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Funding & Alternative Lending

An Introduction to Non-QM Programs

Why it is a Great Alternative for Borrowers By Jennifer McGuinness In the current and ever-changing market environment, it is important to understand the different financing options available to borrowers. Non-QM Programs offer a wide range of flexibility and underwriting criteria. These loans are available for the financing of primary residences, second homes and investment properties, but many do not know what non-QM means or how to get started. What is a Non-Qualified Mortgage (“Non-QM”) A non-QM mortgage loan is a home loan that is not required to meet the requirements outlined by the Consumer Financial Protection Bureau (CFPB). In January 2014, the CFPB issued a set of guidelines to provide “safer and more stable” home loans for consumers called Qualified Mortgages. Qualified Mortgages are a “new” mortgage classification. Commencing in 2014, the concept was created to make it more likely that a borrower would be able to pay back the loan. Lenders need to assess the borrower’s ability to repay and borrowers need to meet a strict set of criteria. If borrowers do not meet those criteria, they will not be approved for a qualified mortgage. In these situations, a borrower may be offered a non-qualified mortgage. A non-QM loan does not conform to the consumer protection provisions of the Dodd-Frank Act but that does not mean that they are bad for the consumer. Applicants whose incomes vary from month to month or those with other unique circumstances may qualify for these types of mortgages. For example, if you have a debt-to-income ratio of more than 43%, a lender may not offer you a qualified mortgage. Or, if you have dynamically changing income and do not meet the income verification requirements set out in Dodd-Frank and required of most lenders, you may not be offered a qualified mortgage. A lender may instead offer the borrower a non-qualified mortgage. If a lender offers a non-qualified mortgage, it does not mean the lender is not required to do any verification or assessment of your ability to repay the loan. It generally means that you do not meet the specific criteria needed for a qualified mortgage. Interest rates on loans will vary from lender to lender, but you may find that a non-qualified mortgage will have a higher interest rate. The Loan Differences While there are differences in how a Borrower qualifies for a qualified mortgage vs. a non-qualified mortgage, there are also differences in the loans themselves. Here are some of the ways the loans differ. Dodd-Frank offered lenders issuing QM mortgages protection from certain legal challenges in foreclosure proceedings and other litigation. With a QM mortgage, lenders generally have shown that they have confirmed that the borrower had the ability to repay the loan, which provides the lender with certain legal protection from lawsuits that claim they did not verify a borrower’s ability to repay. However, if a borrower does not feel that the lender made sure they had the ability to repay, they can still challenge the lender in court. Additionally, only QM mortgages can be insured, guaranteed or backed by FHA, VA, Fannie Mae or Freddie Mac, so they are generally considered  “safer” for investors who buy mortgage-backed investments. BUT IS THIS TRUE? The non-QM share of total mortgage counts declined during the COVID pandemic and reached its lowest level in 2020, at 2% of the market. However, the non-QM share of the market has since almost doubled in 2022, representing about 4% of the first mortgage market (data is as of the first three months of 2022). Though the non-QM loan is a small piece of today’s mortgage market, it plays a key role in meeting the credit needs for borrowers not able to obtain financing through Fannie Mae, Freddie Mac or other government channels. Creditworthy borrowers such as self-employed borrowers, first-time homebuyers, borrowers with substantial assets but limited income, jumbo loan borrowers and investors may benefit from non-QM loan options. The three main reasons why non-QM loans originated in 2022 did not fit in the QM requirements are the use of limited or alternative documentation, a DTI above 43% and interest-only loans. Almost 55% of the non-QM borrowers used limited or alternative documentation, 26% exceeded the 43% DTI threshold and 23% of the non-QM mortgage loans originated were interest-only loans. Today’s non-QM loans are still high-quality loans. They are very different and less risky than the equivalent of non-QM loans originated prior to the housing crisis. The average credit score of homebuyers with a non-QM mortgage loan in 2022 was 771 compared to 776 for homebuyers with QM loans and 714 for government loans (data is as of the first three months of 2022). Similarly, the average Loan to Value Ratio (“LTV”) for borrowers with non-QM mortgages was 76%, compared to 77% for borrowers with QM mortgage loans. Finally, the average DTI for homebuyers with non-QM loans was 37% versus 33% for QM and 40% for government programs. Despite the higher DTI ratios, non-QM mortgages are performing very well. Both the non-QM and QM loans have low delinquency rates. In fact, the serious delinquency rate (over 90 days delinquent) for non-QM mortgages is slightly higher than the rate for QM loans (both being less than 1%) and significantly lower than for the government loans (almost 2%). To offset the risk of default, lenders generally set a higher interest rate on non-QM loans. Additionally, lenders are generally focused on borrowers with higher credit scores and lower LTVs, as this helps to offset the possible added risk from a high DTI ratio, limited documentation and interest-only on non-QM loans. How Do Lenders Verify Income for Non-QM Loans? While non-QM loans offer flexibility for lenders to offer mortgages to people who do not fit the criteria of QM loans, lenders still need to verify the information provided and document anything that supports the borrower’s ability to repay. That includes income sources, assets, or anything else that gives them assurances the borrower will be able to repay the loan.

Capital Markets

“Housing Crisis?”

Is the Fed Trying to Cool Down a Hot Housing Market? By Jennifer McGuinness Federal Reserve Governor Christopher Waller has stated “The housing market is definitely out of whack,” and even shared a personal story about how he recently sold his St. Louis home to an all-cash buyer with no inspection. He was further quoted as saying, “We’ll see how the interest rates start cooling things off going forward.” Low borrowing costs introduced to insulate the economy from COVID brought about a reported 35% rise in home prices over the past two years. While home prices are not part of the inflation indexes tracked by the Fed, they do feed into other factors, such as rents, and this is an influential component to inflation. Rising interest rates mean that borrowing for a house is suddenly more expensive. The 10-year Treasury note yield, a benchmark for mortgage rates, has risen due to expectations that the Fed is going to quickly increase rates. The average 30-year-fixed rate for a mortgage loan is now 5.42% as of May 19th, over a 2% increase since the year began. The last time mortgage rates rose this fast was in 1994. At that time, there was a 20% decline in home sales as the Fed increased rates and based on that, home price appreciation slowed. While many of the economists and Wall Street research teams predict a decrease in home sales again, they are much more conservative and have projected this at approximately 5% annualized by the end of the year. A Market Comparison The market however is very different than in 1994. Today, record-low housing stock, higher household savings, and a job market where there are approximately 1.5 jobs available for every person looking, not to mention the additional “mobile” or “remote” nature of today’s worker, are creating fundamentals that could materially impact many forecasts. The sale of homes that have been previously owned are at a two year low as of March, and mortgage applications were down as well. For the first time in a while, we have begun to see list price reductions on homes for sale with an average days on market of 17 and mortgage applications remain above pre-COVID levels. A review of housing data shows that the correlation between home price appreciation and mortgage rates, while still strongly correlated, has been decreasing the past 20 years. Record low inventory over the past couple of years also means there has been, and is, plenty of pent-up demand, particularly among Millennials ready to set up a home, whose share of purchases has been growing. Today, the average age of the first-time home buyer is 33 years old, and I believe we will see household formation numbers increase dramatically, as my opinion is that they have been under reported due to the pandemic and quarantine. Due to the rising cost of alternative housing, Baby Boomers have not downsized as quickly as anticipated and this is keeping, at times, larger homes from coming onto the market and these are generally the homes that are sought by the younger home buyer. In addition, too few new homes are being built. Pre-pandemic, we were already seeing millennials, who were renting in urban areas, moving out of those areas to more suburban locations and purchasing homes. However, the pandemic really accelerated those moves and we saw a lot of other people moving out of the cities and even moving to different states where, for example, the cost of living was/is better. The other thing that is very different now versus during the housing crisis, is that at that time there was over a 12-month supply of homes available for sale. In a healthy market, you will generally see a 6-to-7-month housing supply, and right now, we are generally seeing a 2-to-3-month supply. During the housing crisis, there was always the option of buying a home at foreclosure auction as many of the homes were underwater. But that is not the situation today. Approximately 90% of borrowers in foreclosure have positive equity, and over 20% of them sit in a 50% equity position. According to realtor research data, the share of all-cash sales was the largest in nearly eight years in March, a sign that much of the supply will be purchased by both investors and second home buyers. Another important note is that rent prices have gone up 14% year over year and we are seeing really strong housing permit numbers right now from builders. While this is positive, they have been under-building for approximately 10 years, so it will take them another four to five years to catch up. Foreclosure Activity Foreclosure activity dropped from March to April, but it was still up 160% year-over-year. One interesting data point is that while foreclosure starts were pretty much flat, foreclosure completions were much lower, as 90% of borrowers in foreclosure have positive equity. Based on this, many foreclosures will result in home sales rather than foreclosure auctions leading to less “distressed” real estate for purchase. According to ATTOM Data’s most recent Foreclosure report, “Lenders repossessed 2,830 U.S. properties through completed foreclosures (REOs) in April 2022, down 36% from last month but up 82% from last year. The states that had the greatest number of REOs in April 2022, included: »          Illinois (417 REOs) »          Pennsylvania (266 REOs) »          Michigan (187 REOs) »          Ohio (150 REOs) »          California (148 REOs) The major metropolitan statistical areas (MSAs) with a population greater than 1 million that saw the greatest number of REOs in April 2022 included: »          Chicago, IL (347 REOs) »          Philadelphia, PA (149 REOs) »          New York, NY (128 REOs) »          Detroit, MI (64 REOs) »          St. Louis, MO (53 REOs).” An interesting fact is that the homes we are seeing in active foreclosure were generally 120 days delinquent pre-pandemic and should have been foreclosed approximately two years ago. Also, the foreclosure rate today is still at about half of the normal level. What’s Next The Fed

Due Diligence

Additional Investors Flock to Single Family Rental

Will diligence standards degrade based on competition and lack of inventory? by Jennifer McGuinness Currently, there are approximately 49 million rental units occupied in the United States of which, approximately 12 million are Single Family detached rental homes and 2.8 million are leased townhomes. Most of these units are existing homes on scattered lots versus new construction. To date, over 5 million homes have been converted from owner occupied properties to rentals. Based on this approximate 17 million units and their performance, there continues to be significant investor interest in the sector. Today, the market presents fundamentals that could lead investors to be uncertain about how investments could perform, but even in a time of uncertainty, Single Family Rental Investors continue to report record occupancy levels and rental growth. DBRS Morningstar recently reported that that rents in institutionally owned single-family rentals have grown more than 3% (annualized) in 2020. Invitation Homes as an example, reported renewal rent growth for pre-existing tenants to be up 3.3% in the second quarter of 2020 and new tenant lease growth up 5.5% in the same timeframe. Another driver of investor interest has been the Single-Family Rental REITS (Real Estate Investment Trusts), as they generally outperformed the broader REIT Market in 2020 by 23%, thus exceeding other real estate sectors by significant margins (i.e., exceeding multi-housing by 9%, office by 22% and shopping centers by 33%). Additional Investors and New Capital Away from occupancy and rent growth, the COVID pandemic and the subsequent stay-at-home orders have forced many to work from home and educate their children from home; hence, individuals and families are seeking more space. The two largest Single Family Rental Investment Trusts, Invitation Homes and American Homes 4 Rent, own a combined 135,000 units, which makes up less than 2% of the total units. According to Amherst Capital Management, there are more than 25 institutional landlords in the space today. Even historical investors like Blackstone, who sold off their remaining interest in Invitation Homes last year to JP Morgan Asset Management, have remained invested in the sector in some capacity, e.g., they still hold a minority stake in Tricon Residential. Additional capital has been raised and acquisitions have been made that indicate the investor appetite is strong in this sector. Examples of recent announcements include, a $375MM joint venture between Rockpoint Group and Invitation Homes, a $625MM joint venture between JP Morgan Asset Management and American Homes 4 Rent, and a $300MM fund raised by Brookfield Management, amongst others. On the acquisition front, Front Yard was initially to be acquired by Amherst Holdings for $2.3B but the parties terminated this agreement in May of 2020, opting instead for an equity investment by Amherst of 4.4MM shares of common stock, at the initial offering price of $12.50 ($55MM invested). They also provided a $20MM committed two year unsecured and committed financing facility to the company. Fast forward to October 2020, just 5 months later, when Pretium and Ares Management Corp. partnered to acquire Front Yard for $2.4B and initially for $13.50 a share but later revised this to $2.5B and $16.25 per share to its investors (a 63% premium over Front Yards closing share price). This acquisition just closed. Supply and Demand The big questions in my mind and I am sure many market participants are: Is there enough supply for the investment demand in this sector? When looking at the capital raised, if there is not enough supply, will the investment managers have to become too aggressive in their acquisition strategies to be able deploy their capital? If this should occur, does this mean that the due diligence of the properties (and/or of the tenants that reside in them) could be “relaxed” to be competitive and thus increase the risk profile of the investments driving a change in the stable cash flow curve the sector has historically experienced? And, if so, could this adjust the potential of continued capital appreciation that many investors are betting on today?  When looking at the market today, the biggest challenge I see initially is that demand does outweigh supply if you are solely looking at “for sale” real estate and mortgage rates. For example, the National Association of Realtors (“NAR”) reported that as of October of 2020, homes for sale were down 20% from October of 2019. It is important to note, however, that generally unsold inventory is on the market for 2.5 months whereas it was 3.9 months a year ago. Homebuyers are also “paying up” for real estate and there are many renters in cities seeking more space and now looking to live in the suburbs, due to both COVID and the fact that they are now at the age to acquire homes. The demand of the homebuyer, coupled with the demand of the Institutional investor, continues to drive home prices up in many markets. A good example is California, where NAR reports that the average price of a home increased more then 15% from 2019 to 2020. This, hand in hand with record low mortgage rates, has well positioned home buyers to make better purchase offers which could result in lower investment returns for investors, should they have to increase “buy prices” to acquire additional real estate. What the market is not looking at as closely however, is how many of the homebuilders have now either entered joint ventures with investors to “build for rent” communities or have started rental community divisions of their own. Single Family housing starts have increased by over $1.2 million in November per the Census Bureau which is more then a 25% increase from 2019. We have not seen this number of housing starts since before the financial crisis. While a lot of the new construction will go to owner occupants, this significant addition of new homes will begin to equalize the lack of supply for investors. Also, with the release of the COVD vaccine, if the country begins to truly open again, we believe we will see

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