Is non-QM growing too fast?

The non-QM space has grown by leaps and bounds over the past few years, and non-QM securitizations have gone from practically nothing to billions of dollars in mortgage bonds this year alone. But as initial indications of delinquency rates begin to emerge, some industry watchers worry that non-QM could be growing too fast.

Lenders have packaged more than $18 billion in non-QM loans into bonds this year and sold them to investors, according to a Bloomberg report. That’s a 44% spike from last year and the most for any year since non-QM securities became common after the financial crisis.

Initial indications of the delinquency rates in non-QM bonds are starting to emerge, and they’re much higher than rates for agency loans, Bloomberg reported. For some bonds, the delinquency rate is 3%-5%, compared to the current 0.7% delinquency rate on Fannie Mae loans.

“It’s obviously disturbing this late in the cycle to see originations for these loans at the kind of level they’ve kicked up to,” Daniel Alpert, managing partner at Westwood Capital, told Bloomberg. “The housing market is not quite ready for a big infusion of this product.”

However, the non-QM bond market is still too small – just $27 billion of the $10 trillion mortgage-bond market – to cause the kind of systemic collapse that subprime bonds did when they failed during the financial crisis, Bloomberg said. Non-QM bonds are also designed to withstand rougher housing downturns than the old subprime bonds.

“It’s not the subprime we remember from 2006 to 2007,” Mario Rivera, managing director of the Fortress Credit Funds business, told Bloomberg. “It’s more of a second or third inning of non-QM. We’re getting the best collateral before the more aggressive lending comes in.”

But many market watchers expect the market for the bonds to grow. The so-called “QM Patch” – an exception to the Qualified Mortgage rule that allows Fannie Mae and Freddie Mac to approve loans with higher debt-to-income ratios than would otherwise be allowed under QM guidelines – is set to expire in 2021. When that happens, up to $185 billion in home loans annually could suddenly be considered non-QM, according to an analysis by Redwood Trust.

But some industry experts warn that even if non-QM bonds aren’t toxic, they’re still risky. Fitch Ratings told Bloomberg that the documentation many borrowers offer to qualify for non-QM loans, such as bank statements, offer only partial verification. Fitch also said that many non-QM borrowers could have unstable incomes because, for example, they own small businesses.

However, the strength in the housing market is helping support non-QM securities right now, according to Bloomberg. Investment bank Barclays said that in the event of a downturn similar to the financial crisis – when home prices fell by about 34% – it’s likely that only the lowest-rated portions of most non-QM securities would lose money.

“At least for now, credit concerns for most non-QM deals should be modest for investors who purchase the investment grade-rated classes,” Barclays strategist Dennis Lee wrote in a note.