Every year mortgage industry prognosticators seem to have bold statements about non-QM, and 2022 was no different. Hailed as the year of non-QM, 2022 started out with many wondering about how, if at all, they would dip their toes into the non-QM water and find “riches in the niches.”
The Verity’s Anselma Antao and Carol Berger sat down with Rob Chrisman from the Chrisman Commentary, Christopher D'Auria, president and CEO of WestGen Lending to discuss the current state of non-QM, capital markets and opportunities for lenders. The discussion was moderated by Elizabeth Michael.
About the Speakers:
Rob Chrisman produces a six-day-a-week commentary, The Chrisman Commentary, on residential lending and the economy. His background is primarily in Capital Markets and hedging pipelines, although he did run a subprime company for a few years in the late 90s.
Christopher D'Auria is the president and CEO of WestGen Lending, a wholesale lender licensed in 47 states in the District of Columbia. WestGen primarily focuses on Ginnie Mae and non-QM originations for mortgage brokers.
Anselma works as Verity’s manager of training and has been in the mortgage industry for 10 years. She is experienced in QM and non-QM segments.
Carol Berger is the director of implementations and strategic initiatives at Verity. She serves as an operational SME. She has extensive experience in the mortgage industry, starting her career in the sub-prime world.
What is the current state of Non-QM?
Every year since Dodd Frank created the CFPB, who in turn created the QM/Non-QM division, every year seems to be the year that Non-QM will make a huge dent in the market share of Fannie Mae and Freddie Mac and FHA and BA and the bond programs and other non agency programs like jumbo. And every year, it seems like it doesn't quite reach its full potential. We started off this year on a very good footing in that rates went up and a lot of the easy deals that lenders were seeing throughout 2020 and 2021 have been refinanced. You are left with, what I was hearing, were a lot of harder to do deals, many of those involving self employed borrowers, for example, which is kind of a Non-QM specialty.
But, you know, low and behold, we come through 2022, and volume starts to pick up a little bit and the Non-QM industry in general is very optimistic about its potential, when suddenly Sprout and First Guarantee go belly up for lack of a better term, and the industry once again, the residential lending industry, once again is looking at Non-QM saying “what the heck is going on here? Here are some very valuable products that are being offered but can we rely on the investor community?" which I imagine we'll talk about later in this session. But if you go back to where we were in March and April of 2020, when the pandemic started to hit and liquidity became an issue, and rates move down, and suddenly you had a fair number of investors and not only Non-QM but also say jumbo investors.
Redwood Trust stopped offering loans, stopped offering products and stopped taking rate locks. And so lenders who had their loans locked in with those companies, suddenly were scrambling to find outlets for them, because they've obviously guaranteed rates and programs to the borrowers, so they needed an outlet.
When First Guarantee and Sprout went away, once again, lenders were left saying, “what are we going to do here with some of these products, especially products that were destined for Sprout and First Guarantee?” And so there's been a bit of a scramble there, but I don't think anybody on the call, or anybody in the industry will deny that there are always people who want to borrow money, and people who want to lend money and companies that want to borrow and companies that want to lend. And so the Non-QM segment of Residential Lending certainly serves a valuable purpose in the industry. The question comes down to the mechanics of how it is done, the underwriting guidelines, the pricing, and so on.
It's not quite, or I should say, it's not near the kind of liquidity of Fannie Mae and Freddie Mac offering DU and LP and FHA and BA and those programs going into Ginnie Mae securities for the most part, and we're not there yet. And so the industry is having to grapple with you know, “What kind of products do we offer? What are the guidelines, where do these things go? You know, what happens if an investor goes away?” and so forth and so on. But I'd like to ask Chris what he's seeing in terms of, you know, in the primary markets with regard to Non-QM and where things stand now.
As a small to midsize mortgage banker, the biggest or one of the biggest stress points for us coming into 2022 was to manage March with essentially the refi boom ending or over in the latter part of ‘21, as early part of ‘22. You know, like all companies, we were scrambling for volume, and built up a rather large capacity model that was expensive to maintain, and was also, you know, we needed to feed the beast.
One of those ways that we as a company filled the gap was to get into deeper into Non-QM lending and we felt it was a good match for us because as a Ginnie Mae lender, we're used to underwriting income credit and assets pretty stringently and so the non-qm environment seemed to be a good space for us to kind of come in and leverage our core strengths.
But you know, as I kind of alluded to, this year is all about managing your margin and being able to potentially revenue out and make money in this environment, which is very, very difficult. So one of the things that we have done is try to achieve an economy of scale. And we did that through our association with Verity. Moving a lot of our pre-underwriting, our setup or disclosure to Verity, so that we can kind of attain scalability.
The other thing that helped us within the Non QM environment is that as a as a mortgage banker who is selling to several different outlets, because unfortunately, we're seeing a lot of these outlets shift and change right in front of us that change their guidelines almost seems almost daily, we're having to adapt to those changes. And having a partner like Verity has helped us adapt not only with just our underwriting and our disclosures, but also across our organization with IT projects and, you know, helping us align our Encompass to you know, what, what these different investors that we're selling to can offer, so that we can turn around and offer it to our clients.
So it's a challenging environment, but we've used, you know, a TPR firm like Verity to really scale into this market, achieve a margin and stay profitable. And, you know, be kind of the exception in the marketplace. We've grown our business by almost 20% this year, in part to our alignment with Verity. And in part to investing in Non-QM and believing in our credit culture and thriving volume from that perspective.
What would you say your biggest challenges are as a lender getting into non-QM? Or, or what advice would you have for someone that's thinking about getting into Non-QM and in that regard?
I would say don't be afraid to get out and make partnerships. So our partnership with Verity, and we had an existing relationship with Verity, on the other side of our business, our QM side, that we've been developing over time, but you know, to get out make a lot of partnerships, and this is either with takeout investors, warehouse banks, and third party companies like Verity that can help you not only grow and scale your operations, but can also be resources for you, when you go to the market to sell. And I guess the other thing I would say is you have to be very, very adaptable.
That means you have to be willing to underwrite a couple of different sets of guidelines, and figure out how that's going to match with your credit culture. And be flexible from the standpoint of, you're going… There's going to be ebbs and flows in this market, and you have to be able to scale quickly and keep up with the volume, either up or down, depending on where the market is heading moving into 2023.
That's what I was going to say there Chris, the relationship between Verity and Chris's organization is that, the scalability. We bring the staff to the table that can be scaled either up or down, but we also work on training them up to prepare for the Non-QM underwriting, TPR, whatever is being needed, we go through a pretty stringent training program and then our best, like GenHomes, are, our best engagements are, where they … We partner in the specific underwriting guideline training. So everybody knows the basics, but then Chris and team come over to our operations centers and actually train our underwriters on their own underwriting guidelines, any overlays that they have. So there's a real partnership that goes on between the two companies. That goes pretty far in the margin compression area. So thank you, Chris, for that nod. I appreciate that. And Anselma does a lot of work there with the underwriting staff herself. So I saw your head nod in there, Anselma.
So one of the reasons why this engagement really works is because of the communication that is between Verity and GenHomes, you know, it really helps. If there is … the thing is that Non-QM is a very new ground for everyone of us, we know Fannie Mae guidelines and Freddie Mac guidelines, but Non-QM is completely unconventional, so it's completely new, so communication helps a lot and constantly, you know, in communicating Chris's team and having communications with them, and we make sure that we get our guidelines upgraded, because they keep changing, as Chris said, they keep changing all the time. So we need to make sure that our underwriters are updated with those guidelines, because if that's not happening, then you know, it really doesn't work. So yeah, communication is one of the skills which makes this challenge a little less, you know, less stressful communication is key, I would say.
One thing is that, you know, to tie a bow around this, I attend conferences like many other folks in my position, and one of the questions I get from peers, when I talk about offshore opportunities that we've leveraged with Verity. I get a little cringe in the face, which is like, Oh, I've tried that in the past and it really did work all that well. Our approach to that… because you know, in prior lives, I tried it, and it didn't work, well it wasn't with Verity, but it was with different companies, but it didn't work well. And what I will tell you is just like anything else in our business, you really get out of it, what you put into it, and so we've invested a lot of time integrating our process with Verity’s process, spent a lot of time communicating, yes! We have taken two training trips to India, we'll be making a third one this fall that we're excited about, because it makes us a better organization. Our Verity employees, I consider them part of our corporate family and vice versa, so it really is a true partnership and it really does help drive business forward and achieve for me margin and scalability, but for our clients is a better brand of service, which is very important.
Leveraging the expertise on multiple levels especially in this non-QM environment is really where you’re going to define the most bang for your buck.
What opportunities exist for lenders with Non-QM? Rob, I bet you have an interesting perspective from the investor side of things as well on that.
The question that inevitably comes up when you're looking, when any lender is looking at any product is “what is the investor going to be interested in,” because, especially as an independent mortgage bank who doesn't have their own deposit base, what they can sell those loans for the secondary market truly does matter. Credit unions and banks, not so much if they're keeping some of those loans in their portfolio, but if you're an independent mortgage bank, you have to ask yourself, what kind of yield investors want to see with Non-QM with non agency in general with Fannie Mae, Freddie Mac, and so on.
And what kind of guidelines are those investors interested in?
Because, different investors have different risk parameters and obviously, they want the highest yield and the lowest amount of risk, where as borrowers want the lowest yield and you know, risk would be damned and so balancing those two is something that capital markets staff generally works on, in terms of what investors want to see and what borrowers are going to be able to, to originate or I should say loan officers or account executives be able to originate.
From an investor's perspective, they are looking at the lending community as part of a big pie. Different money managers, different investors and so on have different sources of fixed income securities, so they aren't always focused necessarily on Non-QM loans or Non-QM backed securities they might be interested in jumbo loan securities, they might be interested in agency securities, they might be looking at municipal bond debt, treasury debt, foreign debt, corporate debt, and so they're looking at the risk and return of all those financial instruments and the Non-QM sector factors into that.
If you have an investor that is dealing with, let's say, the need to buy residential backed securities, once again, they've got options they can go with any kind of non agency product, they can go with Fannie Mae, Freddie Mac, or Ginnie Mae securities. Or, you know, some generic conventional conforming types of securities, but regardless, I think that lenders out there around the call need to remember that investors do have options. And the question is, how do we make Non-QM?
How do we make these loans very palatable, very attractive for investors from a yield perspective and from an underwriting perspective. So there are niches with riches out there, and different lenders are finding those, different lenders are exploiting those and different lenders that are better than others at originating those types of loans. But it is important, I think, for people on the call to remember who you're dealing with in the secondary markets, and what is going to appeal to them and try to figure out what can be sold to borrowers and what can be sold in the secondary market.
Like Rob said earlier, every year, it's been the year of non-QM, but I think with the economic downturn that we're seeing and the interest rate going up, the supply going down, I think you're going to start seeing more lenders and more borrowers looking towards the non-QM market, so that's really something that we need to focus on, make sure we’re providing that for our borrowers.
I think Rob's words ring true. You have to be very, very careful as an independent mortgage banker to make sure that essentially the loans that you are creating are something that is going to be appetizing to one of your investors, and well the riches can be in the niches, you can also get in a lot of trouble. We’ve seen a lot of companies getting a lot of trouble this year overniching, you know, I think the thing that we're hearing a lot out in the market spaces, there are certain LTVs that right now, companies just aren't comfortable with because they've been, I'm not quite sure about where the direction of collateral is going to be in the next 6 to 12 months. They're a little worried, more that you could see regressive values in some markets. So it's really important to have very thorough underwriting practices.
Make sure you're following your guidelines and making exceptions to those guidelines. Make sure that those exceptions are very clearly detailed, and that you're communicating them to your takeouts because the biggest trouble you can get into is thinking that you have something sold at a certain price and then finding out that you don't, and that you're actually going to sell it for much much less, which is very very painful as an independent mortgage banker. So, those are my final words of wisdom.
Do you have any last thoughts for anyone thinking about getting into Non-QM?
I would just encourage everyone to focus on the quality of your Non-QM. You don't want to find yourself out there with a portfolio of loans that you can't sell because it turns out you didn't have an investor that was interested in what you were making. So really, focus towards your quality and work with partners if you can, who do have the experience that can help you along the way.
Non-QM should be a valuable part of any lender's arsenal, and so many of the easier deals quote unquote have come and gone and we've got millions and millions of borrowers out there with rates in the twos and threes for thirty year fixed. And so now with some of these harder to do deals coming through, I think what I've seen and I travel around the nation and talk to different lenders is really, truly incorporating non agency products into their product lineup.
It is important for originators who are used to just watching loans fall out of the sky, whether they're Fannie Mae or Freddie Mac or FHA or BA or bond programs or whatever, like we've seen over the last… since the beginning of 2020. Now that deals are harder, they've got to go out and hunt loans, and they have to be able to offer different products and different borrowers. And so, some lenders obviously, are very focused on Non-QM or non agency in general.
Others they view those products as a kind of a bonus or something that they can offer but they may not be experts at it but it definitely helps for any lender out there to spend some amount of time familiarizing themselves with the product and how the processing works and how the underwriting works because, you know, an ounce of prevention is worth a pound of cure kind of thing. If they know the products and they know the guidelines, and they know how these things work when they're talking to a borrower who might qualify, I'm sure it'll save tons of effort and problems down the road, and hats off to Verity for being able to help streamline that process for lenders across the nation.
And I'll just add to what Rob said, here from a lender's perspective, and from a business owners perspective, the most important things are being able to margin revenue and have a profitable company. So, what I would encourage is to stay focused on your market margins. Stay focused on your scalability and your ability to adapt to this market quickly, and that means having very good partnerships with vendors, and also in alignment with the company like Verity, it's been very meaningful to us and has made a difference in our accounting.