Interest rates jumped more than 2 percentage points in the first quarter of 2021. This spike in rates has put many mortgage lenders in crisis mode.
Lenders saw the value of agency loans issued at lower rates – in the range of 3% – in 2021 and early January 2022 fall precipitously in the first quarter. This had a negative impact on liquidity options in the loan trading and securitization markets, as higher rate loans [above 5%] then came to market. The same soaring rate dynamics also affected non-QM lenders, with rates on these loans also rising a few points over the period, to a range of 6-7%.
“Loans that previously would move to 102 or 103 [above par] all of a sudden were selling at 99 in January, and it was a very 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 it was still a hot trade.
“Then came March, and the rates kind of continued, and it caught everyone off guard. We started to see a pretty steep drop [in loan prices for lower-rate notes] up to 90 or 91 [below par].
“…It is extremely unusual to see such a deep discount on relatively young, fully performing loans,” Toohig added.
Thomas Yoon, Chairman and CEO of a non-QM lender Excelerate Capitaladded that the housing sector in late 2021 and early 2022 was at the end of a historic refinancing boom.
“And when the margins compressed and did it so quickly [because of the spike in interest rates], everyone had to react immediately,” he said. “It’s caused industry layoffs and downsizing, downsizing, whatever you want to call it.
“It always happens after a refi boom. But the kind of unique piece this time around is that interest rates have never risen as quickly as they have in such a short time.
The good news, according to Toohig and Yoon, is that in the second quarter of 2022, so far, extreme rate volatility has eased. Both agree that the industry is not completely off the hook, given that interest rates are still much higher than in 2021 and could rise further in the coming months as the Federal Reserve continues to combat inflation by increasing its benchmark interest rate and reducing its portfolio of mortgage-backed securities.
Yet much of the low-rate mortgage paper has made its way through the system and is being replaced by higher-rate mortgages. “The hope is that we can put a whole bunch of coupons at 5.5% or 5.25% on the current rate [into the system] so we can go back to [a new normal]“, said Toohig.
“There’s still a lot of that paper out there. We’ve seen $2 billion [trade] last week alone [in late May],” he added. “So we haven’t completely cleared the deck, but we’ve had a pretty good bite in that Q1.”
Yoon said he does not expect rates to rise rapidly in the future as they did in the first quarter of the year, as the aggressive interest rate policy of the Fed and others Economic headwinds are “already supported in the market now.”
“And everyone is more inclined to the idea that market volatility and higher rates are here to stay for the rest of this year, so everyone is probably better prepared to handle the circumstances in the event that the rates are changing rapidly,” he added. “We’re a non-QM platform that owns all of our agency tickets, but you know, 85% to 90% of our production is non-QM. We are in an environment where we seek to develop and grow, even in the middle of the cycle in which we currently find ourselves.
“Non-QM is a counter-cyclical product. So when rates rise and the market compresses, non-QM becomes a hotter commodity,” Yoon added.
Non-QM lenders primarily deal in purchase loans which require much more intensive underwriting than agency loans and, once funded, must be quickly taken off the balance sheet in many cases to maintain liquidity. This is typically done through whole loan sales or private label securitizations with hedging – such as the use of third-party forward contracts that allow bulk loan sales at a future date at a pre-determined rate.
Non-QM mortgages include loans that cannot direct a government or “agency” to approve Fannie Mae Where Freddie Mac. Lenders originating from the non-QM space use alternative income documents because borrowers cannot rely on conventional payroll records or they do not fall under the agency’s credit guidelines. The pool of non-QM borrowers includes real estate investors, real estate buyers, foreign nationals, business owners, gig workers and self-employed people, as well as a small group of buyers facing credit problems, such as past bankruptcies.
Yoon said the first quarter rate crisis forced Excelerate to lay off some of its staff, “less than 5%”, but he added that most of those who were laid off have since returned to work. The company currently employs about 450 people, he added.
“We did a small resizing, probably less than 5% [of our staff], and most of them have been furloughed,” Yoon said. “Since then, we’ve brought most of those employees back, and we’re currently in expansion mode.
“We have added several senior executives to our business, and we are looking to continue the [growth] strategy [being pursued] before the market drove us crazy in the first quarter.
Part of this growth includes Excelerate’s plan to complete its inaugural private label securities transaction by the end of the year.
“We expected to do our first securitization, but instead of doing it in the third quarter, it will probably be in the fourth quarter,” Yoon said. “Also, instead of doing two [this year]we will probably only do one, simply because the volatility of the first quarter really forced us to push back part of our game plan.
“But in terms of us doing our own securitizations, that hasn’t changed. We are actively committed to doing so. Apart from the adjustment periods, our vision and our overall outlook have not changed for this year. »
Yoon said Excelerate also invests in technology to ensure the lender is at the start of the bell curve of innovation and adoption. Among the plans is an effort to develop an automated underwriting application for non-QM loans, he said. The initial version of the program is expected to launch later this year, Yoon added, and it will work more like a loan rating and qualification app – showing users who provide basic app information to which loan programs they are eligible and at what rates.
“But every phase launch [or new iteration of the app] what we will do next will integrate more and more of our AI [artificial intelligence] technology behind it all,” Yoon said. “Ultimately, this will become a front-end underwriting platform for our non-QM proprietary loans.
“As non-QM activity begins to become more commoditized and more progressive and advanced, I hope our company will be at the forefront of this.”
Yoon added that the new app will also be “built from the back end as blockchain-enabled.” He said blockchain technology enables the creation of smart contracts that cannot be forged and “technically do not require title or escrow to validate, which means blockchain can serve as a platform where” you have the seller and the buyer entering into a contract via…a smart contract that’s stored on the blockchain, and that could potentially be a game-changer, which could be done with a real estate purchase agreement or…notes [securities].”
Blockchain technology instantly links transaction records in an encrypted chain of data replicated across a network of distributed computers, creating a transparent yet indelible and authenticated cyber record, or ledger, which authorized parties can securely access. Yoon said full industry adoption of the technology is still years away, but it has the potential to transform the mortgage world.
Even though Excelerate’s Yoon sees a brighter future for the mortgage market, especially for non-QM lenders, that doesn’t mean the new normal is the same as the old. A recent private label securitization market forecast report reflects this reality.
“We continue to expect 2022 to close as a record [post-global financial crisis] year of issue, with nearly $131 billion in total [prime, non-prime and credit-risk transfer] emission,” Kroll bond rating agency states in a market forecast report released last month. “…KBRA expects Q2 2022 to close at around $38 billion and Q3 to decline further to $29 billion across prime, non-prime and credit risk transfer segments due to the rising interest rates and an unfavorable spread environment for issuers.
“…Similar themes could continue into 2023, which would further negatively impact blue chip shows. The not first [including non-QM] expected emissions from the sector are expected to increase moderately in 2023, as [rate] spreads normalize after rising precipitously [in early 2022].”
In April, as the rate crisis peaked, Yoon told HousingWire he was confident that non-QM origination volume at Excelerate would still top the lender’s $2.6 billion mark in 2021 and would be probably “north of $4 billion”. In early June, Yoon said he was still certain this year’s production will eclipse the 2021 mark, but he tempered his upward optimism a bit, indicating that Excelerate’s non-QM production in 2022 “will exceed $2.6 billion but probably [will be] less than $4 billion.
It is still growth.
“There is no question [lower-rate loans are still] being sold at a discount. That is firmly true,” Toohig added. “But I think we’ve largely solved that problem.”