout executives declined to address the layoff question.]
2022 GROWTH PROSPECTS
We did $2 billion last year [in non-QM originations]. We were targeting $3.5 billion this year. If I needed to haircut that just because of the volatility, I think we’ll do $3 billion comfortably, but we’re still shooting for the $3.5 billion. — Acra Lending’s Keith Lind
I believe that the self-employed market is underserved. And whether rates are high or rates are low, it’s still an underserved market. I think the opportunity is still great for non-QM. It’s hard to predict levels of origination, but I still think we’re in a really good space. …The interest in securitization and investing in this space is still very strong. The hiccup that we’ve seen isn’t a credit issue. No one’s concerned about the [underwriting quality of] non-QM loans. It’s just that the rate environment has been so crazy. [Angel Oak’s lending operations originated about $3.9 billion in non-QM loans in 2021 and, as of late February, had projected volume of $7.5 billion in 2022, according to the company.]— Angel Oak’s Tom Hutchens
We think it has been an extremely difficult start of the year for all mortgage originators, not just non-QM lenders. Higher coupons are significantly reducing refinance volumes, and we think mortgage volume will continue to fall with higher coupons. We think market coupons for traditional non-QM should be in the 6.25% to 7.00% range. The market is gradually getting rates toward these levels and, in meantime, is working for less gain on sale margin.
We expect volume to be challenged at these rates as they will impact mortgage affordability, purchase and refinance decisions as well as compete against using cash for higher net worth borrowers. …Within non-QM specifically, we think lenders have increased rate hedging and likely are no longer originating loans at a loss. Margins are still tight for originators but won’t be anything like early 2022. Longer term, if volumes cannot be sustained, then margins will still be pressured. …We expect volumes to be materially challenged in most mortgage products this year due to higher rates, and it is difficult to see non-QM being a material exception to that. — CarVal Investor’s David Pelka
We see non-QM growing through the remainder of this year and into next. …No one has a crystal ball in terms of predicting when and at what level interest rates will normalize – but eventually they will. We are confident the non-QM market will be able to navigate this cycle for two primary reasons. 1.) There is true borrower demand, due to a significant number of self-employed borrowers, gig economy borrowers, and investment property borrowers. These are all borrowers who, despite strong credit profiles, struggle to find homeownership financing solutions through conventional offerings. And 2.) there is strong investor demand for the product via both PLS [the private label securities market] and in whole-loan form.
— Deephaven Mortgage’s John Keratsis
We expect non-QM volume to continue growing in the coming quarters as increasing rates hamper the growth of conventional-loan origination volume. …We much prefer to focus our efforts on maximizing production during any changing rate environment. We’re confident that the non-QM sector — and Sprout in particular — will not only ride out the turbulence but outperform expected growth rates. — Sprout Mortgage’s Shea Pallante
Do we think that we’re in a rising rate environment? The answer is yes. Do I think non-QM is going anywhere? Absolutely not. We didn’t hit the numbers that we wanted to hit in the first quarter of this year, but we still think really positively about this year in terms of what we can do. We have to recalibrate and re-assess that number, but I can assure you that it will be north of the $2.6 billion [in non-QM origination volume] that we did last year. We’re already on pace to eclipse that even with the gyrations we had in the first quarter. No one saw this stuff [the rate crisis] coming. It’s true. And I have to read the numbers, but I can safely say we’re probably going to be north of $4 billion for sure. — Excelerate Capital’s Thomas Yoon