In the 16 years since the peak of the global financial crisis, the structured products industry has transformed from a market dominated by large banks to one with room for new players. New relationships are forming between insurance companies seeking long-term fixed income investments and management companies that specialize in structuring, securitizing, and distributing mortgage-backed securities. This new movement has led many investors to look to alternative assets in search of yield, increasing interest in the non-conforming mortgage securitization space.
Non-QM loans are primarily used by entrepreneurs and other self-employed individuals who do not have the necessary documentation to qualify for a traditional Freddie and Fannie mortgage. Non-QMs are attractive because of their strong credit quality, low loan-to-value ratios, and stable originations. And it is expected that even more players will join the game next year.
Historically, life insurance companies have avoided investing in mortgages. But thanks to the influence of private equity investors, cash-rich insurance companies are increasingly attracted to private debt assets, which pay higher premiums due to their illiquidity. These premiums have risen in recent years as traditional banks have scaled back private lending activity amid regulatory pressures, consolidation, and a recent move toward wholesale financing that has spurred declines in retail deposits. are. All of this left a vacuum for insurance companies, which stepped in to fill the space and in doing so collectively become “one of the world’s largest private debt investors” (Foley-Fisher et al. , 2020, p.2) ). According to 2022 data, only 10% of private debt will be dominated by real estate debt in 2022, but much of that 10% will be directed to non-QM loans (IMF World Financial Stability Report, April 2023, p73).
Investment firms have historically been reluctant to invest in mortgages, in part because the asset class is complex and has significant operating costs. However, with the increase in non-QM loans, insurance companies tend to shift their allocations towards non-QM loans. Investors are reassured by the stricter regulatory framework created by Dodd-Frank and other post-GFC legislation. This has fostered significant growth in entrepreneurial activity in non-QM areas and has brought the sector to the fore as a highly attractive asset class for long-term investors.
Non-QM market share increased from less than 3% of US mortgages in 2020 to 5% in 2024 (Scotsman Guide). Due to our strong borrower profile and strict underwriting standards, non-QM delinquency losses are rare. Cumulative losses since 2018 total less than 0.02% (BofA Global Research, loan history as of December 31, 2023). These assets can be purchased as wholesale loans or debt securitizations, and annual non-agency, non-QM RMBS issuance reached $66 billion last year (Guggenheim Investments – Non-Agency Mortgage-Backed Securities: High Interest Rates discovery of value within). Mortgages can be borrowed through FHLB financing, another reason why insurance companies view them as an attractive asset.
But it’s not just insurance companies that are eyeing this opportunity; banks may also re-enter non-QM areas. The next administration has so far supported deregulation, especially for small and medium-sized regional banks, which have consolidated in recent years. In fact, during the incoming administration’s first term, a series of laws were passed that eased limits on local banks’ risk exposure. This raised the designation of systemically important banks from $50 billion to $250 billion. This change meant that fewer banks were subject to the most stringent requirements, and more banks subsequently had access to more revenue-generating strategies. Much of the impediment to greater bank participation in non-QM areas is the capital treatment of the underlying products. RWA requirements set by regulators determine the amount of capital a bank must hold based on the credit rating of the assets on its balance sheet. Therefore, relaxing RWA requirements, such as that proposed by Fed Vice Chairman Michael Barr in September, would reduce the amount of capital reserves banks need for non-QM investments.
What would increased bank participation in non-QM look like? Perhaps banks would prefer wholesale loans, which currently offer better capital treatment than lower-rated bonds. Additionally, whole loan investments allow exposure to specific geographic regions, making them a useful tool for regional banks focused on one part of the country. The overall loan allocation is focused on specialist mortgage securitization firms, such as Imperial Funds, which invest in non-QM loans. This is particularly advantageous for local banks that need low-cost exposure. Many in the insurance industry utilize Separately Managed Accounts (SMAs), a low-cost investment vehicle that outsources operating costs to SMA managers. Management companies like Imperial Fund perform due diligence, obtain and manage loans on behalf of their clients.
All these factors suggest that insurance companies and banks may increase their participation in non-QM areas. This expected increase in investor activity suggests that 2025 will be a strong year for non-QM markets.
Victor Kuznetsov is the founder of Imperial Funds Asset Management.
This column does not necessarily reflect the opinion of HousingWire Editorial Department or its owners.
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