U.S. RMBS: H1 2022 Non-QM RMBS Performance Update—Solid Credit Performance Continues as New Issuance Slows Amid Market Volatility

The credit performance of residential mortgage-backed securities (RMBS) backed by non-Qualified Mortgage (non-QM) loans rated by DBRS, Inc. (DBRS Morningstar) remained steady in the first half of 2022. Since the beginning of the year, non-QM mortgage rates and funding costs have increased as a result of the sharp rise in long-term interest rates. Credit spreads also widened and market liquidity in non-QM loan and bond markets generally worsened following the volatility of the broader capital markets, which quickly retrenched into the "risk-off" mode as interest rates began rising steadily. Non-QM RMBS new issuance was active in the first quarter of 2022, slowing down considerably as unprecedented market volatility ensued in early March 2022. That said, credit quality of new issue non-QM RMBS remained steady through the volatile markets.

The credit performance of non-QM RMBS has not been directly affected by the unprecedented capital market volatility, with no visible signs of the cracks in the non-QM ecosystem yet. Although voluntary prepayment rates declined, the share of delinquent loans remains modest, new delinquency rates low, serious delinquency cure rates robust, liquidations infrequent, loss severity rates low, and losses near zero. That said, DBRS Morningstar expects performance of non-QM RMBS to be tested in the month to come, as voluntary prepayment rates may fall further and the rise in home prices may moderate, slowing the buildup of non-QM borrowers' equity. Also, if rising interest rates and elevated inflation cause a meaningful economic slowdown, delinquency rates may rise.

Non-QM transactions are well poised to meet a potential economic downturn because credit enhancement rose for all rated bonds since issuance due to robust prepayments and low collateral losses, a credit positive. Also, lower delinquency rates help non-QM transactions pass trigger events' performance thresholds, thus directing more principal to senior classes and shortening repayment periods for the senior bondholders, which is also a credit positive. Also, many non-QM borrowers built significant equity, which bolsters their incentive to preserve homeownership and helps cushion losses when properties backing seriously delinquent loans are sold off. Non-QM equity has likely increased since loan origination for most non-QM borrowers due to robust home price growth over the last few years and principal payments and curtailments.