Issuance of securities backed by riskier US mortgages roughly doubled in the first quarter from a year earlier, as investors lapped up assets blamed for bringing the global financial system to the brink of collapse a decade ago.
Home loans to people with scratches and dents in their credit histories dwindled to almost nothing in the aftermath of the crisis, as litigation-weary lenders retreated to patch up their balance sheets. But over the past couple of years a group of specialist firms has begun to bring the loans back, navigating a dense web of new rules drawn up to protect borrowers and investors in the $9.3tn US home-loan market.
Last year saw issuance of $4.1bn of securities backed by loans that would have been called "subprime" before the last financial crisis, according to figures from Inside Mortgage Finance, with the pace picking up in the latter half of the year. The momentum has continued into 2018, with deals worth $1.3bn in the first quarter — twice the $666m issued in the same period a year earlier.
"The market is . . . starting from such a small base that it has a lot of room to grow," said Jamshed Engineer, a partner at Axonic Capital, a New York hedge fund with more than $2bn in assets under management. "[Investors] are definitely chasing yields. Whenever these deals come out, for the most part, they are oversubscribed."
Matt Nichols, founder and chief executive of Deephaven Mortgage of Charlotte, North Carolina, has bought about $2bn of non-prime loans from a network of 100 or so brokers, and has re-sold about $1.2bn of that into the mortgage-backed securities market. He expects issuance of nonprime MBS to top $10bn this year.
"The originator appetite to produce more of it is growing," said Mr Nichols, who spent more than a decade running the residential mortgage business at Goldman Sachs. "It's a question of loan officers learning about the availability of the products again and . . . being willing to teach realtors and borrowers that there is more credit available."
The loans in these deals go under a variety of names and range all over the US. But what they have in common is that they are not eligible to be bought by Fannie Mae or Freddie Mac, the government-backed mortgage enterprises, or to be insured by the Federal Housing Administration, which supports first-time buyers. As such, they're often identified as "non-QM" loans, or non-qualified mortgages.
More lenders could be tempted into the non-QM market, say analysts, as they grow more comfortable with the regulatory environment and as they look to offset business lost from mortgage refinancing, which tends to fade while interest rates rise. Kroll, the rating agency, expects issuance this year of about $6bn or $7bn of bonds backed by riskier mortgages.
Some analysts say the deals are safer than the ones that tested the financial system last decade. For one thing, under Dodd-Frank reforms that took effect in 2015, sponsors of riskier mortgage-backed securities deals have to retain at least a 5 per cent interest in the pools of loans they offer. Since 2014, every mortgage lender also has had to take account of a borrower's ability to repay the loan.
Even so, the new regime seems to be allowing loans to reach borrowers with limited room for manoeuvre. DBRS, another rating agency, notes that some non-QM MBS deals have featured borrowers with scores as low as 500 on the 300-850 "Fico" scale, which is deep into subprime territory.
Angel Oak, an Atlanta, Georgia-based firm, is presently marketing a $329m non-QM deal, easily its biggest to date. One-tenth of the loan portfolio, which is concentrated in Florida, Georgia and California, comes from borrowers whose credit reports show multiple delinquencies within the past year, according to DBRS.
"These loans have gone through due diligence and [credit scores] are much higher, and loan-to-value ratios lower, than what we've seen in the past," said Sujoy Saha, analyst at Standard & Poor's.
S&P is back in the non-prime market, three years after paying $1.4bn to settle allegations it issued overly rosy ratings on MBS in the run-up to the crisis, in order to win more business.
"The risk is contained, in our view," said Mr Saha.