Why private label mortgage securitization will have a strong 2024, according to one expert

March 8, 2024 10:22 AM

About 15 months ago, observers of the private label securitization business were predicting that a bad 2022 would actually be a better year than the upcoming 12-month period.

But a funny thing happened in the fourth quarter of 2023. The shift in the interest rate environment helped to drive activity because execution became an attractive option again.

That has held so far during the start of 2024. Year-to-date issuance is currently about $8 billion, a Kroll Bond Rating Agency report from Feb. 23 noted.

"We have revised our expectations for [the first quarter] to close at over $20 billion," KBRA analysts Armine Karajyan, Jack Kahan and Eric Thompson said. "While we expect non-prime and government-sponsored enterprise [credit risk transfer] issuance to remain relatively steady versus last year, we see meaningful growth in both the prime sector and in second liens."

KBRA expects second quarter issuance to also be about $20 billion. It expects full year PLS volume of $67 billion up from its previous projection of $57 billion.

But the cloud on the horizon is that the 2023 vintage is putting out a higher rate of delinquencies than older deals, a Fitch Ratings report from earlier this year said.

KBRA also noted a rise in late payments, as "RMBS 2.0 credit performance YTD 2024 has continued to show generally consistent outcomes for the prime sector; however, delinquencies have increased across the non-prime and CRT sectors. These increases are generally measured, mitigated by meaningful equity, modest monthly payments, and generally prudent underwriting practices."

Recently, National Mortgage News spoke with Vadim Verkhoglyad, vice president and head of research at dv01 (which is now owned by Fitch Group) to discuss the outlook for nonagency securitizations in the upcoming year, including issuances and performance.

The following question and answer session has been edited for length and clarity.

What are you thinking about for the private label market for 2024? We know 2023 was not a great year.

On one positive note, we've seen a pretty material compression in spreads since the third quarter of 2023. We've seen spreads on Triple A's [rated bonds] all the way down to Bs come down materially thereby making securitization execution seem a lot more attractive. Because as spreads tighten it means issuers have a little bit more profit on their residuals, which kind of creates a bit of a tailwind for future originations. So we've seen the securitization volume rolling out of the gate very hot.

Secondary trading has also come kind of very hot, especially because the volumes were not very high.

When spreads were really really wide, there really wasn't a lot of trading. We've seen a very strong start to the year. I think largely what's happening is that originators are securitizing loans that they originated in 2022, holding them in warehouses until it was economical to securitize. What remains to be seen is whether this rebound in securitization volume and securitization spreads leads to higher origination and leads originators to maybe either open up the credit box, get a little bit more, I wouldn't say aggressive, in a bad way. But more like forward thinking in terms of volume expansion rather than very minor growth.

Another thing that I know a lot of people have been focused on, certainly we have at dv01, is creating securitizations that meet the European Union standards and the U.K. standards for U.S. ABS in terms of risk retention, and in terms of cleanliness of data delivery, and having all the necessary fields in the loan tapes that are required for EC delivery by an entity. I think so far there's only been about three or four issuers that have done deals that adhere to those standards. As more issuers are able to adhere to those, that opens up an additional wave of buyer demand for their paper which again gives them further tailwinds.

The broad macro picture is that 2022 and 2023 have easily been the worst years in the limited history in the non-QM space in a lot of meaningful ways. They really are the worst years in the mortgage markets since 2008. But what is positive is that unlike 2008, 2009, we haven't seen any of the major non-QM players go out of business. We may have seen some small shops originate a little bit less or do smaller deals. But all the large lenders are still in play.

A company like Impac, which has had fits and starts because of secondary market issues, shifted totally to brokering these loans.

But they're still in business. Which is okay, but people have to adjust when you have an interest rate move like you've had in 2022 or 2023. There's no question that people have to adjust models but again, everybody's in business.

That 2022 paper was finally sold now because companies can actually offload it successfully?

That's correct. There's usually about a seven-month lag between when a loan is originated and securitized, so a nine-month lag between when a borrower starts the process and the loan is completed. When you're thinking about 2022 third quarter, fourth quarter originations, those that have been securitized in the third quarter of 2023, and maybe the fourth quarter, because spreads were particularly great.

At this point when we think of the 2022 paper, the stuff that is low interest rate, the stuff that they originated in late 21, or early mid 2022 that had a 4%, 5%, 6%, 6.5% weighted average coupon that couldn't be sold, that's all gone. They've gotten that off the books. That's either been sold, securitized or [disposed of in] some mixture thereof.

At this point, they're only dealing in loans that are pretty close to in the money on securitization, which is now more economical, so they're no longer facing that issue of they originated loans before rates shot to the moon so now they're basically just selling high WAC loans to securitizations and doing so more profitably than six months ago.

So it's borrowers who have better credit but for whatever reason, they're not conforming eligible?

There's really three major flavors. Credit is one thing. They may have a good credit score, but they may have had a foreclosure within the past seven years or a bankruptcy within the past seven years. That usually disqualifies them, not formally, out of the agency markets, but informally. You don't see a lot of that in the agency market.

There's also borrowers that just don't have full documentation, that don't have a W-2 or have a variable income and they find it much easier to go the non-QM route often than the QM route and that's probably the largest universe — self-employed borrowers, small business owners.

Then you have a very large number of investor loans. Almost 40% of the non-QM universe is investor loans that don't qualify for agency execution for a number of reasons. Some of it is low debt service coverage ratio. Some of it is just the fact that the borrower has more than one property. Fannie and Freddie have a limit to the number of mortgage properties that they will allow for each new mortgagee even if the loan would otherwise qualify. But given the performance of the investor universe, it doesn't seem to be very disproportionately negative in any material sense.

To the original question about credit performance, we've seen delinquencies tick up, that's for sure. A lot of the discrepancy in performance comes down to loan purpose, and the mixture of loan purpose over time explains a good deal of the difference in delinquency trends. But even with delinquencies going up, they're still going up from very low levels in the mortgage universe overall, and they're still not translating into losses. Losses in the non-QM universe remain on in aggregate [in the] single digit basis points in the universe overall and no individual deal has losses anywhere above half a percent.

We're hearing that CRE and other asset classes are having a lot of problems right now. But we shouldn't be hearing about the same types of large-scale issues with PLS at this point, correct?

You haven't seen the mortgage market exhibit the same level of performance that you've seen in subprime auto or consumer in particular. Delinquencies are about 100-to-110 basis points up from last year. But when you factor the loan purpose and you factor certain trends, a lot of that difference kind of fades away.

Also even though you're seeing delinquencies, you're not seeing losses, and that's I think a very important thing, it's ultimately credit losses. If you have a 4% mortgage in your pool that defaults, that actually goes from delinquency to a loss and you take a 20% severity loss on it, in today's rate environment have you even lost anything?

You took a noneconomic loan that's probably would be marked-to-market and you took a 20% loss on it, but that's off your books. So what did you really lose?