Unqualified Loans: The Mortgage Market’s Next Big Game?
As 2016 approaches, there are signs that US homeowners have truly recovered from the 2008-2009 financial crisis. Those who were in difficulty have refinanced themselves and new buyers are entering the market. For mortgage investors, the long recovery has been an easy source of money, but to maintain yields they are now turning to unskilled loans.
?? In 2010, if you were investing with a structured credit manager who invested in mortgages, this bet was guaranteed to provide positive returns due to the amount of beta in the recovery trade, but that trade is over now ,? ? says Greg Parsons, CEO of New York-based Semper Capital Management, which specializes in $ 1.1 billion in residential and commercial mortgage-backed securities.
US mortgage delinquencies have fallen to pre-crisis levels, according to the National Delinquency Survey, ?? published Nov. 17 by the Washington-based Mortgage Bankers Association. By the end of the third quarter, the delinquency rate for mortgages on residential properties one to four units had fallen to seasonally adjusted 4.99 percent of all outstanding loans ?? the lowest since the first quarter of 2007. Meanwhile, the foreclosure starts rate has not been lower since the second quarter of 2005. These figures show that there is not much left to recover in recovery trading, therefore, investors will need to focus on new mortgages.
Parsons says ineligible mortgages ?? loans for first time buyers that banks and other traditional lenders cannot or do not want to serve ?? are the next chapter for investors. But they and borrowers will have to rethink what financing looks like, he notes.
There seem to be a lot of opportunities. A report released last year by Deutsche Bank analysts Richard Mele and Ying Shen estimated the size of the US market for unskilled mortgages at around $ 50 billion. The Deutsche report also shows that as the demand for such mortgages increases and lending formulas evolve, the unskilled market could reach up to $ 400 billion.
At present, most of the potential applicants for unskilled loans are very high net worth individuals who are in need of jumbo mortgages for their expensive homes. But unskilled borrowers could also be self-employed, working on commission, or have recently repaired their credit.
New data from Washington-based think tank, the Urban Institute, shows that while traditional lenders struggle to extend credit, liquidity remains at pre-bubble levels of the early 2000s. This means that the overall market is still healthy, as housing is experiencing robust demand. Private capital is increasingly responsible for maintaining this liquidity.
Gapstow Capital Partners, a billion dollar credit investment firm based in New York, works with a list of fund managers to build funds or create loans for non-qualifying mortgages, which include structures such as only fixed rate mortgages and interest-only loans.
Dealing with ineligible mortgages requires a certain type of expertise that many credit companies cannot easily find. To invest in these loans, managers must create their own conduits to mortgage brokers and create, store and securitize the loans. For its part, Gapstow invests as a sponsor in the funds that its affiliated managers create, and sometimes in the loans themselves.
?? Structures change, ??? says Christopher Acito, founder, CEO and CIO of Gapstow. Everything is no longer in a fund format. Other players in the space include New York-based Blackstone Group and Los Angeles-based Oaktree Capital Management.
Semper ?? s Parsons compares the evolution of the unqualified market to the dynamics between high yield bonds and quality bonds. ?? This is going to be an interesting opportunity because private capital comes into play, ?? he says. ?? Once these companies start reaping the rewards of unskilled mortgages, I find it hard to believe that the banks are not going to find a way back.
Semper’s $ 430 million MBS total return fund is up 3.9% year-to-date. Currently, nearly 70 percent of the fund’s assets are held in non-agency mortgage-backed securities, which account for over 70 percent of returns.
Parsons cites new financing structures such as peer-to-peer mortgages as one of the ways that people who need an ineligible mortgage have been able to find a loan. For example, Boston-area peer-to-peer lender National Family Mortgage has funded more than $ 350 million in mortgages between family members since 2012, according to the company’s website.
Non-bank lending platforms like Prosper Funding and LoanDepot also finance mortgages by combining lenders and borrowers. These transactions can be peer-to-peer or involve hedge funds and banks. In September, Foothill Ranch, Calif.-Based LoanDepot funded a total of $ 20.9 billion in mortgages, according to news and data provider Inside Mortgage Finance.
Other parts of the unskilled space are less new: Managers like the ones Gapstow works with are backing loans that are more like what a bank would provide. These loans and those from platforms like LoanDepot can end up in a securitized basket that is valued much like mortgage loans guaranteed by an agency.
A report by the Goldman Sachs group released in March suggested that platforms such as National Family Mortgage and LoanDepot, hedge fund lenders and other so-called shadow banks operating in the consumer debt market could make $ 11 billion in profits that banks would otherwise have on traditional lending fees over the next five years. And that’s before the potential loss of investment when investors start buying baskets of securitized loans offered by hedge funds or putting their own capital into the service of peer-to-peer lending services.
For investors, all of this activity means more options to participate in the mortgage market, but these investments will be different from traditional home loans and backed by a more diverse group of financial companies. Gapstow? S Acito and Semper ?? s Parsons believe that to be successful, participants will need to understand credit markets at a granular level or work with a manager who does. ?? Investors in this market will be better served by finding managers who can do their own credit work, ?? Parsons said. ?? The barriers to entry in the future will be complex and will require a lot of analysis.
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