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This is the uncertain future of the PLS market

Market pros responsible for assessing PLS deals see a resilient, diverse market despite headwinds

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The pace of deals in the private-label securities market has started to slow as the second quarter of the year gets underway and interest rates continue their upward climb — with rising inflation and the war in Ukraine, which is impacting supply chains, helping to fuel uncertainty over the future. 

That’s what it looks like to some of the experts behind the scenes who are responsible for rating and conducting due diligence on private label securities (PLS) offerings. With that said, the pace and volume of deals in the PLS market so far this year has still outstripped last year’s market performance over the same period. 

What the future holds, however, is less certain.

“If you compare the first quarter of this year to last year, yes, the volume is still higher [this year],” said Sonny Weng, vice president and senior credit officer at ratings firm Moody’s Investors Service. “We also saw that on our end. So, generally that’s correct. I think the harder question is what will happen going forward.”

Michael Franco, CEO of third-party due-diligence review firm SitusAMC, explained that it usually takes two to three months for loans originated in the primary market to make their way through the residential mortgage-backed securities (RMBS) pipeline. “Therefore, you would expect the loans being securitized in transactions during Q1 2022 to have been largely originated during late 2021,” he explained.

But the precipitous rise in interest rates over a very short time — up 1.5 percentage points over the past three months — has made it difficult to price PLS deals in a cost-effective way for some issuers, according to Weng. The volatile rate environment affected deal volume in the first quarter of this year, even if it exceeded the mark set in 2021 over the same period. 

It is likely to continue to impact PLS deal count and volume in the second quarter, so long as rates continue to rise. That’s being driven, in large part, by the fact that many of the mortgages being pooled for PLS deals now were originated two to three months ago at rates lower than current market rates.

“We begin to notice that because there’s just too much supply in the market, and because of inflation and the expectation that the [Federal Reserve] will increase the rates, that investors were demanding a higher coupon,” Weng said. “And obviously, when your mortgage pool has a lower [interest] rate, and you also have to cover certain fees, a higher coupon translates into a higher funding cost for the issuers.

“So, we saw a couple of deals pushed [postponed] in January and February, and as time went on, more deals got pushed — and of course, the war in Ukraine didn’t help at all. Issuers either cancelled their deals or pushed the timing of the deals further down the road in hopes of better market conditions, and that will obviously have an impact on the issuance volume.”

Padma Rajagopal, also a vice president and senior credit officer at Moody’s, said the slowdown in the PLS market was not predictable. She noted that it’s a byproduct of external factors such as rapidly rising inflation and interest rates, and a brutal war in Ukraine that is exacerbating inflation because of its impact on supply chains. 

“I think the driver of this — the decisions to cancel or move some issuance to another time — is driven a lot by the volatility with respect to [interest rate] spreads, which is happening in the market due to many reasons, including the war [in Ukraine], and also because of rate movements,” Rajagopal said. “But there were still [PLS] deals that went out after pausing because maybe they [the issuers] found an investor to buy it, and it just took them more time.”

Franco added that the current rising-rate environment is likely having the greatest impact on smaller players hoping to access the PLS market.

“We expect the volatility in the market to shake out some of the less-capitalized origination entities that may have been interested in issuing PLS,” he said.  “…They don’t have the balance sheet to hold onto assets longer term if the securitization window isn’t open when they need it to be.” 

Franco said that will likely result in some smaller issuers become less active in the PLS market.

“Expected [PLS] volumes were usually being predicted in the $200 billion range [in 2022] coming from prime, non-QM, reperforming/non-performing [securitizations]; CRT [credit-risk transfer transactions]; single-family rental [deals]; agency investor loans and other areas,” Franco said. “Some of those projections have come down a bit over the course of March. [However,] many players still expect overall securitization volumes in the non-agency space to be $175 billion-plus for 2022.”

When rates in the housing market will stabilize is an unknown at this point, however. Weng said the market has clearly shifted to a purchase cycle as rate-and-term refinancing has declined in the face of rising rates. That, in turn, has led to an overall decline in mortgage originations, which is the collateral fuel that drives the PLS market.

Non-QM player Angel Oak Mortgage Solutions caught flak from brokers when it announced last week that it would break locks and have borrowers re-lock at current rates, instituting a new 30-day rate lock policy. The company said it was forced to make rapid adjustments to ensure liquidity in a highly volatile market.

“The sharp rise of the 2-year swap rate along with the rapid increase in credit spreads of the securitization market have led to an unusually fast increase in non-QM rates that the industry has not seen before,” an Angel Oak spokesperson said. 

“The 30-year fixed mortgage rate increased for the fourth consecutive week to 4.90% [as of the first week of April] and is now more than 1.5 percentage points higher than a year ago,” said Joel Kan, associate vice president of economic and industry forecasting for the Mortgage Bankers Association. “As higher rates reduce the incentive to refinance, [mortgage] application volume dropped to its lowest level since the spring of 2019. The refinance share of all applications dipped to 38.8%, down from 51% a year ago.” 

Freddie Mac’s chief economist, Sam Khater, points out that rates have actually “increased 1.5 percentage points over the last three months alone,” which has increased the monthly payment for those seeking to buy a home by 20% compared to a year ago and consequently “softened purchase activity.”

Weng said that if inflation remains untamed, then potentially rates can go up even higher. “So, that’s why it’s hard to say where that stability is” at this point, he added.

“Mortgage rates have moved higher after being very low for an extended period of time, so prime rate-term refi activity will naturally slow unless something pushes rates back down again,” said Roelof Slump, managing director of U.S. RMBS at Fitch Ratings. “However, this seems unlikely given where we are in the rate cycle and against the inflation backdrop.”

Still, rates don’t have to drop for the PLS market to thrive. They just need to stay put for a while.

“Once this volatility settles out, rates could moderate somewhat, and the stabilization may also spur more activity,” Slump added. 

For example, he said “there may still be opportunity for some borrowers to credit cure and refinance into conforming or prime mortgage products, at lower coupons versus where they are today.”

And although the non-QM market, which serves non-agency borrowers, such as the self-employed, also faces challenges in a rising rate environment, Slump said “non-QM needs aren’t likely to go away.”

Franco echoed that sentiment, saying expanded-credit products — such as non-QM loans — will likely “increase as a percentage of total mortgages moving forward.”

Year to date as of the beginning of April, a total of 29 non-QM securitizations were completed or underway valued at $12 billion, compared to 17 deals valued at $4.8 billion over the first full three months of 2021, PLS data compiled by Kroll Bond Rating Agency (KBRA) show. 

An additional eight non-QM securitization offerings were active over the first three months of this year as well but didn’t show up among the deals tracked by KBRA — although they were rated by other agencies, such as Fitch Ratings. If those eight non-QM private label transactions are added into the mix, the total number of deals over the period rises to 37 valued at $15.2 billion. 

“Home prices are moving up and rates are moving up, so people will be spending a higher percentage of their income on housing, which means more loans moving into expended credit non-agency programs,” Franco said.

Rajagopal added that one sector that appears to be less affected by the current volatile rate environment is the single-family rental market, “where we are seeing more new issuers showing interest in the space.”

In fact, year to date through April 12 of this year, according deal data tracked by KBRA, there were a total of 62 prime and non-prime RMBS transactions backed by loan pools valued in total at nearly $32 billion. RMBS deals backed by investment properties accounted for 18 of those offerings valued at $8.4 billion, or a 26% share. 

In addition, over the same period, a total of seven single-family rental (SFR) offerings valued at nearly $5 billion were in the PLS pipeline — for a total of 25 investment-property deals across both sectors backed by loan pools valued in total at $13.4 billion.

In a single-family rental, or SFR, transaction, a single borrower, such as a corporation with an ownership interest in thousands of rental properties, issues securities that are backed by a single loan, which is, in turn, secured by a pool of rental-property mortgages. The typical RMBS private-label transaction, by contrast, involves issuing tranches of securities that are backed directly by a large pool of residential mortgages.

“PLS is now a diverse market, and mortgage-financing needs continue in many areas,” Franco said. 

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