2022: The Year Investors Start Paying Attention to Residential Bridge Lending

Institutional investors, starved for yield in the current low interest rate environment, which persists with no end in sight, have come back to the RMBS space in a big way. Investors have poured into mortgage backed securities, including non-qualified (non-QM) and non-prime securitizations – the rebranded versions of subprime lending that sparked the housing crisis. In fact, senior tranches of such securitizations have consistently received AAA ratings and issuance is routinely oversubscribed. This renewed interest, despite the pain of the subprime crisis that still roils public discourse ten years later, has bolstered the non-QM and non-prime securitization market from effectively zero to tens of billions of dollars in annual issuance in the span of about five years.

Make no mistake, it is not just low yields fueling the rapid resurgence of non-agency MBS, it is also the fact that credit quality, regulatory oversight and risk retention have dramatically improved in the post-crisis period.

Now there’s another burgeoning asset class catching the attention of investors that offers higher yields and a lower risk profile than non-QM lending – residential bridge loan securitizations. Residential bridge loan securitizations, sometimes called “fix and flip,” have only been in existence for about three years, but the performance has been outstanding with negligible losses, and the unique characteristics of the underlying loans creates the potential for extremely attractive risk-adjusted returns. Many investors are quickly realizing that residential bridge securitizations pay off more quickly, have lower LTVs and higher average FICO scores than non-QM issuance. But because the asset class is so new, rating agencies haven’t caught up to develop a rating criterion. As a result, investors in unrated residential bridge securitizations are being paid a premium. But before expanding on the credit characteristics of residential bridge securitizations, it’s important to highlight the structural differences of residential bridge loans and how they benefit investors.

Drawing down risk
First, the draw process, by which a portion of residential bridge loans are funded, helps ensure loan performance. Beyond credit checks and related due diligence performed at the time of initial loan funding, residential bridge borrowers are required to substantiate renovation progress of their investment property before they can draw on the full amount of the loan in lock-step of value creation. The loan is de-levered through value creation upon completion of work (see Figure 1). For example, a bridge borrower that purchased a $300,000 home and intend to increase the home value to $450,000 by upgrading the bathroom and kitchen (i.e. business plan), will only get $225,000 at initial funding and upon substantiation of rehabilitation completion and professional inspection to ensure progress as intended, will be able to draw on the additional $67,500 of the maximum loan amount.