DBRS Morningstar Publishes 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

DBRS Morningstar published a commentary titled “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. The share of borrowers that became delinquent on their mortgage payments remains low at approximately 3.8%, up slightly from 3.5% in June 2022 and declining from 5.1% in December 2021. Similarly, the share of seriously delinquent borrowers (those who were delinquent for 60 or more days under the Mortgage Bankers Association method) remained steady at about 2.2%, also in line with 2.1% in June and down from 3.0% in December.

Over the last few years, the deals benefited from fast voluntary prepayments, which helped to build the rated bonds' credit enhancement 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.

STEADY CREDIT PERFORMANCE CONTINUES AS MORTGAGE RATES SPIKE, DEMAND TUMBLES, AND HOME PRICES START TO EDGE LOWER
Since June 2022, non-QM mortgage rates and funding costs continued to rise as a result of the persistent increase in long-term interest rates. The yield on the 10-year U.S. Treasury note spiked to about 3.9% as of October 10, 2022, from about 2.9% as of June 1, 2022. The rates rose steadily since early March 2022 following the Federal Reserve's raising the federal funds target rate to stalwart the inflation. As a result of spiking rates, credit spreads gapped and market liquidity dwindled in non-QM loan and bond markets, which generally followed the broader capital markets' behavior. Mortgage rates continued to rise, with the 30-year fixed-rate mortgage average for conforming loans rising to about 6.9% as of October 13, 2022, from 5.1% as of June 2, 2022. The non-QM mortgage rates followed the trend with the current coupon well above 7.0%.

The 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.

HURRICANE IAN WILL HAVE LIMITED IMPACT ON NON-QM RMBS IN THE LONG RUN
Hurricane Ian, a Category 4 hurricane, hit several states at the end of September 2022, claiming more than 100 lives and billions of dollars in damages. The hurricane had the most damaging impact in the state of Florida and disrupted the lives of many people, some being non-QM mortgagors, causing them to abandon their homes seeking shelter, forego their wages or business income, and spend additional funds to repair houses if home insurance does not fully cover the cost of repairs. We expect that Hurricane Ian will not have a material impact on the ultimate realized losses in rated non-QM RMBS, barring a sudden drop in home prices in Florida, though the exact impact on non-QM RMBS performance will be pool- and transaction-specific.

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.

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The commentary is available at www.dbrsmorningstar.com.

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