Deephaven's Tom Davis on hedging, lock policies, and what to check before choosing a lender
As more brokers and loan originators turn to non-QM loans to solve a myriad of challenges in the current market, new non-QM lenders are popping up across the market.
Some non-QM lenders, both established and new, have been able to beat agency mortgage rates for their loans. And while the established ones understand the mechanics behind offering a lower-rate loan, that might not be the case across the board.
A non-QM lender advertising a rate well below everyone else's may not be able to deliver it once the market moves.
That is the lesson one executive draws from the lenders that came in with aggressive pricing over the past six months and got caught when rates moved.
Tom Davis (pictured top), chief sales officer at Deephaven Mortgage, said brokers should look closely at how a non-QM lender has handled rate swings.
"I think in today's environment, when you're in the non-QM or equity space, non-agency, you want to work with an investor who has a proven track record, that's disciplined, that's been able to manage the volatility," Davis told Mortgage Professional America.
How low rates go wrong
Sprout Mortgage, a non-QM lender, shut down abruptly in July 2022 after the rise in rates left it with loans it couldn't sell at par. It was the second non-QM lender to close within weeks, following First Guaranty Mortgage Corporation.
"Rates took off, and some folks were sitting on loans, and they ingested loans that were at these lower note rates, and they had to sell at a loss," Davis said. "Some guys went out of business."
Non-agency lending is now about 20% of the market, Davis said. Optimal Blue's September data showed non-QM lock volume up 8% from August while total volume fell 2%.
One of the reasons for the move involves changes to condo lending. Fannie Mae retired its limited condo reviews in August, so many established buildings now need a full review. Reserve requirements for those reviews rise from 10% to 15% of the annual budget on Jan. 4, 2027.
“That’s going to knock out a lot of projects,” he said. “So that’s all going to go private label.”
Growth like that attracts new lenders. Some of the newest set out to win volume quickly.
"There were a couple entrants over the last, let's call it, 6 months that they wanted to grab market share and they came in with these lower note rates and the market moved, and they ingested all this low note rate stuff," Davis said. "Now they're trying to sell it on the market, and it's not trading where they thought it was going to trade, and they weren't hedged.
“And hedging non-QM is not simple like hedging agency or Ginnie. You have to hedge against spread risk, duration. It's complicated."
Davis said Deephaven has managed that risk for years. The cost of skipping that work has shown up in secondary market pricing.
"There's guys that weren't hedged at all, and they're sitting on these lower note rates," he said. "And now they're selling loans that they thought they were going to make 102, 103. Now they're selling them at like 98."
What to check before locking
Ginnie Mae securitizations in the third quarter came in below the first quarter, Davis said, and the first quarter is typically the slowest of the year. Some lenders are responding to that squeeze by altering the terms brokers thought they had.
"I've seen some folks that change their lock policies and not honoring certain things and change their extension costs, doubled them overnight on the existing pipeline," Davis said. "And there's guys in the non-QM space that were aggregating loans, not locking them, and they were sitting on these large pools of loans. Now they go to sell, and the market moves against them."
That is how a bad sale becomes a problem for borrowers waiting on a closing. Davis said the damage spreads past the lender's own books.
"If you take a loss, or you're sitting on loans you can't sell, then the warehouse guys, you're going to break warehouse covenants, and then there'll be margin calls," he said. "And then either cut your line or you lose the ability to fund loans."
Layoffs are already moving through the industry, and Davis expects more consolidation, including among non-QM lenders. He said some non-agency lenders lack the discipline for this market.
"You want to work with someone that has the expertise, the knowledge, the focus, has the track record, has diversified execution on the back end," Davis said. "You need to be able to rely on someone as a partner."
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