U.S. RMBS: Q1 2023 Non-QM RMBS Performance Update—Credit Performance Weakens but Remains Historically Strong as New Issuance Trembles amid Higher Rates and 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) weakened slightly in Q1 2023. Despite a small increase in delinquency rates, the overall performance of the rated non-QM RMBS remains solid. Rising mortgage rates, softening home prices, and remaining uncertainty regarding the next steps needed to tame persisting inflation failed to put a notable dent in the performance of non-QM deals as delinquencies still remain historically low, liquidations of properties backing seriously delinquent loans infrequent, loss severity rates contained, and cumulative losses very low in Q1 2023. As the same time, the credit quality of the new deals weakened slightly but remained generally sound. Loan origination continued, though at a significantly slower pace than before the Federal Reserve started monetary tightening in March 2022. However, issuers continued to bring new deals to the market despite credit spreads and treasury yields volatility.

In Q1 2023, the higher mortgage rates continued to depress origination volumes, with several lenders citing volumes declining to a fraction of the peaks reached before 2022. However, in Q1 2023, both fundamental and technical factors remained favorable for the housing market. Despite pockets of layoffs in certain industries, unemployment remained low, and earnings generally grew, supporting demand for housing. At the same time, generally low housing inventory kept the home price declines, typically following mortgage rate increases, contained (though home prices softened in some areas that have experienced sharp home price increases within the last few years). As a result, home buyers returned to the market, and real estate investors continued to purchase properties or, in some cases, refinance investor property loans. DBRS Morningstar continues to maintain the view that home prices will not meaningfully decline unless an economic downturn forces many homeowners to sell their properties at below-market prices because of a protracted disruption or loss of income.

Also, in this report, DBRS Morningstar examines credit quality and performance of rated securitizations of investor loans underwritten to property-level cash flows or debt service coverage ratio (DSCR). Some market participants expressed concerns that for some such loans, the DSCRs may decline if an increase in property related funding costs, for example, because of rising mortgage rates, outpaces the growth in rental income. In this report, we evaluated select credit characteristics of DSCR loans in DBRS Morningstar-rated non-QM RMBS issued over the last two years and backed partially or exclusively by DSCR loans. We concluded that the credit quality of such securitizations weakened but remains generally acceptable because of the compensating factors such as meaningful equity and near prime borrower credit quality. Also, the performance of DSCR loans is generally in line with the overall performance of non-QM loans, which remains steady.