Nondepository origination of home equity products has been growing as traditional mortgage opportunities have waned, leading to increased reliance on secondary market buyers whose interest may vary over time.
And while investors' collective involvement has generally kept pace with increased production as lenders have originated more second liens,
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A key way to manage this risk has been for nonbank sellers to ensure they and any aggregators they partner with have multiple outlets for home equity products that include both the securitized markets and whole loan buyers, according to Tom Davis, chief sales officer at Deephaven Mortgage.
"The last thing you want to do is work with an investor that has only one exit," Davis said. "If the market goes sideways, you're in a pickle, so it's always important to work with an investor that has diversified execution because you want liquidity."
What investors want from home equity underwriting
Key to investor interest in home-equity loans and lines of credit is whether they think the borrowers involved are likely to repay.
Borrowers with lower combined loan-to-value ratios, which measure the extent to which their homes have value beyond their first- and second-lien debt, are one indicator of this. A ratio of their broader debt obligations relative to their incomes and their track record repaying the former are two others.
"There's definitely investor demand for second liens. They like performance. They like the collateral," Davis said.
Recent performance has been strong and what little distress exists has been manageable because there is favorable secondary market demand for distressed product with a demonstrable track record and strong underwriting, said Ryan Chernis, vice president of capital markets at Achieve.
"Our strategy is we generally charge off loans after 120 days past due. We don't work loans to foreclosure. What we do is we generally sell those charge offs, and we're seeing charge-off pricing in the 65 to 75 cent range, so a really strong recovery profile," he said.
Chernis said that isn't something that rating agencies are currently paying much consideration to but could be soon as the current iteration of the small but growing HELOC market develops more of a track record.
"Right now, most rating agencies for us and our peers in the rated markets generally don't give any credit to recovery, so they're receiving 100% severity, which is just not the reality," he said. "Hopefully, as more time goes on, they see that data. We can start to get some support for those recovery numbers."
Rating agency approaches to home equity securitizations vary
Rating agencies have a variety of strategies in their approaches to home equity securitizations. That's significant in that certain investors will only buy bonds that have particular ratings from specific companies. Some players like Fitch only rate part of the market.
"We've said no to a lot of product," said Court Lake, a senior director at Fitch, which has focused primarily on rating securitizations of closed-end second liens underwritten based on traditional full-documentation standards as a growing number of players have
Fitch does not rate home equity investment involving sales of shares in future appreciation, citing risks that include
Securitizations can get done without getting acceptance from the big three but having it does increase the range of investors interested in the bonds, which as Davis noted, can be helpful when interest in the secondary market can fluctuate.
Todd Stevens, chief capital officer at Figure, said securitizers with that fit into a tighter credit box can differentiate themselves.
"There's a scarcity of quality collateral," he said.
Rating agency opinions may improve as the current iteration of the home equity market matures.
Figure brings prefunding to the new HELOC market
One sign that the secondary market for home equity lines of credit is getting more established was
The securitization included a tranche with a top AAA rating and received interest from 17 investors, including asset managers, private credit funds and insurers. It was the first of its type in over 15 years and the company could use the practice more regularly in the future, the company said.
"If we can presell a security, we think it opens up the investor box a bit," said Todd Stevens, chief capital officer at Figure, noting rated prefunded securitizations offer efficiencies to buyers who trust a AAA rating.
The practice aims to help Figure deepen the business it does with companies that are traditionally whole loan investors such as insurers and annuity providers.
Both whole loan trades and securitization active, TPO growing
Home equity products have been in demand both in the securitized market and from whole loan investors, and that's helped fund nonbank originations of the product that have been expanding into a variety of loan channels.
"On the whole loan side, we are generally four to five times over subscribed monthly on what we're producing so we want to meet that demand," said Chernis.
Achieve has been focused on direct-to-consumer and is looking at expanding into third-party origination channels in the second half of this year, he said.
Deephaven has been growing in TPO channels too. For example, it recently added a product for correspondents that allows borrowers to take out a second mortgage on their investment homes to purchase a new property or make renovations on an existing one.
How to weigh the secondary market risks for home equity
So long as underwriting and performance remain strong, the secondary market will likely be, too.
But more jolts from developments that cause uncertainty in the broader capital markets are always possible, and there are some signs financial strain on consumers is growing, which could affect the latter. Also,
Fitch has recently determined home prices to be 11% overvalued and baked that into its ratings for home equity securitizations, according to Lake.
However, there are some trends that help offset some of these risks. Amortization of existing first-lien loans has helped reduce CLTVs and home equity products can have an advantage compared to other types of debt when consumers experience strain due to their collateral and relatively lower rates.
"Unsecured consumers generally tend to be more sensitive to inflationary pressure, jobs, and I think in this particular environment, investors are attracted to the secured nature," Chernis said.
