U.S. RMBS: Q3 2022 Non-QM RMBS Performance Update—Steady Credit Performance and New Issuance Continue amid Rising Rates, Sliding Home Prices, and Hurricane Ian

The credit performance of residential mortgage-backed securities (RMBS) backed by non-Qualified Mortgage (non-QM) loans rated by DBRS, Inc. (DBRS Morningstar) remained stable in the third quarter of 2022. Over the last few years, the deals benefited from fast voluntary prepayments, which helped to build the rated bonds' credit enhancement (CE) levels, and borrowers' equity increased from the strong home price growth and principal payments. Although voluntary prepayment rates have recently fallen, the share of delinquent loans remains low, new delinquency rates are low, serious delinquency cure rates are muted, liquidations are infrequent, loss severity rates are low, and losses are near zero. That said, non-QM RMBS will continue to face growing uncertainties with respect to the near-term economic growth, unemployment rate, household incomes, and home prices. Even if the delinquency rates rise somewhat due to the slowing economy, DBRS Morningstar considers existing non-QM RMBS to have a meaningful cushion to withstand the headwinds, barring a sharp economic downturn coinciding with a sharp drop in home prices.

The recent surge in mortgage rates caused borrowers' interest in home purchases and refinances to drop. As a result, housing demand began to curb, and home prices softened. However, it is unlikely that the home prices will retreat meaningfully unless an economic downturn forces many homeowners to consider selling their properties at the below-market prices. Absent such a recession, home prices will likely grow at a more moderate pace in the long run, though they may remain stagnant or even turn lower in some areas, particularly those in which the prices recently ran up, in the near term as would-be homebuyers adjust to the new funding costs.

We expect that Hurricane Ian, a Category 4 hurricane that hit several states at the end of September 2022, will not have a material impact on the ultimate realized losses in rated non-QM RMBS, barring a sudden drop in home prices in the affected states. Although the exact impacts from the hurricane are yet to be fully evaluated, DBRS Morningstar believes that in the near term delinquency rates may rise in non-QM RMBS with a significant concentration of properties located in the affected areas and, potentially, in Florida. However, the delinquencies will likely be resolved within six to 12 months as servicers work with the affected borrowers, insurance companies review and pay claims, and borrowers with damages not fully covered by the related insurance policy assess the means to fund repairs. The exact impact on non-QM RMBS performance, however, will be pool- and transaction-specific.