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Non-QM’s Year Of Living Dangerously
It’s just past a year since the bottom fell out of the Non-QM mortgage space, creating what industry insider call “The Pause,” as investors dropped out of that category and lending ground down for months. The biggest takeaway from what started in March 2020? It’s kind of twisted, but follow along:
People need to be more important than profits. Yet… the reason profits plummeted and the Non-QM market almost collapsed was the overwhelming necessity to protect people.
With a year of hindsight, folks in the market space now know what they would do differently – from being less quick to cut to not being aggressive enough to grab even more market share. Granted, they’re primed with reasons they spout quickly for the actions they took, but many Non-QM insiders are candid and willing to admit missteps were made.
Tom Hutchens is executive vice president of production for Angel Oak Mortgage Solutions. With over 18 years in the mortgage industry, he has seen all the economy can do to the business. He’s frank about how Angel Oak reacted initially when commerce came to a terrifying halt in mid-March 2020.
In a phone interview not long before the first anniversary, he recalled the chaos everyone was facing. Who knew what the effects of a pandemic were going to be? But the economy was put on hold, and investors were scaling back sharply. “We had to make tough decisions quickly. We didn’t know the scale of what was happening.”
“Business came back so quickly,” he acknowledges. “But we didn’t know” it would when everything went on pause.
“We should have just kept entire company together,” Hutchens says in hindsight. “But we didn’t know that rates would drop to the lowest in history and the mortgage industry would do more volume. From an operations standpoint, we got pretty lean. We let go 80% of our ops team and 50% of the sales team. A lot came back but a lot of ops people were snapped up by agencies.”
Then he adds, “Maybe we should have made different decisions.”
A Different Reaction
Robert Senko, president of ACC Mortgage, didn’t have to make those decisions. His claim to fame is that his company never stopped making Non-QM loans. His decision wasn’t made recklessly. He wasn’t a rebel questioning the scientists. “I was the guy during COVID in Costco with a full flatbed of toilet paper, cleaning supplies and dry goods. I stocked up.”
He didn’t need to stock up at ACC because the coffers were already full, metaphorically speaking. “My philosophy has always been to be nimble enough to adjust.” Senko said he saw companies when he first started 30 years ago fly high and then plummet when a rate increase put them out of business.
His desire when he started ACC in 1999 was to always be able to adjust. He saw the crash coming in 2007 and pivoted. With a right balance of assets, he was able to pivot when the pandemic struck.
‘Hogs Get Slaughtered’
Senko uses a porcine analogy to explain why the nimble survive. “It’s an age-old discussion – pigs get fat and hogs get slaughtered. Everyone thinks every day is going to be great. You don’t need a rainy day fund or the spigot will not close. It’s a mistake not recognizing the reality and fickleness of the capital markets that can turn on a dime.”
Employees were furloughed at ACC, Senko admits, but the lights kept burning and the doors stayed open. About 12 people out of 50 had their lives put on pause, but most quickly returned. When the market flowed back, ACC wasn’t starting from a standstill.
Still, the company needed to make adjustments, some of which it has retained. Critically, ACC changed the compensation structure for its account executives. Commissions became the income stream, not salaries plus commission. It’s one COVID takeaway the company is going to keep.
Senko recalled a story a consultant had told him. The consultant was working for the United States Postal Service during the anthrax scare. “Everybody was in a panic,” Senko recalled. Years later he and the consultant still talk about that scare and this stuck with him: “It’s easy to shut down a business. It’s harder to restart. A lot of business struggled to regain their footing.”
Lessons Learned But…
Jim Anderson, Chief Marketing Officer, Finance of America Mortgage, says his company would do nothing different in hindsight. “We stopped and took inventory of where the market was, and liquidated assets as appropriate based on the available information and thought about how we do this better and safer for our customers.
“Given everything that was happening with increases in volume in other products, lenders needed to take a step back, review capital and make internal decisions on whether they wanted to sell loans or retain them. Once everyone realized this didn’t trickle down to the banks and credit markets, the Non-QM segments opened back up and Non-QM went on to outperform the modeling.”
Anderson argues “we are coming out of this even better, the product has been stress-tested, and serves a valid segment of the market. Innovation is back and we are in the race to zero. The pandemic basically allowed us to restart in a safer way for the consumer.”
Katherine Gardner, Chief Production Officer at Arc Home, said leaving the lights on during a period when no one understood the scope of the pandemic meant a great deal to Arc Home employees. “We were able, and had the foresight, to retain staff and the sales force had a significant advantage in re-launching Non-QM products. This also had a very positive impact on culture and the trust employees have in the stability of their employer.
The F Word: Forbearance
Even though it had nothing directly to do with the Non-QM market, forbearance was an F word of sorts for lenders in the segment. The government wasn’t backing their loans to begin with. “Forbearance was never in anyone’s vocabulary before the pandemic,” Hutchens said.
Suddenly customers were inquiring about it. “Part of the challenge was the government was saying if you need forbearance, you’ll get one.” But of course only for government backed mortgages. That forced companies like Angel Oak to extend the olive branch of financial assistance to those who needed it. “Most borrowers once educated about it wouldn’t take it. But if people were in a hardship, they were given it,” Hutchens said.
Investors Did Wrong
John R. Lynch, CEO and founder of PCMA Private Client, said long-term errors were made by investors with short-term focuses. “The gravest mistake during the early stages of the pandemic were made by the major liquidity providers exiting the market immediately and not honoring their commitments to purchase loans from their seller partners and warehouse banks. This not only hurt the firms originating these loans, but strained warehouse line relationships, but irreparably damaged the reputation of the Non-QM market.
“Now as the non-QM market is regaining its footing and market appeal and the liquidity providers re-enter the market, you have major push back by the warehouse lenders who will no longer accept these firms as counterparties and the seller partners have moved their origination capabilities to more acceptable and consistent agency originations and will most likely never come back to NQM.
Lynch lamented that “the street firms and hedge funds that looked to profit from this amazing market opportunity should have been good stewards and taken the approach of long term investors. Instead, they were in it for the trade and not for the good of the market. The moment the market traded away from their position, they were out.”
“If they thought like investors of a great opportunity and not like typical vulture traders, they would have recognized this was temporary, honor their covenants, protect their partnerships and invest long term in the health and well being of the category,” he charges. “This was the biggest and most unforgiveable mistakes that were made.”
One Year Later
Hutchens said there continues to be a bigger demand from borrowers for Non-QM products. S&P Global shares his optimism. It says that Non-QM issuance volumes will return to 2019 levels this year, reaching an estimated $25 billion, due to a strong purchase loan market and slowing agency refinancing activity. It also thinks that older Non-QM securitization cleanup calls could contribute to additional new securitization collateral in the low-interest rate environment.
“The gig economy and the gig worker are growing exponentially,” Hutchens points out. “It’s a gig economy with remote working. Employers don’t give out W2s as much any more. We see more 1099s and the self-employed and credit challenges that signify growth.”
And that, he asserts, means there’s money to be made. “There’s so much opportunity for originators. When refinancing goes down, everybody starts working harder on purchase loans.”
That’s a sentiment shared by others in the industry. “We anticipate that the upcoming market will attract more brokers and lenders to Non-QM business,” says Aaron Samples, CEO of First Guaranty Mortgage Corporation. “As rates increase and borrower fatigue around refinance takes hold, we believe that purchase business will climb and it will be necessary to reach these borrowers who fall outside of agency guidelines. The increase in home prices, building costs, and self-employed borrowers is likely to drive exponential growth in the Non-QM space.”