The residential mortgage-backed securities (RMBS) market is reeling from an unfavorable interest rate environment, which should suppress private label securities offerings for at least the rest of the year, concludes a recent market outlook report.
Private label titles (PLS) market update Kroll bond rating agency (KBRA) attributes most of the market difficulties to the rapid rise in mortgage rates, fueled by the Federal Reserveinflation-fighting rate hikes. The agency notes that uncertainty and inflationary pressures caused by ongoing geopolitical upheavals, including the war in Ukraine, are adding to the market turmoil.
For the year, KBRA forecasts an RMBS issuance of $112 billion, based on the value of loan pools backing the deals. That’s a significant reduction from KBRA’s May projection of $131 billion. The revised RMBS issuance figure, according to KBRA, “represents an 8% year-on-year decrease from 2021.”
Still, at $112 billion, total emissions in 2022 would represent the second-highest level of emissions on record since the global financial crisis (GFC) some 15 years ago.
“First quarter 2022 issuance totaled nearly $43 billion, the second highest quarter after the GFC, and was almost two and a half times higher than the first quarter of 2021,” according to the July KBRA report. “But the second quarter of 2022 ended at nearly $28 billion, or $10 billion below our expectations – with the prime rate down 55% quarter-over-quarter. Non-prime was down 20% quarter over quarter, while credit risk transfers (CRT) were down 14% over the same period. »
The report focuses on so-called “RMBS 2.0 transactions”, defined as all issuances of post-GFC residential mortgage-backed securities in the prime, non-prime (including non-QM) and CRT spaces – the latter usually being issued by government-sponsored companies. .
KBRA expects PLS issuance in the third quarter of this year to be around $20 billion across the prime, non-prime and CRT segments, down from its May estimate of $29 billion. The decline is attributed to “rising interest rates and an unfavorable spread environment for issuers,” the report said.
“The core sector saw the largest quarter-over-quarter drop in issuance, reaching just $9 billion in the second quarter (actual),” the KBRA report continued. “With inflation rates remaining historically high, accompanied by prolonged geopolitical uncertainty, we expect RMBS issuance volumes of up to [the second half of] 2022 will be affected by unfavorable issuance conditions, as the Federal Reserve continues its efforts to stabilize the economy.
Compared to 2021, PLS volume in the second and third quarters of 2022 will be down $20 billion, or 43%; and $21 billion, or 51%, respectively, according to the report’s forecast.
“We expect core sector issuance to decline in 2022, driven primarily by sharp interest rate hikes that have reduced overall mortgage production and increased extension risk. [a reduction in refinancing]“, states the report. It also concludes that the existing market conditions are likely to decrease “the attractiveness of the PLS as a financing outlet”.
Keith Lind, CEO of Acra Loanone of the leading non-QM lenders, said tapping into the PLS market as a liquidity channel has been a challenge in 2022 for many lenders – especially non-banks trying to digest many low-cost loans rates that have been essentially “market orphans”. ”
At the height of the refi boom and early this year, dozens of loans were issued at interest rates well below current rates, which have risen dramatically in recent months. Many of these lower rate loans were still working their way through the securitization pipeline in 2022, as most loans have several months to mature before being securitized.
However, the mismatch between these lower rate mortgages – typically around 3%, and today’s higher rate mortgages, now hovering around 5.5% – has distorted execution and pricing on the secondary mortgage market. This is the case even though low rate loans are generally considered to be well underwritten quality loans.
In fact, a recent KBRA PLS bond performance report shows that the yield of prime and non-prime PLS issues, as measured by weighted average coupon (WAC), fell below conforming mortgage rates, from of June 2022. For the prime sector, the WAC in June 2022 stood at 3.36%, according to the KBRA report. That’s slightly down from January’s mark of 3.44%. The WAC for non-preferred mortgages, which are considered riskier credits than prime loans, stood at 5.44% in June, according to KBRA data, compared to January’s average coupon of 5 .87%.
“Investors don’t jump to buy [PLS] bonds backed by [lower-rate] coupons that can’t even cover the coupon [rate investors demand] on bonds,” explained Lind, from Acra. He said Acra had raised rates aggressively this year to avoid ending up on the wrong side of the yield curve.
“The loan coupon is so low [on some PLS deals] that it can’t even cover the coupon on bonds and securitization [costs]”, Lind said. “So I think it’s going to be difficult for those who want to securitize [these lower-rate loans] because they do not seem to be very well received by investors in the securitization market.
In its May PLS market forecast report, KBRA suggested deals backed by reverse mortgages, mortgage servicing rights, ginnie mae prepayment loans, home equity lines of credit “and other esoteric RMBS transactions” are expected to increase through the remainder of 2022 and into 2023 – “as interest rates rise further.”
The new July report raises the prospect that the PLS market could greatly benefit from the huge increase in home equity in recent years. Single-family home prices rose at an annualized rate of 19.4% in the second quarter of this year, according to Fannie Maethe most recent home price index report. The Federal Reserve estimates that home equity nationwide is now valued at nearly $28 trillion.
Borrowers have generally seen their home equity rise in recent years, according to the KBRA report. Tapping into that equity through cash refinances probably won’t make sense for most homeowners in the current rate environment, given that the rates on those loans would be much higher than their existing loans, in most case. However, the report says “second lien” mortgages — such as home equity loans (fixed rate and term) and home equity lines of credit (HELOCs) — could be attractive options for wealthy homeowners. equity.
Since the 2006-2007 global financial crisis, however, there have only been five securitization transactions worth a total of $900 million, which used closed-end or HELOC loans as collateral, the report says. . These agreements were concluded between the first quarter of 2020 and the second quarter of this year.
In contrast, “at least $185 billion of second lien collateral was securitized before the GFC in more than 300 private label securitization (PLS) transactions,” according to the KBRA report. “If this past market serves as a useful guide to the potential second-link market [today] is an open question.
“However, we believe that second liens remain a potential opportunity for increased PLS issuance and a relatively attractive option for borrowers interested in tapping into the equity in their property. … The PLS market could see an influx of transactions backed by these loans if the propagation environment permits.