Leveraging Non-QM Products in a Volatile Market: A Q&A With Verus Mortgage Capital

Not all homeowners or potential buyers fall into the typical mortgage lending buckets. Whether it’s income documentation, property or loan features, or any number of other credit-benign exceptions, some creditworthy people simply do not meet conventional loan guidelines. That’s where non-agency/non-Qualified (or non-QM) mortgages come into play. These products can often fill lending gaps that aren’t always covered by standard mortgage requirements.

MBA NewsLink recently sat down with Jeff Schaefer, executive vice president of correspondent sales at Verus Mortgage Capital in Washington, D.C., a non-QM correspondent investor backed by investment firm Invictus Capital Partners, to discuss non-agency products and the challenges of today’s market.

MBA NewsLink: Verus specializes in non-agency products and was the largest securitizer of non-agency loans. What non-QM products are most popular and how do you adapt your product offerings to meet the changing market demands?

Jeff Schaefer: There are always very interesting dynamics on the origination side – higher rates, new non-QM programs popping up all the time, and so on. Non-QM loans represent a huge opportunity to serve more borrowers that fall through the traditional loan cracks.

For example, self-employed bank statement loans have always been popular, but they’ve never been bigger than they are today. DSCRs (debt service coverage ratio loans) are seeing an uptick and same with prime seconds. We’re also seeing elevated interest in second mortgages.

Second mortgages are popular today because people have a lot of equity in their homes. Closed-end second-lien mortgage programs are a great way for borrowers to capitalize on this record amount of available home equity that continues to grow across the country. ICE Mortgage Technology’s market data shows that roughly 48 million people across the U.S. have access to tappable equity, which averages to $206,000 per homeowner. That’s up from $185,000 at the same time last year. So, there is a massive amount of equity being held and sometimes folks really need it.

In general, I’ve seen that there is a broader acceptance of the entire non-agency ecosystem. In the past, people went to a broker for a non-QM loan because they already went to a bank and were turned down for a mortgage. Today, we’re seeing that those initial conversations with loan officers are sometimes leading straight to non-agency products because non-QM is just a better fit for them.

MBA NewsLink: How has the landscape of non-agency evolved over the years?

Jeff Schaefer: In the past, loans with alternative documentation were often broadly grouped together as non-QM. But the changes to the QM rule have made this differentiation less accurate. Plus, the term “non-qualified” belies the fact that these loans typically are of higher credit quality and just as thorough as the standards in the qualified loan market. That’s why we feel these loans are more accurately represented by the term non-agency 2.0.

The non-agency 2.0 market has evolved substantially over approximately the last decade, and unsurprisingly the quantity and composition of major players have evolved meaningfully in that time. Early production was dominated by so-called “credit event” borrowers who typically had experienced foreclosure or a bankruptcy at some point in the past and subsequently experienced full financial recovery, but were locked out of agency loan eligibility due to guideline restrictions.

That was quickly supplanted by bank-statement and other alternative income documentation approaches that specifically cater to self-employed borrowers. Programs for these borrowers remain a core offering in the non-agency space today, along with the aforementioned DSCR loans that can provide greater flexibility to property investors.

At any rate, despite the evolution in target borrower and funding solutions, the 2.0 space has remained unified by the commonality of extremely strong credit and underwriting standards—with borrowers across the spectrum of loan types typically having higher incomes and making larger down payments than what one would observe in the conventional space. This is a major departure from the pre-crisis conception of non-agency mortgage lending, which was dominated by below prime products.

In addition to product mix, the advent of the major rate swings in recent years catalyzed a number of operational improvements that have indurated the market to these risks and really brought stability to the top of mind among operators in the market. Some of these improvements include widespread adoption of more sophisticated hedging methods and warehouse financing terms, as well as more streamlined underwriting that shortens time to close.

Lastly, as one might expect of a growing and maturing asset class, the number and manner of investors in the space continues to expand. Today, practically all of the largest and most sophisticated money managers are active participants in securitizations backed by non-agency 2.0 collateral.

Furthermore, we are increasingly seeing investor demand beyond securitization: We note residential mortgage loans experienced the largest growth in holdings among life insurer portfolios in recent years, and this was driven in part by outright purchase of non-agency 2.0 loans.

MBA NewsLink: With an increasing number of lenders considering adding non-agency products to help them increase originations, what advice can you provide to those looking to successfully navigate the market?

Jeff Schaefer: As industry regulars are well aware, conventional market and refinances have slowed down considerably in the last few years, and I think that non-agency is a way for lenders to build and maintain healthy pipelines by reaching more consumers.

I’d say that most lenders agree the conventional and government standard programs are pretty well saturated. They are reaching the supply of borrowers and are able to satisfy the demand for those borrowers. Where originators are now finding incremental growth is on the non-agency side. They might have a particular borrower that doesn’t qualify for a conventional loan and want to try a non-QM product instead, but they don’t have a lot of experience with it–nor do they know where to start. So now they have this excess capacity and their originators want to expand their products and look for a non-delegated approach or third party to review these types of loans.

That’s where a non-agency correspondent investor, can step in. Some, like Verus, even offer non-delegated channels to help lenders review files pre-funding. More and more businesses are starting their non-QM journey and it is a catalyst for them to seek out the help of an expert. Now is a very exciting and beneficial time for lenders that are considering expanding their non-QM products.

(Views expressed in this article do not necessarily reflect policies of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to Editor Michael Tucker or Editorial Manager Anneliese Mahoney.)