Mortgage origination has fallen off a cliff since rates started rising
Mortgage originators have had a difficult time over the past year, as rates have begun rising. The increase in interest rates pretty much stopped the refinance boom in its tracks. This meant that originators have had to focus on the purchase business, which is a much more difficult channel. Refinance shops were able to put up a website, advertise the best price, and compete for business through awareness and national campaigns. The purchase business is more local and more relationship-driven, and service matters more than price.
The private label market has only begun to come back
As you can see from the graph above, government-backed mortgages have dominated the scene since the real estate bubble burst. Most mortgages are guaranteed by Fannie Mae and Freddie Mac, and the rest are primarily FHA and VA. Prior to the real estate bust, FHA loans were largely a backwater of the origination business. Their primary selling point is that they require very little money down (around 3.5%) and target lower-income and first-time homebuyers. During the real estate bubble, borrowers had numerous choices if they couldn’t scrape together the money for a downpayment. Today, those options are gone, and the only game in town is FHA/VA.
That said, the jumbo market has been strong. But these are typically low loan-to-value loans and a lucrative (albeit competitive) market for originators. So far, we’ve only seen jumbo private-label securitizations.
The non-QM opportunity
The Consumer Financial Protection Bureau promulgated a list of requirements for a mortgage to be considered a qualified mortgage (or QM). Starting January 1, the new QM rules take effect. This rule gives the originator safe harbor from being sued by the borrower if they default, provided that certain requirements are met, the biggest of which is that the debt-to-income ratio must be below 43%. In other words, the mortgage payment and all other debt service can’t be more than 43% of the borrower’s gross income. Many originators are choosing to stick with QM loans, but some are starting to look at the non-QM opportunity.
Non-QM loans would typically be useful for borrowers with sporadic income but a large amount of assets. In many ways, these are typical of the “stated income” loans of the bubble days. But the big difference is that lenders will only consider very low LTV loans (like 60% max). This ensures that the borrower has “skin in the game” and won’t choose to default.
Mortgage originators like PennyMac (PMT) and Nationstar (NSM) are looking at possibilities in the non-QM space. Right now, these loans are unsecuritizable, or at least no one has tried to do one. The only private label securitizer has been Redwood Trust (RWT), and it’s doing strictly high-quality jumbos. Once the private label market comes back, we could see some non-agency REITs like Newcastle (NCT) or Two Harbors (TWO) take an interest in non-QM securitized loans.
To learn more about how REITs are currently faring, see the Market Realist series Important takeaways from the December 2013 FOMC minutes.