are moving back into a corner of the mortgage market where new home loans to borrowers with imperfect credit are being packaged into private bond deals.
The two banks are following the lead of JPMorgan Chase
which have already restarted similar programs to expand credit to homeowners, including using alternative means to verify income.
That might bring to mind “ninja loans” of the past, where mortgage loans went to borrowers with no-income, no-job and no-assets, but investors say the new breed of mortgages and bonds are a big improvement from the old subprime market that imploded in the 2008 financial crisis.
“We continue to be excited about, and focused on, developments within the ‘next generation’ non-agency mortgage markets, Greg Parsons, chief executive officer of Semper Capital Management, a $3 billion fund with a mortgage bond focus, told MarketWatch.
“Citigroup and Credit Suisse are both examples of issuers/bank institutions that traded these non-agency mortgage securities during and after the crisis, and they have remained involved in various facets of issuing transactions within mortgage sectors.”
“Non-agency” is what Wall Street calls the small, but growing part of the mortgage market where home loans are pooled into private-label bonds without government backing from Fannie Mae
or Freddie Mac
Wall Street had been pumping out several trillion dollars worth of private-label mortgage bonds each year before the 2008 financial crisis, but since then the U.S. government has kept a firm grip on American mortgage finance, including through guarantees it provides to the $6.7 trillion “agency” mortgage bond market.
Fannie Mae, Freddie Mac, and other U.S. housing agencies issue agency mortgage bonds, which currently make up more than 60% of the $10.9 trillion mortgage debt market, according to data for July from the Urban Institute.
Private-label mortgage bonds accounted for just 4.2% of the financing pie for the same period.
The bonds that Credit Suisse and Citigroup are issuing make up an even smaller “non-qualified” or “non-QM” portion of the private-label bond market.
Non-QM is a catchall for home loans that fall outside of stricter “qualified mortgage” standards set by regulators in the wake of the foreclosure crisis, which aim to make mortgages safer and easier for borrowers to understand.
Adjustable-rate mortgages, which can reset at higher rates and squeeze affordability for borrowers, are an example of non-QM loans. Mortgages to self-employed borrowers with harder to document income are another type. Both kinds of loans have grown in popularity in the past few years.
Credit Suisse and Citigroup declined to comment about their bond sales.
But analysts at Bank of America Merrill Lynch, in a recent note to clients, said the addition of Credit Suisse and Citigroup reinforces their forecast for $21 billion of non-QM bond supply this year.
This Bank of America chart shows the upward trajectory of non-QM issuance each year since 2015.
So far, the new breed of bonds has seen solid performance.
In July, Fitch Ratings said that newer types of mortgage products were “fairing well so far.”
But the credit rating agency also warned that relying on alternative income documentation instead of full tax returns for self-employed borrowers was an “area to keep an eye on,” particularly since its usage in non-QM deals had nearly doubled since 2016.
“It is a much healthier market than in the past,” said Paul Norris, head of structured products at Conning, a global investment firm with $145.5 billion of assets under management, in an interview with MarketWatch.
“I think the big banks will take baby steps in the market, but they have a big advantage over private equity and hedge fund lenders in the space, because if they turn on the lending spigot, they already have the infrastructure in place.”
Major investment banks often have research analysts, secondary bond trading desks, and warehouse lines that can help support the production of new mortgage loans and bond deals.
Hedge funds, private equity and asset managers, recently including a fund managed by Pacific Investment Management Company (PIMCO), had been quicker to lend to less pristine borrowers in the aftermath of the housing crisis than major banks.
Now the sector could see a spike in activity as big banks jump back in.
“They are much more vertically integrated,” Norris said of the capacity of major money-center banks to ramp up originations.
By this time last year, most big banks had resolved multiyear investigations by U.S. regulators into their role in creating toxic mortgage bonds in the run-up to the 2008 crisis, a potential reason for their slow return to the market.
For its part, Credit Suisse now looks to sell $355.8 million of non-QM bonds of mostly adjustable-rate mortgages on homes predominantly in California, according to Kroll Bond Rating Agency.
Kroll gave the bulk of the Credit Suisse bonds its top Triple A ratings, but it also warned that adjustable-rate loans can “result in payment shock,” that can be “significant, particularly for those originated in a historically low interest rate market.
More details on Citigroup’s mortgage bonds are expected, but investors said its transaction also has a high concentration of loans on California homes, which can bring their own set of disadvantages.
Geographic concentrations can “expose a transaction to larger impact from regional economic effects or natural disasters relative to more nationally diverse pools,” Kroll wrote of its assessment of the Credit Suisse bond report.