For decades, the types of investors that purchased mortgage-backed securities (MBS) were typically institutions – large broker-dealers, the government, insurance companies, endowments, etc. MBS, by themselves, were never really intended to be a retail product – they have typically been acquired via bulk transactions.
In recent years, however, new variations of MBS, including collateralized mortgage obligations, or CMOs, have opened the door for these securities to be made more widely available to smaller investors via a range of channels. Technology and, in particular, the advent of peer-to-peer platforms have resulted in new opportunities to bring MBS to a wider swath of buyers – only in smaller “slivers.”
Considered by some to be an “undiscovered gem,” an MBS can provide safe income, as well as the opportunity to get some capital appreciation as interest rates fall. Another advantage to these securities is that they are very suitable for most tax-deferred savings accounts.
A new start-up, Income&, seeks to capitalize on this “undiscovered gem.” The fintech has built a peer-to-peer platform that enables it to sell its own, pre-vetted CMOs on a retail basis to smaller, fixed-income investors.
According to Brad Walker, CEO and co-founder of the San Francisco-based company, the goal is to “reinvent the idea of fixed-income investing” by delivering a new kind of mortgage-backed investment product with high yields and low risk. Basically, the firm is doing the “polar opposite of what the banking industry has been doing for many years.”
“Largely, what we are is tech-enabled financial services,” Walker told MortgageOrb during a recent interview. “Ultimately, what we’re doing is accessing the mortgage market in a whole new way in allowing retail investors – right now, just accredited investors – to buy into mortgage debt and build a portfolio in a way that they never could before.”
Walker says the firm has put together a team of accomplished financial services and technology veterans, who have been hard at work developing the Prime-Rated Individual Mortgage-backed Obligation, or PRIMO, which it plans to officially launch later this year.
Currently in soft-launch, the PRIMO is a high risk-adjusted yield alternative to existing investment options, especially those backed by hard assets. As Walker explained, each PRIMO is backed by a high-quality, prime-rated residential mortgage, but unlike traditional mortgage-based investments, PRIMOs seek yields of 6% or better. This is possible because Income& has focused entirely on the non-qualified mortgage (non-QM) space, a growing market that is currently inaccessible to the vast majority of investors.
Walker reports that so far, the firm has raised $2.9 million, which it is now deploying to acquire prime, nonconforming mortgages for its inventory.
“Ultimately, what we have done is solved a major problem in this country,” Walker said. “We have the largest population, the baby boomers, either in retirement or moving into retirement, and it’s happening at a really unfortunate time in that the fixed-income assets that they would typically buy to support their retirement are yielding at historic lows – things like century bonds, muni bonds, corporate bonds, etc. In order to get better yields, as a retail investor, there have been some exciting new options with peer-to-peer lending, but to get those better yields, you are going down the risk curve quite a bit – and that profile does not really fit a retiree.
“So, the challenge was, how do we build a product that offers a compelling adjusted return and [that] we would be comfortable selling to our own parents?” he said. “We looked at what [the peer-to-peer] lenders had done from a transparency standpoint, and a technology standpoint, of allowing investors to buy tiny fractions of individual notes because with technology, you don’t really need to take them on with a management fee, like, to manage a fund or a pool. So, we got that aspect of it. But we said, ‘How can we take that out into the marketplace?’”
Ultimately, Walker and his team set their sights on the residential mortgage debt market – in particular, “high credit areas that were no longer conforming.”
“And we did that for a number of reasons,” he explained. “First of all, historically, in the prime and high credit space, it has held up very well – when used responsibly – and I think that caveat needs to be there. And, we have another really interesting opportunity that has arisen from the regulations that came out of the financial crisis – with the limiting of what the federal agencies could buy – that tightening of the definition of what they could buy.”
One particular area within the non-QM space that the firm identified as being a strong opportunity for growth is the emerging nonconforming, self-employed or “thin file” borrower market. Fannie Mae, with lenders to follow, is now allowing the use of trended credit data in the underwriting of underserved borrowers, including the self-employed, who have largely been shut out of the mortgage market because they’re not W-2 wage earners. Yet, these self-employed borrowers are often high-income, high-net-worth, high-FICO, low-debt-to-income individuals – thus, the loans are far less risky than the nonprime loans of the pre-crisis years.
“These are very high credit borrowers, but they are paying a two- to two-and-a-half-point spread for these performing mortgages – and that gives us an opportunity to get good yield out there – but yield that we believe to be very safe,” Walker explained.
The genesis for the idea came while Walker was working for PENSCO Trust, a self-directed IRA custodian with more than $12 billion in assets. There, he witnessed the meteoric rise of the peer-to-peer mortgage marketplace.
“I come from the more traditional side of finance, but our main asset classes at PENSCO were private company stock, tangible real estate – investment properties – and promissory notes, hard money lending,” he said. “It was an interesting time. And when I saw the [peer-to-peer] marketplace forming – and the success of Lending Club and Prosper – it was really interesting to us because what they had ultimately done is just figure out a way to [secure] unsecured promissory notes. So, we started thinking, ‘Gee, collateralized debt is usually a better investment – and why isn’t anyone going after that market?’ That was really the genesis.”
Walker said he and his team “spent a year and [a] half speaking with everybody from SEC commissioners to lobbyists to figure out why nobody had ever done this.”
But what of the headwinds the non-QM market has been facing? For a variety of reasons – rising interest rates being one – not every investor is so confident in this market.
“That is an observation that we had, as well,” Walker said. “Early on, there was a lot of hype and excitement about the potential growth and formation of the non-QM market. I think it has formed decently. We see some liquidity starting to enter that market – and people seem to be more excited about it. We believe that that market will continue to form. But for right now, we’re fairly small, and even with a tiny fraction of what’s already being originated, we can build a very successful business. And as that market forms, we believe we can scale along with it.”
When asked whether Income& will play any type of role in stimulating the non-QM market – whether through marketing or thought leadership – Walker said, “Yes, absolutely, at some point we will play that role.
“The main educational role I see us playing is in educating the retail investor population,” he said. “Most mortgage investment, historically, has been done by institutions – it was never a huge retail product. So, a lot of our job will be getting individuals to understand what our product is, what the market looks like and how our technology enables it all.”
Walker is quick to point out that Income& is “not an originator,” nor does it modify or “cure” any of the loans it buys post-acquisition.
“What we do is we work with a number of mortgage originators and some aggregators, and we buy closed loans,” he explained, adding that the firm handles due diligence in-house and also uses a reputable third-party review firm. “So, what we’re doing is making sure that the mortgages we buy fit our standards – and then if they do, we acquire them, and we fit them into our product. We are a window for liquidity for the originator market.”
Of course, the big question is, is now a good time to be launching this type of product?
“We knew that introducing a new mortgage-backed product to a retail market right after the biggest housing market crisis that we’ve had in a very long time was going to be a really big challenge,” Walker said. “I think a lot of the mistrust in that market stems from the fact that people didn’t know what they had, ultimately. The opaque funds structure became problematic – and it was abused.
“So, what we wanted to do [was] just take the good [performing] loans and make them incredibly transparent,” he continued. “So, if you come onto the platform, you can look at all the inventory we have, and we will show you the borrower’s credit score, the borrower’s down payment, the borrower’s debt-to-income, where the property is, how much in reserve they have, why they were getting the loan, was it first-time purchase or a refi – all with the ultimate goal to make sure that people understand what they’re buying and how it is performing, all on a per-mortgage basis.
“I think right now is a really good environment to be starting this,” Walker added. “The spread that we have right now between conforming and nonconforming high credit space is favorable for us. I think as the market changes, we will see compression between the two, from a mortgage rate standpoint. But I think our constraints right now are more internal than they are market-driven. As a smaller company, we have a pool of capital that we’ve raised to acquire loans – that’s a constraint – and we’re working to deploy that now. Meanwhile, we’re working on raising a larger pool of capital so we can really start building programs with our lending partners and start taking on more volume.”
Income& also puts a proprietary rating on each loan. Users can filter loans to buy based on credit score and other criteria. Critical to its initial success, investors can buy into any of these PRIMOs for as little as $100 per loan.
“So, it lets investors tiptoe into it and get comfortable before they put more money in – and we think that’s really important,” Walker said.
Although the product is still in “soft launch” mode, Walker says it has already been receiving a lot of attention.
“Largely, most of the interest has been coming from the baby boomer generation – because that’s really who we’re targeting with this,” Walker said. “And so far, the response has been really validating.
“From what we’re seeing, the first movers coming to us are people who have invested in other marketplace lending sites and they’re comfortable with the fractionalized loan concept – and they’re apparently very motivated,” he added. “The other channel that we believe will be the largest channel for us is the independent registered investment advisor segment; these are financial advisors who are not part of the big broker-dealer organizations. They’re often smaller shops that have broken off from the big broker-dealer and wealth management firms because they wanted the flexibility to put people in the best investment products they can find. And they can go into alternative assets. We’re also getting pretty good interest from our RAs – all I can say is, it’s a big and growing market.
“I think we are very compelling when compared to other traditional fixed-income opportunities for investors, and we’re seeing rates right where we hoped they would be, from a product standpoint,” he added.