What’s next for private label market?

Sarah Wheeler: Welcome, everyone. This is Sarah Wheeler, editor in chief at HousingWire with the latest episode of the “HousingWire Daily” podcast. Today, I’m interviewing senior mortgage reporter, Bill Conroy, who covers a secondary mortgage market for HousingWire. We’re gonna talk about the rise of the private label market, the new conforming loan limits, which are very high and kind of into jumbo territory, and a recent report by Kroll ratings on risky loan review practices. Bill, welcome to the podcast.

Bill Conroy: Hey, good morning. How are you doing?

Sarah Wheeler: Doing great. So, excited to get to interview you today. And before we dive into our topics, I’d love to give our audience a chance to find out more about you. You joined HousingWire not that long ago, pretty recently, but you have decades of experience as a business journalist for weekly newspapers and magazines, and five pretty different cities, you know, so that’s Milwaukee, Phoenix, Minneapolis, St. Paul, San Antonio, and Seattle. And you served as the editor in chief of Scotsman Guide. You’ve also been an investigative correspondent for several online publications with national or international audiences on some really interesting beats, including the drug war, law enforcement, corruption, and national security. You have a very impressive resume of reporting on complex difficult topics, which is why we were so excited to have you join our team. So, how does that kind of experience inform what you do now?

Bill Conroy: Well, I get asked that question occasionally, and so I had to think about it. And the one common denominator across all those different beats and cities is I covered business. I mean, I could follow the money. I’ll put it that way. And so that’s really, even as an investigative reporter, that’s what you end up doing most of the time is, if you wanna get to the bottom of something, you follow the money. And that’s business reporting. So, I really think, you know, at the end of the day, that’s what I’ve been doing in my whole career, is business reporting, it’s just for applying those tools and techniques to different beats and different cities. That’s all. So, yeah, it has definitely been an interesting career. And I can see why people looking at it from the outside say, “None of that really makes sense together. What are you doing?” But, really, that is the beeline through it all. It’s just follow the money and do, you know, solid business reporting and let the readers interpret the facts for themselves as best as possible because what I’ve discovered too many times is when you step out in front of a story and try to be the expert yourself, that’s when things go south real fast. So, you gotta let the people you’re interviewing and the facts speak for themselves.

Sarah Wheeler: Well, I think that’s true. And also, just one of the really important things about business reporting that applies to any kind of reporting that you’ve done or that you’re doing for us, which is find the right people to talk to, develop a host of sources across different spectrums. I mean, that’s so important. And you’ve already done that. And the short time you’ve been with us, we’ve been thrilled with what you’re doing.

Bill Conroy: Yeah. Well, it’s a big world, though. I got… So, you wake up every day with more to do. And I guess that’s job security if you do it well.

Sarah Wheeler: Right.

Bill Conroy: So, it doesn’t stop. You never feel like you have enough sources. At least I don’t.

Sarah Wheeler: Well, you know, one of the exciting topics, so we hired you…really wanted you to do…you know, look at the secondary market. That was a part… When I joined HousingWire way back in 2013, we covered that pretty extensively, and then it kind of fell to the wayside there with different hires or different people coming and going. And we really wanted to beef up that coverage once again because that’s really… We wanna have all things housing. That’s our motto. And so we wanna take it through from, you know, the first way someone is starting to look for a house, all the way through the mortgage transaction to the secondary market where that loan gets sold.

And so, you know, one of the things…one of the exciting topics you’re covering for us is the non-QM market. We saw this market almost completely disappear. In the dark days of 2020, boy, that was scary, and, you know, people had to kind of pause there, originations there, but it made a huge comeback in 2021. And apart from jumbo and investment properties, which we’ll talk about shortly, we’re really seeing a jump because of gig workers and entrepreneurs. Right? So, these loans are harder to underwrite, but you recently report on some of the automation that’s targeting those kinds of loans specifically. So, what are some of the innovations we might see there?

Bill Conroy: To set the stage on that, one of the things that is expected to happen next year if rates bump up. And, again, controlled interest rate increases, you know, 50 to 75 basis points makes a difference in that market. So, we go to high 3s or 4% at the end of ’22 to ’22. That’s… And it’s controlled and not volatile. That’s actually very good for the non-QM market because it’ll push a lot of refies to the side, and then purchase loans, you know, are on the map, and non-QM does well in that environment because there’s a lot of loans that they can handle that maybe don’t fit into the agency box. And that’s why they think next year is gonna be big for them. This year already, you know, they’re looking at a $25 billion market for securitization. And next year, they think the potential for the market is, you know, up to $200 billion, some say $300 billion. So, to go from $25 billion, which was a great year for them to that level, they’re gonna have to… That’s where they think automation is gonna have to play a role.

So, it’s really in its infancy. And right now we know, for example, Angel Oak is trying to develop some kind of desktop underwriter, automated desktop underwriter, for non-QM loans. That shows up in a bond rating report on them. So, a lot of what’s going on is not necessarily out in the public yet. And I’m still reporting at it trying to figure out how they’re gonna do it because all these loans are a little different, right? Non-QM is not cookie cutter. So, to create any kind of automated systems for it is gonna take some doing. And I guess we’ll see how they accomplish that. But even if it doesn’t underwrite everything, like, if it just takes some of the tasks and automates them, like, even if it’s plugging in, you know, wrote information to save the underwriter’s time, that creates efficiencies that can allow them to keep up with the pace of the growth.

So, I would expect over the next few years in that FinTech space that we’ll see more coming out as to what kind of products they’re looking at, who’s developing proprietary products that actually work. And so that’s what I know about the automation. I know that Angel did make an investment in a FinTech. That one right now, I guess, is more for asset management for some of their clients. It’s not really directed at underwriting non-QM loans, but the desktop underwriter mentioned in the bond report, you know, that’s the kind of thing I think we’ll see more of moving forward into the next year in the next few years as that market grows. So, that’s, you know, more reporting ahead on that.

Sarah Wheeler: Yeah. Looking forward to seeing what you find there. I do think, you know, that’s the secret sauce for non-QM lenders is how they have figured out how to do that very complicated underwriting as efficiently as possible. And, I mean, those aren’t… Where we saw some originators in the last year, just staff up with, you know, like, pulling teachers in, pulling people who wanted a job change and teaching them to do that sort of really easy refi underwriting. That is not the case with these loans and with these companies. I mean, these are very experienced underwriters who get paid a lot of money because you need them. So, automation there is gonna be interesting.

Bill Conroy: Yeah. It’s true across the whole industry. There’s a push for automation. They’re using desktop underwriter the Fannie’s product to do jumbo loans. Well, Fannie is using that and, you know, the private label market. And there’s a lot of arguments for it. But the thing we don’t know yet is gonna take time is how those loans perform. And right now the market is such that it’s pretty low risk in the sense that prices are rising, you know, especially in a jumbo territory. Even if somebody did have to, you know, get out of their home for some reason or lost a job or something, the odds are that they’re gonna be able to sell their home for more than they bought it for. So, they’re not gonna be underwater like we saw back during the subprime crisis. So, maybe it is the time to try to integrate automation, and, you know, there’s a little more space for error right now than try to do it in a different kind of market. We’ll see. But time will tell.

Sarah Wheeler: Great points there. And let’s go now. Let’s talk about that private-label securitization market because we saw a huge boom in that in 2021, right? These securitizations are backed by jumbo loans and mortgages on residential investment properties. And we saw a huge demand spike during this pandemic era for that kind of buying, right? They also got a big boost from the PSPA changes put in place by the Trump Administration in January, which capped the number of mortgages on investment properties and second homes that can be bought by Fannie and Freddie to just like 7% of their acquisitions. So, those changes have been rolled back. And, of course, there are other economic factors, you know, in play looking forward. But what are experts predicting for private-label securitizations in 2022?

Bill Conroy: Well, you’re right. This year was explosive. I mean, it was double the volumes of the last two years, like, not combined, but each year, year over year. And next year, you know, I mean, who knows? I mean, there’s projections you could find all over the map, but when I look at the one that… I tried to do apples to apples when I’m comparing numbers. And the story I’m working on right now is based on the projections made by one of the bond rating agencies, Kroll. And next year, without giving away all the numbers because, you know, read the story and get those. But, essentially, next year is going to be a good year, but it’s going to be flat in terms of growth, I mean, relatively flat, there’ll be some growth. but that’s based on, you know, expectations of interest rates rising. And therefore a lot of the jumbo loans that were packaged in the loan pools for the private label market tissue, which really drove the private label market, that was, by far, the biggest volume of securitizations is in that prime jumbo space.

Those are expected to kind of taper off as rates bump up next year. And that’s because a lot of those were refied loans packaged in the loan pools, right? So, some of that’s going to dip off. And you’re right, the PSPA, the suspension of that cap in September, also going forward is gonna, you know, lower the volume, reaching the private label market is more that scooped up by the GSEs. And the same… I mean, with the loan limit increase. So, in a sense, the GSEs are kind of a governor, if you will, in the private label market, what they scoop up, the private label market can’t do. And that’s where there’s some tension maybe or at least questions around where’s the role of the GSEs versus the private label market? Where are those lines? And that’s, you know, something that ultimately, I think, you know, the least people in the industry think Congress needs to weigh in on to give some more direction and definition of where these markets start and stop. But that’s kind of the scenario for next year. All that could change overnight.

If the GSEs, you know, decide, you know, that they’re going to kind of address the loan limit issue or the PSPA returned to capping some of the investor property loans that they purchase and securitize. So, that overnight could change the volume and protection for next year. But as it stands right now, we’re looking at another good year, but not the same kind of growth that we saw this year. I mean, actually, let’s put it this way. At the peak of the private label market in the, like, 2005, 2006, just before the crash, it was nearly 60% of securitizations, right, in that RMBS space. I mean, that’s… And even I think industry leaders today don’t think we will return to that level and maybe shouldn’t. That might be too much. But, certainly, now it’s, you know, below 5%. Right? And I think they would argue easily could be doubled, if not a little more, maybe tripled and still the private label market would function well and serve as a, you know, competitive counter force to what the GSEs are doing. And it depends what you think about how the market should work, but more competition generally produces better results for borrowers because, you know, there’s competition and for rates and everything else.

Also, the private label market, the folks, the issuers anyone would argue, especially in the jumbo space, they have been very competitive when you look at rates that they can handle these loans. And the more that’s chipped away by the GSEs, you know, that kind of lowers…obviously, for their own self-interest, lowers their ability to make money. And the bottom line, though, is somebody’s gotta step back and look at what best serves the borrower and, you know, what best keeps the market functioning well and doesn’t, you know, let it get out of control like we saw. And that’s the boom and bust of the real estate cycle everyone knows about, and it’s a hard thing to control for, but that’s what we’re trying to do or at least what all the changes that have been made and will still be made are about, just trying to make the market function well and efficiently and not crash.

Sarah Wheeler: It’s so interesting because I’ve only been covering this industry. So, I joined HousingWire in 2013. So, for my entire experience with this industry is, you know, the GSEs have been in conservatorship. It’s been via that tiny private label market. So, it’s interesting to me to see this rev back up and look towards what that might be. Let’s jump into some of that. You talked about the tension on the conforming loan limits, right? So, the FHFA‘s new conforming loan limits, which, you know, they, generally speaking, have been going up every year. I saw a big jump this year because of the rise in home prices, right? But that raised my eyebrows among affordable housing groups and, you know, companies like Redwood Trust, which is a major player in the private label securitizations. So, Redwood Trust, you know, understandably has a business interest here. Right? But two of their objections were interesting from that larger perspective you were talking about about what is the government’s interest in these high-value loans, how do they best serve the borrower. You boiled them down to two main questions. So, maybe you could…the objections that Redwood Trust brought up, which were echoed by some affordable housing groups. So, maybe you can revisit those questions?

Bill Conroy: Well, I think the big issue that they’re kind of focusing on is when the GSEs put their resources into, let’s say, the jumbo loan market, like chipping away at that loan…making the loan limit rise. As a loan limit rise, it scoops up more of the traditional…the jumbo loan territory on a million… And I can… California where a lot of this is where most of the 50% of the jumbo loan securitizations in the private label market. And if you look through all the bond rating documents, they’re out in California where, you know, I think the median price is over $800,000 for a house, right? So, the people that are buying $1 million-plus homes in California, though, if you look at their income, and that was Redwood’s argument, you know, you’re talking about well-established middle to upper-middle-class buyers like $200,000 to $300,000 a year to qualify for those kinds of loans.

And so their question is, how does that serve the GSEs affordable housing mission? Because it does two things. One is they would say it diverts some resources that could better be deployed or at least attention that can better be deployed programs to get people in on the lower-end that don’t have $200,000 to $300,000 incomes that are actually, you know, struggling to buy homes at all. And the other issue with it besides the resources is there’s some argument that the private label market or private issuers have more experience in the jumbo space and actually are just as competitive as the GSEs, if not more so. And the GSEs, you know, have limited experience in that space. And the higher that loan limit goes, the more questions arise about, you know, are they cookie cutter? Can you really, you know, do these without some more experience? Are they gonna start making mistakes? And, again, we won’t know because, you know, the market… Everyone saw…

People forget that it’s not always underwriting that causes problems in the housing market. It can be like the tech sector went under a, like, the dot-com bust, and we saw a bunch of people lose their jobs in the West Coast due to that. That would affect the housing market here in a big way. So, we don’t know where the shocks come from. So, that’s one of their arguments. Let’s let the private label market do what it does best and let the GSEs do what they do best and let’s figure out what that is.

The other argument with the loan limit creep is, you know, where does it stop? Because it’s just gonna keep going up, and it somewhat supports higher prices. In other words, if the GSEs are underwriting these higher-price loans, then that means they’re easier to get generally because they’re, you know, pushing out more of these loans. And that kind of means that prices are supported. So, if there’s all kinds of buyers for these $1 million, $2 million homes because the GSEs are, you know, cookie-cutter, underwriting them, then that supports and props up those prices. They’re not gonna drop, you know, supply and demand. So, how much of that is true, I don’t know, but that is arguing around the edges that these higher loan limits actually prop up higher housing prices in the markets where they’re existing. And we’ll see what happens.

I think the new director or she’s the acting director who was just nominated to be permanent, Sandra Thompson, you know, has, I think, a real vision of advancing affordable housing in the country. It’s desperately needed if you look at cities like Seattle where I live. And it’s crazy how many homeless folks are here. And it’s because, in some measure, housing prices are just out of reach for the average person in many cases now. I, for example, couldn’t sell my home and buy a similar home. I’d be downsizing or even if I could get one. Even though my… So, we’re house rich, but we can’t move, right? And that also affects the housing market in terms of turnover and housing sales. So, somewhere along the line, we gotta get the balance right, and I think that’s what Redwood was trying to bring up. And I think Sandra Thompson, based on her comments, she’s open to reviewing it in the sense of she wants to look at that loan limits in the context of affordable housing. So, we’ll see what happens. There’s so much going on, so much polarization in the country that it’s difficult to see smart policy compromises coming out of Washington right now. But maybe this is something that can bring more people across the aisle together because it’s not really a Republican or Democratic issue. I mean, homeownership is just an American issue. So, there you go.

Sarah Wheeler: I love that positive optimistic take right there. Yes. So, this could be… Housing should be what could maybe bring us together more. I like that. We’ve seen such a change this year with the…from the… There was just sort of a whiplash from, you know, the Obama years to the Trump years now back to, you know, Biden where it’s like as far as regulation and as far as really having active regulators and active agencies in DC. So, it will be interesting to see how Thompson continues to address this. One of the things that you’ve brought up a couple of times is just like we’ll have to see how these loans perform. So, that loan performance when we’re talking about private labels market, different kinds of non-QM is really interesting. And you wrote a story last week on loan review practices in the private label market and some of the yellow flags that were being raised by KBRA on loan sampling. What did Kroll find troubling there?

Bill Conroy: Well, it’s kind of a geeky story. So, most people…

Sarah Wheeler: We love geeky stories. Listen, if you’re a housing geek, we want you to [inaudible 00:21:07].

Bill Conroy: I mean, what they brought up is a legitimate concern, but it also kind of runs up against the reality of how, you know, business works in the housing market and real-time. So, in a social science sense, which is statistics, loan sampling is something that’s become much more popular over the last year because of the volume coming through the market. So, if you got 3000 loans in a loan pool being securitized, basically, re-underwriting or examining every one of those loans again in time to get the issue to market, especially when there’s a stacking effect already going on where you’ve got multiple deals just stacked up because there’s not enough people to get all the work done. And that time costs money in that market. So, they’re doing a lot more loan sampling. So, they’ll pool a sample of maybe 300 loans out of a 3000 pool. And the idea is those 300 loans are representative of the whole pool.

And the best analogy here to try to get across the statistics part is if you had a classroom of 30 kids and you pulled out the 5, you know, most disruptive kids that had the worst grades, and then you did the average grade for the class, it would be higher than if you included and kept those 5 kids in there and included their grades. Now, at the end of the year, those kids might come around or three or four of them might come around and be A or B students, but, you know, you’re still kind of… When you pull those students out and measure at that point, you’re still creating kind of a biased sample. And that’s a concern that Kroll has is that what’s happening is these securitization pools are moving so fast, they’re sampling them, and then maybe, I don’t know, out of 300 loans that they’re sampling, maybe 10 they have to, you know, pull out for various reasons because they can’t get the review done, underwriting review done, in time where they’re coming up with, you know, Cs and Ds on them, but it’s for reasons that they’re pretty sure they can cure, you know, once they do a little more underwriting and investigating that those will pop up to A or B, but it’s just taking too long, so they pull them out of the sample. And then they’re rating the entire pool based on what amounts to a skewed sample.

How do you fix that? It’s a difficult thing because, you know, there’s not… It’s not like, oh, well, just don’t pull them out because then the deal gets delayed, and that can cause other problems. Do you do more disclosure in the bond reports? Because that’s one of the issues they brought up that it’s really the nature of the loans that were pulled, there’s not a lot of discussion about that normally in the reports from the due diligence firms that are doing this and then consequently in the bond rating firm.

So, that’s some of the discussion in industry. And then the third thing, I guess, is investors are already buying these bonds. They must accept. I mean, it’s a little more risk maybe, but they’re willing to take that risk. Do they really care? Is this really an issue? If it’s not an issue for the bondholders, then is it an issue for the industry? But, remember, this is my… I didn’t necessarily say this in the story, but these are just little things now, they can grow into bigger things, but one of the problems in the subprime crisis was toxic assets where a lot of bad loans were getting mixed with good loans and bought up by, you know, insurance companies and banks and everyone else that hold these bonds. And that contributed greatly to the crisis.

We’re nowhere near that. That’s not what this story said, but it’s one of those things where a good analogy and a story that the rating firm came up with was they talked about a researcher in World War II that was, you know, retained by the government to kind of figure out where to put the armor on planes because they were getting shot down over Europe and so forth. And the researcher made the decision to not put the armor… They were looking at the returning planes where the bullet holes were, and they said, “Well, let’s beef up, you know those places.” And he said, “No, no. We need to consider the planes that didn’t return. So, we should put the armor where the bullet holes aren’t.” In other words… And that’s kind of what, you know, we’re trying to solve for the last crisis or we’re always fighting the last war. I mean, the industry, you know, should not… It’s not likely the same scenario events that’s gonna ever happen again, but we’re gonna have different issues that we need to control for. And that’s kind of, I think, what the spirit of the Kroll report was trying to get across is that let’s pay attention to this now, figure out how we wanna handle it, and any issues we have like this, they don’t grow into big problems later.

Sarah Wheeler: It’s great to see something like that, you know, where we’re thinking ahead. This is a very reactive industry in many ways. And sometimes it swings back and forth. Sometimes I feel like people are stuck in 2008, and they’re afraid of the same things. It’s probably never gonna be the same things again. It’s gonna be variations on that theme, but, you know, it’s not like we’re gonna make those exact same mistakes again, but still, it’s interesting to see, you know, especially when it comes to loan sampling, especially when we’re looking at how we’re looking at the quality of those loans really important.

Bill Conroy: Yeah, yeah. And also just the…like, we mentioned the performance of the loans. It does appear in this particular segment of the market that we’re in that, you know, the underwriting is clearly far better, far better than it was back in the subprime era. And the nature of the loans, I mean, we can… The arguments over where the loan limits should be are pertinent, but these are still, you know, houses that are going to, you know, people with some means at that limit, the jumbo limit, and the houses themselves are rising in value. So, part of the reason the jumbo loan and the limits are going up is we’re seeing this precipitous rise in housing prices, which appears some initial reports as it continues to escalate next year.

And we all know why that is, to a large extent, it’s because we gotta build enough houses to supply the market at a level that keeps prices somewhat contained and not so volatile. But that’ll start to happen eventually, right? Eventually, there will be more housing supply, and that’s gonna have an impact. But we’re in a point in the market now where there’s not enough housing supply and there’s a lot of demand. And it’s interesting because I didn’t mention the gig workers completely, but the gig economy… I guess I’m part sort of the gig economy now. Well, not completely because I do have a payroll job. But those people that don’t have payroll W2 jobs are all non-QM territory. And there’s a lot of people out there like that. And they’re not all buying in Seattle or all these hype-price cities. I mean, now they can live wherever they want in this economy.

The COVID world has created some different dynamics. So, markets that were… Markets that traditionally didn’t attract buyers at the level they are now, that’s changing widely. I can live in the country if I want to still do this job. And so it’ll be interesting to see how that works out. And that’s where the non-QM market is gonna play a role as the gig economy, the non-W2 economy expands, and it’s still growing. Those are all home loans that they can make, and they’re gonna be made in all different parts of the country now the way things look. So, it’s an interesting era. And I expect, you know, we’ll see some major landscape changes in the housing market in the next 5, 10 years assuming, you know, things stay on this track. And we continue to work as, you know, kind of self-employed gig workers and as technology makes, you know, where you work less and less pertinent.

Sarah Wheeler: Now, great points all. And I actually love that you’re in Seattle at some of the heart of this, right? So, much of the housing story. You’re a representative of that West Coast, a very expensive market you live in. So, I’m sure that helps with your lived experience there. But, Bill, so appreciate you taking the time to talk about what you’re reporting on. And we’re excited to see some of these articles you were talking about that are gonna come out over the next couple of weeks. Thank you so much for being on.

Bill Conroy: No, it’s fun. I appreciate it.

Sarah Wheeler: We’ll do this again. We do this every day on “HousingWire Daily.” We talk to our reporters about what they’re covering and the stories that our listeners need to know. And for our listeners, you can check out those coverage on housingwire.com. His articles are only available to our HW+ members. Well worth it just to read his articles, and we’ve got other people as well on that HW+, you know, reporting bit. So, thank you so much, Bill, and we will talk to you again.

Bill Conroy: Okay. Take care.