The faucet turned off almost immediately for nonqualified mortgages (non-QM) this past spring. When the pandemic struck, lenders across the country pulled these products. By summer, however, many lenders had opened the tap for these loans once again.
What happened gives insight into what lenders and investors think about non-QM lending. It also speaks about the future of these products.
Non-QM lending is a type of mortgage that allows borrowers to qualify based on alternative methods of income verification. It’s also called non-agency or nonconforming lending since it is privately securitized and not guaranteed by the government or government-sponsored enterprises.
This past March, there was a flight to cash by investors as the corona-virus spread in the U.S. and businesses shut down, says Raymond Eshaghian, president and founder of Greenbox Loans Inc.
“Part of the reason that non-QM lending effectively came to a screeching halt was really due to the liquidity issue in the secondary markets,” Eshaghian says. “Bond investors, which are institutions, were uncertain of the future. I think it was a panic.”
There were no underlying problems with non-QM loans, Eshaghian says. The loans have performed well and have provided excellent returns for investors. “What happened was really unnecessary,” Eshaghian says. “It was not an indication of toxic assets, like what we saw back in 2007, 2008, when we had a market meltdown.”
The situation that occurred answered a lot of questions about non-QM products, which have been on the market for a relatively short amount of time, says Tom Hutchens, executive vice president of production for Angel Oak Mortgage Solutions. “The non-QM market really hasn’t been stressed or tested, so to speak,” Hutchens says. “And this is a pretty good test.”
Non-QM lending emerged in the aftermath of the housing crisis more than a decade ago. These loans can be useful for business owners, gig-economy workers and others who don’t receive standard paychecks but can verify their income through such things as bank statements.
Initially, this type of lending was dogged with concerns that it was just another name for subprime. But nonqualified mortgages require safeguards that the “fog-a-mirror loans” of the past housing crisis never had, Hutchens says.
These loans must still satisfy ability-to-repay requirements. Checks and balances can be done behind the scenes. Income needs to be verified. FICO-score requirements are much higher. Appraisals are done independently. And there’s more transparency and protections for investors and originators alike, Hutchens says.
When the pandemic struck, non-QM lenders were able to determine fairly quickly which borrowers were hurting and which were not. A lender might have had to tell a restaurant owner that they couldn’t do a deal now, for example, but other qualified borrowers could go forward.
“This had nothing to do at all with the loans themselves or the performance of the loans,” Hutchens says. “It wasn’t a credit issue. It was simply a virus.”
A&D Mortgage originates non-QM loans and retains servicing on some of these mortgages, says Max Slyusarchuk, the company’s founder and CEO. Non-QM loans have performed in much the same way as the conventional loans on his company’s books in terms of delinquencies, forbearance requests and borrowers resuming payments after forbearance.
I personally believe in this product even more now than I believed in it before, because there was no stress test before.
— Max Slyusarchuk, Founder and CEO, A&D Mortgage
“I personally believe in this product even more now than I believed in it before, because there was no stress test before. And right now, after the stress test, it’s behaving the same as conforming (loans),” Slyusarchuk says.
Since the start of the COVID-19 crisis, non-QM lenders have become more conservative by requiring higher FICO scores, lower loan-to-value ratios and more cash reserves, Eshaghian says. “It’s basically taking on a higher-quality borrower, if you will,” he says. “The products were getting a little bit too flexible before. It has kind of pulled back and maybe that’s not such a bad thing.”
One way to measure the size of the non-QM market is to look at the total volume that is securitized each year, which captures many but not all of these deals. This number has been growing aggressively in recent years, from $570 million in 2016 to $23 billion last year, according to Moody’s Investors Service.
The non-QM securitization market will likely be smaller next year simply due to the disruption caused by the pandemic, Slyusarchuk says. He notes that it took time to ramp up production once lenders started offering these mortgages again.
Hutchens says that Angel Oak Capital had completed five securitizations of non-QM loans totaling $1.86 billion as of early September, including four post-pandemic. Although non-QM lending is only a slice of the overall U.S. mortgage market, many lenders believe that it could grow to 10% of all originations, Hutchens says. And even though uncertainty remains in the market, passing this first stress test is a good sign for the future of non-QM lending, Hutchen says.
“We’re not going to celebrate and give high-fives yet, because there are still states that are shutting down and the virus is still a factor,” Hutchens says. “The economic impact is still to be determined but so far, so good.” ●