One might assume that Wall Street developed, at some point in the seven years following the housing collapse, distaste for new subprime mortgage-backed securities. Think again.
Money manager Angel Oak Capital and the U.S. unit of Japanese bank Nomura Holdings are attempting to suture old wounds that have long festered in that corner of mortgage finance, according to John Hsu, head of capital markets at Angel Oak.
For the first time since the crisis Angel Oak plans to offer bond investors a securitization of all newly originated subprime, nonqualified residential mortgages, he said. The $100 million deal, underwritten by Nomura, would be issued in the second quarter.
"We do need a nonqualified mortgage market, and right now, that need is not being well met," said Laurie Goodman, director of the Housing Finance Policy Center at the Urban Institute. "In a healthy market, you want all channels open and available, including securitization."
The $6 billion-asset Angel Oak Capital is among investment firms circling lenders to snatch up higher-yielding types of mortgages. They want to show lenders that they can buy the loans if they are made, and successfully move them in the secondary market.
Nomura is holding up to $150 million in subprime mortgages on behalf of Angel Oak Capital. The two sides have been talking since at least 2013, when Nomura and Angel Oak officials first discussed a warehouse facility for new loans that Angel Oak would acquire. (Angel Oak has acquired most loans through its wholesale affiliate, Angel Oak Mortgage Solutions, but the agreement is not exclusive). The parties ultimately agreed to a short-term, 364-day facility. Angel Oak has utilized about half of the credit facility so far, Hsu said.
A Nomura spokesman declined to discuss the matter.
The New Subprime
Subprime is not what it was in the old days, said Tom Hutchens, a senior vice president at Angel Oak Mortgage Solutions, which lends to firms that make the loans to borrowers.
"Is this nonprime? Subprime? Absolutely. Not due to credit score, but looking at credit history, they all have a blemish. They all have something that has happened along the line," Hutchens said in a phone interview last week.
Traditional subprime involved high debt-to-income ratios, high loan-to-value ratios and low FICO scores, but the mortgages that Hutchens is selling, including those sold to Angel Oak Capital, have average debt-to-income ratios of 34%, average loan-to-value ratios of 72% and average borrower FICO scores between 670 and 680. Total borrower fees may exceed 3%, which is the primary reason they are non-QM. All borrowers comply with ability-to-repay guidelines, he said.
More than 19 nonbank lenders easily identified by American Banker are making nonqualified residential mortgages today, often to borrowers with less than pristine credit. They range from traditional lenders like Caliber Home Loans to online startup lenders like Privlo.
"No one is really sure what these loans should be valued at today, because there hasn't been any securitization of new subprime originations in seven years," Hutchens said.
Angel Oak Mortgage Solutions intends to originate $500 million by yearend. It made $100 million in loans in 2014, one-quarter of which were made in December.
Hsu believes Wall Street will create up to $1 billion of mortgage-backed securities backed by this kind of loan next year.
A healthy housing market has room to include this kind of credit, the Urban Institute's Goodman said, but the biggest question will be how investors handle the risk of defaults and the protections that specify their rights.
"Until those questions are solved, this credit type will be handled in nonbank-portfolio form," she said.
Angel Oak's deal may illustrate the depths of private capital for this kind of credit, and a good reception could encourage lenders to make more of them.
Investors have sought for many years to strengthen protections and safeguards written into representations and warranties. The industry has been gridlocked. The lack of progress means private capital's return has stalled. Currently, in part because of the gridlock, residential mortgages are mostly being held in portfolio where the bid for them has been stronger. Jumbo mortgages to highly qualified borrowers have dominated the small, slowly recovering securitization market in recent years.
A trade organization, the Structured Finance Industry Group, recently began circulating recommendations in a "green paper" that may address some of these concerns. The group said it sought input from more than 300 participants, representing 50 different institutions.
Angel Oak's Hsu praised the SFIG proposals. "People want to know what vintage year to use as a comparable for a mock pool, but ten years ago there was only an originate-to-sell model, and now it is originate-to-maintain. So it is hard to say you can overlay it with anything. So, you quickly come upon the reps and warrants. It's like inventing from scratch all of securitization."
Postcrisis Credit Ratings
Theoretically, the other gatekeepers in this realm of mortgage finance are the rating agencies, which were squarely blamed for too easily awarding top grades to bad deals leading up to the crisis.
This time around, rating agencies appear to be playing a much more conservative game, according to an Urban Institute report analyzing a recent exercise with ratings agenciesconducted by the Treasury Department.
Ratings still play a vital role to assess credit risk even though the pay-for-ratings system is largely unreformed. But it remains to be seen whether the firms like Angel Oak will actually pay for credit ratings, or whether they may skirt them. Top ratings may cost too much for the sponsor to be worth the trouble, as the low-rate environment may draw in enough investors to take any smaller deal.
Angel Oak has in the past month met with four credit rating agencies to discuss buying credit ratings for the deal, Hsu said, declining to name the firms. The deal is going ahead, on time, with or without their ratings, he said.
The three big established firms, Fitch Ratings, Moody's Investors Service and Standard & Poor's, as well as newcomer Kroll Bond Rating Agency, would be the most likely candidates to participate in such transactions.
Top grades of AAA could theoretically be assigned to Angel Oak's deal, Hsu said. "Nothing was said to counter that."
Kroll says it has had discussions with approximately six firms about potential rating assignments to nonprime, nonqualified-mortgage securitizations.
"In terms of nonprime and non-QM programs to mostly high-quality borrowers, but with alternative documentation, that has a good chance to get rated," said Michele Patterson, a senior director at Kroll. "But when we talk about nonprime assets made to distressed borrowers, with impaired credit, those deals will be harder to get rated by Kroll, because the expected enhancement levels would be too high."
According to a Standard & Poor's summary of a recent roundtable, a lack of liquidity and "inefficient pricing" may motivate warehouse lenders to keep non-QM products on their balance sheets, rather than including them in securitizations.
"We found that caution is still apparent among lenders considering origination outside of the super-prime, interest-only and high-reserve products, which have been included in a few nonagency securitizations to date," S&P spokeswoman April Kabahar wrote in an email.
Fitch Ratings' Grant Bailey, head of residential mortgage-backed securities, also said in an emailthat it may be still too early to tell how the nonprime mortgage sector may evolve.
"With that said, we expect new nonprime RMBS would have full documentation, high levels of due diligence and retained risk by the issuer.
Angel Oak said it would retain at least 20% of any deal.
Other parts of the industry are waiting on the sidelines, too. They want a piece of this business, no matter how much smaller it may be compared with the precrisis era.
David Gansberg, CEO of Arch Mortgage Insurance, in January launched a private mortgage insurance company called Arch Mortgage Guaranty, for example.
It is intended to cover mortgages not guaranteed by Fannie Mae or Freddie Mac, including jumbo and nonqualified mortgages. The greatest demand has come from lenders who intend to keep mortgages in portfolio, rather than securitize them, Gansberg said.
"There needs to be a certain level of comfort achieved before non-QM can become more popular," he said. "Some deals have included some non-QM loans in their overall pools. We are seeing more firms offering errors-and- omissions insurance and other forms of protections on this product type, but time is necessary to gain more comfort."