Non-QM Sector Set for Growth as Banks and Insurers Reenter Market

In 2025, the non-QM sector is set for growth as banks and insurance companies diversify and increase investments in this evolving mortgage market.

A Transformative Landscape for Non-QM Investments

The non-qualified mortgage (non-QM) sector is on the brink of a transformation in 2025, as banks and insurance firms start to reengage with a landscape that has changed dramatically since the 2008 Global Financial Crisis.

Over the past sixteen years, the market for structured products has evolved from being dominated by large banks to becoming a bustling space for a spectrum of participants.

Insurers are keenly pursuing stable, long-term debt investments and are collaborating with managers specializing in originating, securitizing, and selling mortgage-backed securities.

As this landscape develops, there is increasing interest in alternative assets, with non-QM securitization emerging as a favored avenue for investors in search of better yields.

Growing Interest in Non-QM Loans

Non-QM loans primarily serve the needs of entrepreneurs and self-employed individuals who might not have the traditional documentation demanded by Freddie Mac and Fannie Mae for standard mortgages.

These loans are attractive, characterized by robust credit profiles, low loan-to-value ratios, and consistent origination patterns.

Industry trends suggest that more players will enter this space in the coming years.

Traditionally, life insurance companies have proved hesitant to invest in the residential mortgage arena.

However, the arrival of private equity has shifted this perspective, encouraging cash-rich insurers to explore private debt assets that can yield higher returns, despite their illiquidity.

As regulatory pressures and challenging market conditions have led traditional banks to scale back private lending, insurance companies have stepped into this breach, positioning themselves as some of the largest private debt investors globally.

While data from 2022 indicated that approximately 10% of private debt was allocated to real estate, a significant fraction of that was directed toward non-QM loans.

The Road Ahead for Banks and Insurers

The complexities and high operational costs associated with residential mortgage loans have previously discouraged many investment firms from entering the fray.

However, the surge in non-QM lending is prompting insurers to reevaluate their investment strategies.

Stronger regulatory frameworks introduced by Dodd-Frank and subsequent legislation have bolstered investor confidence, cultivating a vibrant entrepreneurial spirit within the non-QM sector, which is rapidly gaining recognition as a legitimate long-term investment asset.

The share of U.S. mortgages composed of non-QM loans has seen a substantial increase, rising from under 3% in 2020 to an estimated 5% by 2024.

The risk of borrower delinquency appears minimal, owing to stringent underwriting standards and the overall quality of the borrowers involved.

Since 2018, cumulative losses in this sector have been reported at a mere 0.02%.

Investors can access this asset class through wholesale loans or securitized debt, with non-agency non-QM Residential Mortgage-Backed Securities (RMBS) issuance hitting $66 billion last year.

Moreover, the ability to leverage residential mortgages using Federal Home Loan Bank financing further enhances their attractiveness to insurance firms.

Banks are also eyeing opportunities to re-enter the non-QM space as the regulatory environment shifts.

The incoming administration has expressed support for deregulation, a stance that could significantly benefit smaller, regional banks that have recently consolidated.

A notable change made during the previous administration raised the threshold for defining a systemically important bank from $50 billion to $250 billion.

This adjustment has alleviated some of the constraints on numerous banks, enabling them to explore a wider array of revenue-generating opportunities.

However, capital requirements imposed by regulators have often discouraged deeper involvement in non-QM lending, as these rules dictate how much capital banks are required to set aside based on the credit quality of their asset portfolios.

Potential changes to Risk-Weighted Asset (RWA) requirements could further ease capital reserve requirements for banks willing to invest in non-QM options.

If banks increase their participation in the non-QM sector, there may be a growing focus on wholesale loans, which currently offer more favorable capital treatment than lower-rated bonds.

This strategy allows banks to concentrate their investments in particular geographic regions, providing a significant advantage for regional banks targeting local markets.

Many institutions are investing in specialized residential mortgage securitizers, like Imperial Fund, which prioritizes non-QM loans—particularly appealing to regional banks looking for cost-effective investment strategies.

Separately managed accounts (SMAs) are emerging as a preferred method for many insurance companies, enabling them to delegate operational costs to expert managers such as Imperial Fund, who oversee due diligence, loan sourcing, and management.

In conclusion, the convergence of these factors suggests that banks and insurance companies are set to increase their activity in the non-QM sector.

Consequently, 2025 is poised to be an exciting year for the non-QM market, as new participants contribute to a diversifying and expanding landscape.

Victor Kuznetsov is the founder of Imperial Fund Asset Management.

Source: Housingwire