U.S. RMBS: Q4 2022 Non-QM RMBS Performance Update—Steady Credit Performance and New Issuance Continues Despite Higher Rates, Lower Home Prices, and Lingering Economic Uncertainty

The credit performance of residential mortgage-backed securities (RMBS) backed by non-Qualified Mortgage (non-QM) loans rated by DBRS, Inc. (DBRS Morningstar) continued to remain steady in Q4 2022. No visible cracks have yet emerged in the non-QM ecosystem despite a significant strain from rising mortgage rates, falling demand for housing and mortgage loans, and persisting economic uncertainty. The existing non-QM RMBS performed well, the credit quality of the new deals remained sound, and loan origination continued, though at a notably slower pace than before March 2022. Issuers continued to bring new deals to the market despite wider credit spreads, particularly for the subordinated bonds that are more sensitive to the credit exposure and longer payoff timelines. Notably, higher rates and wider spreads prompted new investors' interest in the non-QM sector, with some eyeing the possibility of sponsoring deals in 2023.

In Q4 2022, the drop in borrowers' interest in home purchases and refinances caused by the spiking mortgage rates continued to weigh on origination volumes, which for some lenders declined to a fraction of their peak origination volumes before 2022. In addition, the uncertainty about the future path of interest rates and inflation, as well as the probability, timing, and severity of the potential economic downturn, persisted, besetting investors' sentiment and keeping the credit spreads wide and liquidity choppy. However, funding for non-QM loans remained generally available, and the lending activity continued. The prognosis for non-QM origination looks better over time owing to several factors that bode well for future growth.

Notably, as housing demand dropped, home prices remained relatively resilient thus far, though they rose at a slower pace than before and even declined slightly in some areas. Housing inventory, the unemployment rate remaining at historically low levels, and other factors help explain home prices' general resilience in the wake of waning demand. That said, the exact path of future home prices in each area depends on many locale-specific socio-economic considerations, such as supply and demand, the local economy, disposable income, the family formation rate, affordability, and many others, in addition to the cost of mortgage debt. DBRS Morningstar continues to believe home prices will not meaningfully decline unless an economic downturn forces many homeowners to sell their properties at the below-market prices because of a protracted disruption or loss of income. Absent such a recession, home prices will likely grow at a more modest pace in the long run and may remain stagnant or even retreat in some areas, particularly those in which the prices recently ran up, in the near term as would-be homebuyers continue to adjust to the new funding costs.