This guest commentary was written by Michael Bright, CEO of the Structured Finance Association. It was originally posted on The Institutional Risk Analyst.
Forbearance is certainly the new trending word. It’s all over the media. And suddenly everyone is an expert on the once-arcane business of mortgage servicing.
Dire predictions are being made about nonbank servicers, although the data is coming in one week at a time. Thus far, the nonbanks are generally holding in, and they are supporting the secondary markets and their borrowers as best they can. Many nonbanks are also taking the lead in addressing COVID19 on behalf of the global investors in mortgage backed securities (MBS) they represent.
No one knows the mortgage business better than the servicers, other than perhaps the GSEs – Fannie Mae and Freddie Mac. And right now, the scoreboard is Government Enterprises: 100, Private Servicers: O. That’s not by chance. The servicers appear to face a deliberate strategy designed by the Federal Housing Finance Agency (FHFA) to stick the private market with the cost of dealing with COVID19 in the conventional loan space.
This is not a reluctance to bail out private nonbanks with public funds, as some have argued. Instead, this looks more like the expropriation of private resources of banks, nonbanks and bond investors to shield Fannie Mae and Freddie Mac! The FHFA agenda is tantamount to a bailout for the GSEs at the expense of bank and nonbank servicers, and bond holders. Here’s why. Under normal circumstances, Fannie Mae and Freddie Mac make arrangements with their seller servicers to buy delinquent mortgages out of MBS securities once those mortgages go 120 days delinquent.
A servicer will collect and then advance borrowers’ monthly payments to the GSEs. They do this in exchange for a small servicing fee of typically around 25 basis points plus ancillary fees that cover the elevated cost of default servicing.
Often, a small percentage of borrowers miss their mortgage, and the servicers advance payment of principal and interest for them, then collect the arrears when they either resolve the default or foreclose and sell the house.
If, however, a borrower goes from one or two months missing their payment to full 120 days – or four months – delinquent, the delinquent loan shifts from being the servicers’ problem and becomes the problem of Fannie or Freddie. The role of guarantor, and of performing this function, is the essence of the GSEs’ business. Fannie and Freddie take on the credit risk of conventional loans in exchange for a guarantee fee (which is much larger than the servicer fee).
All makes sense, right? But then we get back to the kicker - the way the GSE COVID-19 forbearance program is designed, it puts all of the cost of administering it on the servicers. Why? Because this program’s “forbearance” never triggers the clock to when a borrower is 120 days delinquent. Again, that is a private sector bailout of the government in all but name.
Adding to the challenge of today’s market, originators are reacting to the FHFA stance by curtailing conventional lending. If the originators (also called “seller-servicer” to the GSEs) are unable to deliver loans into GSE securities because between the time the loan funds and is delivered, the borrower requests a forbearance, then they won’t do conventional loans.
How many new conventional loans will seek forbearance? No one knows for sure. The numbers from mortgage servicers suggest that participation could be well into double digits. But to protect against this eventuality, lenders are now only originating loans that they have a VERY high degree of certainty will not go to forbearance prior to delivery. The position of the FHFA in refusing to support loan servicers, banks and nonbanks alike, is adding to the restriction of mortgage credit in the economy at this time.
The irony of this situation is quite stunning. I like to be positive and look for silver linings in any situation. Clearly, the FHFA has a strong desire to shrink the role of the GSEs in our economy. Fine. But moving forward with this agenda at a time when the alternatives, particularly the market for private label mortgages, has evaporated for now seems short-sighted.
The FHFA may have had some thought about re-positioning the GSEs in the private label market, but that option is not viable until investors come back to the table. The FHFA’s position is making that process of restoring investor confidence even more difficult than it need be.
At a bare minimum, FHFA should help advocate that the Fed provide liquidity to "AAA" private RMBS the way it is doing for other asset classes such as commercial real estate. That won’t save private label mortgages alone, but it could help limit the damage to an important market that exists alongside the conventional market.
It remains to be seen whether we will experience large scale defaults that cause servicers to go bankrupt. And it remains to be seen whether or not the Fed and Treasury will step in to help the conventional market. With 22 million newly unemployed in just a month, surely the delinquency numbers will rise and could force Treasury’s hand.
If the Fed does act, remember one thing: the real recipients of this emergency assistance are the firms that took on the credit risk. That is, Fannie and Freddie.
ABOUT Michael bright
Michael Bright is the CEO of the Structured Finance Association. Prior to joining the Structured Finance Association, Michael was the EVP and Chief Operating Officer of the Government National Mortgage Association (Ginnie Mae), which guarantees $2.2 trillion in residential mortgages.
This piece does not necessarily reflect the opinion of Hedgeye.