By Tim Rood
Tim Rood is Head of Industry Relations for SitusAMC.
Leading up to the Covid-19 crisis, U.S. housing market fundamentals were quite strong, driven by historically low interest rates, limited supply, a growing pool of Millennial buyers and the longest economic expansion on record. In less than 60 days, the landscape has radically shifted due to the direct impact of Covid-19 and the resulting economic shutdown, as well as indirect consequences of the government’s response to the crisis.
Prior to the Covid-19 crisis, about 80 percent of mortgage market was comprised of government-backed loans. Today it’s closer to 95 percent, because the market for jumbo, prime and non-QM loans, which have a variety of different proxies for credit worthiness and capacity, has essentially shut down.
The impact of job losses and increased delinquencies is not a new phenomenon in the mortgage market, especially after the Great Recession. As economic conditions worsen, the market begins to price in expectations for non-payment of borrowers, lower home price appreciation or even home price depreciation, increased servicing costs, and higher advances. More speculative areas, or areas without a “buyer of last resort” in the Government Sponsored Enterprises (GSEs), retrench or disappear. Weaker, or over-leveraged, hands are exposed, and assets are reshuffled. The normal process of excess and renewal is completed.
What is different this time around is the indirect consequences of COVID-19, triggered by the government response.
THE FORBEARANCE DILEMMA
On March 27, 2020, The Coronavirus Aid, Relief, and Economic Security Act (CARES) was signed into law. As part of this $2 trillion economic stimulus plan, borrowers with a federally backed mortgages are able to request forbearance from loan servicers without documentation or support for the need. The consequence of these advancing requirements and the ability to freely seek forbearance has left the industry reeling.
While the Act will be a boost to consumers, who can delay payments, it does not provide a liquidity solution for servicers who must advance payments to investors, even when borrowers don’t make normal payments. As a result, these mostly independent mortgage companies may be expected to advance ongoing principal, interest, tax, and insurance payments for as much as 20 to 30 percent of the outstanding residential loans in the market, well beyond their statutory liquidity requirements.
According to a letter sent to the White House and federal agencies by the housing industry’s largest trade groups, it is estimated that if 25 percent of the nation’s outstanding mortgages receive forbearance, servicer outlays would be $36 billion over three months, and would reach $100 billion over nine months.
To help the non-bank servicing industry, the Government National Mortgage Association(Ginnie Mae) recently announced the Pass-Through Assistance Program (PTAP) program, which providing a financing option for servicers caught in a liquidity bind. But Federal Housing Finance Agency (FHFA) Director Mark Calabria told reporters this week that there is no similar plan for Fannie Mae and Freddie Mac, and that instead, the GSEs may transfer servicing rights away from struggling firms to larger ones. A bi-partisan group of seven senators has asked the administration to provide temporary liquidity, warning that a failure to do so could trigger a domino effect that would threaten the entire housing finance system.
Ginnie Mae went a step further on April 7, announcing that it will make enhancements to its acknowledgment agreements to increase the supply of private financing from large banks and other institutional investors to support investment in Ginnie Mae mortgage servicing rights (MSRs). Through this new transaction, PennyMac will be the first issuer to leverage its MSR financing facility to support a separately defined servicing advance facility within the existing structure. In this case, the security of the collateral for the advance line depends on the control of the MSRs granted under the Ginnie Mae acknowledgment agreement.
The CARES Act has produced overwhelming financial and operational demands for originators and servicers, as massive numbers of homeowners try to refinance into lower rates and millions of others seek to qualify for forbearance. As a result, the pricing associated for mortgage servicing rights has faced a double-whammy of higher refinance volume for the better credits and a higher probability of default for the lower credits. These trends have dried up liquidity.
BORROWER PROFILES AND SCALE MAKE THIS EVENT DIFFERENT
The profile of borrowers seeking forbearance today are very different than those who sought relief in the Great Recession. These homeowners include individuals who have never missed a payment, are current on their loan, and are not accustomed to how to react to or manage a default. As a result, servicers are inundated with multiple phone calls, emails, letters, faxes, etc. to resolve the forbearance request. This additional contact is putting more pressure on the system and overwhelming already-stressed mortgage operations.
Meanwhile, the scale of the problem is enormous. During the Great Recession, the delinquency rate peaked at just over 11 percent in 2010. Industry expects, based on early numbers of forbearance requests, predict that deferral and default rates will exceed those of the Great Recession within a few months. Indeed, the Mortgage Bankers Association reported that the number of loans in forbearance grew from 0.25 percent to 2.66 percent between March 2 and April 1, with mortgages backed by Ginnie Mae seeing the biggest jump (from 0.19 percent to 4.25 percent).
Independent mortgage bank servicers now have the largest share of loans in forbearance — 3.45% percent of their loans services – as a result of their focus on Federal Housing Administration and Veterans Affairs home loan programs, and a customer base of low- and moderate-income borrowers. Putting the onus on independent mortgage companies to implement the CARES forbearance policy will have a severe impact on those organizations, and on the market for loans that are not guaranteed by the federal government.
ORIGINATION IMPACT: INTEREST RATES, REFINANCING & PURCHASE VOLUME
In addition, Covid-19 has triggered a cross-section of consequences for the origination market. On the one hand, interest rates are at historical lows, with the 10-Year Treasury, usually utilized as a benchmark rate, around 70 basis points. This scenario would typically encourage an optimistic view of origination volume, as a number of loans should now be re-financeable. However, this initial optimism on refinancing was partially tempered by the wide spread between mortgage rates and the 10-Year, which was subsequently solved through Fed intervention. That relationship is now being tempered by the unknown impact of forbearance versus refinancing. Will a consumer prefer a newly minted loan with a lower rate that comes with the potential for upfront fees and outlays, or would they prefer not making payments at all for up to 12 months?
Potential homebuyers are pulling back as a result of their uncertainty about future employment prospects and a hesitancy to even visit homes for sale. Purchase applications have fallen 25 percent month over month, especially in hard-hit areas such as Washington, California, New York, Illinois and Louisiana. In prior disasters, such as hurricanes, the mortgage market tends to go dark for a period of months. The combined impact of job uncertainty and health concerns can mute purchase activity, regardless of rates, for a prolonged period.
SOLUTIONS: SERVICER LIQUIDITY AND LENDING OPTIONS
The industry is seeking a backstop to the funding advances thrust upon it by the CARES Act through lending facilities that can be orchestrated or backed by the Federal Reserve, FHFA, Ginnie Mae, or another party. Without a sizeable and low-cost lending solution, many of the servicing institutions that are supposed to aid borrowers during this time may not be able to serve that purpose.
The Covid-19 crisis and the response has also limited options for consumers by taking away non-government-backed lending options. To help withdraw the support from the GSEs, the Federal Reserve could include non-agency Residential Mortgage-Backed Securities (RMBS) within its Term Asset-Backed Securities Loan Facility (TALF). This would help bring liquidity and rational pricing to the market, including the high-quality jumbo loan market. An inclusion of this RMBS should also help to establish a market, and more normalized pricing, for re-performing loans, which are likely being created in mass by current forbearance programs.
The Federal Home Loan Bank system could also be opened up to qualifying REITs which have been forced into overreliance on bank-provided repurchase financing. Access to a more stable funding source would help to alleviate the pressure in the market being created by margin calls and subsequent liquidation of underlying collateral.
Given the unprecedented nature of Covid-19, the timeline for a normal economic recovery is difficult to forecast; however, the recovery of the mortgage market is also clouded by newly implemented government policies. As policy solutions are reworked, we should all get a better picture on how to think about the market moving forward. In the interim, get your helmet on. It’s going to be a bumpy ride.