Mortgage Servicing Crisis – Chapter 2 – Forbearances
I submitted a post last week summarizing some issues in the mortgage industry. It was a long article from Barry Habib with some insight/conclusions. I’m writing this to add to that post with some additional info about what’s going on in the industry and how the forbearances are impacting mortgage servicing.
The two big points from the previous post that I’ll touch upon: Margin Calls – the Fed buying mortgage-backed-securities (MBS) was causing lenders to run into significant margin calls, a fairly significant risk to lenders. Lenders hedge their locked loan pipelines against market fluctuations.
Forbearance Poses Risk to Lenders – The CARES Act, Section 4022, provides that a mortgage servicer must provide borrowers a forbearance of up to an initial 180 days, and then it can be renewed for a subsequent 180 days. During this period, the servicers are expected to keep making payments to the asset owner – Fannie Mae / Freddie Mac / Ginnie Mae (the government sponsored enterprises, or GSEs). So, even if providing the borrower the loan forbearance required by the CARES Act, a servicer is sending payments to the GSEs. As I’ll discuss below, the Act does not identify specific methods to resolve the forbearance at the end of the period.
So, whats new? Well, the margin call is still an issue – but the fed backed off of their level of MBS purchasing by a little bit, but not enough to resolve the issue. Lenders clearing out their active loans will help resolve this, so in time it will improve as long as the Fed continues to be timid on MBS purchase. It will still hurt lenders but I don’t think this is going to be a nail in the coffin for any of the big servicers.
The forbearance process is worth further describing. So, hypothetical situation: lets say I have a mortgage serviced by Quicken (don’t get excited they are private) and I just heard the CARES Act allows me to skip payments. I’m a waiter, I just got laid off, I could really use 3 months without my $2k mortgage payments. I call them, wait on hold for two hours, and then they agree to let me not make payments for the next three months – and they will send the info to sign. Great, right? Almost too good to be true.
So, here are the three outcomes of a forberance after Quicken quickly agrees to it:
1.) BY DEFAULT – From the borrower’s perspective, I don’t hear anything for three months. Then, in month 4, Quicken calls and says I have 4 payments, three of which are “delinquent.” I now learn there are 4 payments – all due in month 4. Well, hold on I just returned to work I don’t have $8k – what can I do besides YOLO FDs? Well, probably not much.
2.) Payment Plan – the next option is to resolve that past due $6k on a payment plan, if the lender agrees to this. So instead of a $2k payment, I might have a $2500 payment for a year. Now I just returned to my service industry job – I was already paycheck to paycheck, I have all sorts of other past due credit card/auto/student loan bills from being laid off, and now my mortgage is 25% higher. That’s not going to work for me.
3.) Loan Modification – A loan modification is the option that everyone thinks they are getting through CARES Act by default – it extends the term of the mortgage and adds the missed payments to the end. This is not a scenario that will be provided over the phone as an immediate solution if I call Quicken and ask. It has to be applied for, I would have to qualify, and it has to be approved by the lender. It is not a trivial request, and it will not be approved lightly given the current lending environment and amount of credit risk. Plus, considering the lender has already made 3+ payments to the GSEs without one from me – they are going to want to quickly determine whether this is going to be a performing loan or a non-performing loan (more to come on this). They will want to flush out the good loans from the bad as soon as they can get past the time periods required in the CARES Act.
So, a loan modification requires a level of qualification (credit check, paystubs, etc.). As a borrower, I am then going to have to show this lender the amount of debt I’ve racked up paying for everything with credit cards while laid off – and how f*cked my credit has gotten not paying any bills while waiting for my $1200 Starbucks allowance from the Feds.
I am a Loan Officer, as mentioned in the previous post. Half my week has been talking to past clients about forbearanaces, and most of them just want a few months of skipped payments so they can relax about the economy and have that safety net. Sure, some have lost their jobs or are on the verge of losing their jobs – in which case it makes sense, your alternative is worse. One owns three rentals I’ve financed and 0/3 renters can pay their rent this month.
SO MANY PEOPLE are requesting the forbearance on an elective basis that our industry experts are begging real estate professionals to properly describe to them how this works, and what they will be faced with. Servicers are quick to approve the forbearance, and the borrowers are not understanding the possible outcomes.
I have a friend I consider to be a business-minded, prudent, and intelligent individual. He called servicers for two properties, US Bank and Wells Fargo – one offered a forbearance of 3 months and the other offered 6 months. He took them, they said they’d send something for him to sign but that it was in effect. Neither made any effort whatsoever to explain to him the resulting options at the end of the forbearance. He called me to ask if it would have any adverse impact, as they had not described the process well to him.
These are call centers taking the requests, obviously they are doing what they can to get to the next call.
My company has a $110B servicing portfolio, and we got 8000 requests for forbearances IN A WEEK. Mr. Cooper (subject of my last post) has a $640B servicing portfolio.
At the end of this initial 3-6 month forbearance that lenders are required to offer, we are going to see lenders quickly decide how to handle each file. As mentioned above, they consider the account delinquent during the forbearance (although not reported to credit) – so they already have a jump on the next steps to collect past-due payments. There will likely be a flood of “performing” loans (paid on time) turning into “non-performing loans” (past-due 180+ days). If a loan becomes non-performing, the GSEs end up auctioning off the assets (mortgage notes) in blocks. These blocks are generally bought at auction by funds and securitized into non-performing loan MBSs. Of the companies that do this, there are only a few that have publicly traded entities.
Now, I’ll touch briefly on what is going on with mortgage lending – because a lot of the servicers like Quicken have revenue split between originating and servicing: Purchase Volume – The last two weeks we saw purchase mortgage applications decline 15% and 11%. Personally, I have had a noticeable reduction in purchase apps, and all of my preapproved borrowers are putting their home search on hold. Refinance Volume – Because of current credit risk lenders are considering, rates are only attractive on an owner-occupied primary residence with an optimal borrower. Low credit score, investment properties, etc., have rates so high they don’t make sense. General Volume – Loan programs have tightened up considerably in the last two weeks. Yesterday my company scrapped all of our jumbo programs. We had already scrapped all of our non-QM programs (subprime). Our FICO requirements are up 40 points, for self-employed individuals we can only use 75% of their income now, use of gift funds is more restrictive, etc. We are definitely going to see less individuals qualifying for financing because of these guideline adjustments.
TL;DR folks can start here with only knowing “non-bank mortgage lenders in trouble”
How to use this info: 1.) Puts on non-bank mortgage lenders – They are going to suffer because all of their revenue comes from originating and the residual from servicing. They are going to lose the servicing revenue on a significant amount of non-performing loans, and they are going to have trouble originating loans for at least a few months. My last post included COOP, the largest publicly traded servicer – they also originate. I still like it and expect the underlying share price to continue to decline, but the premiums are outrageous right now. I like puts on any non-bank publicly traded mortgage originating/servicing company. Not 100% in line with this recommendation, but I decided to make a move on REM which is a closed-end mortgage-based REIT. It has 80% in residential mortgage securities and 20% commercial (which I also think is vulnerable). So, REM 15p 10/16
2.) I spent a long time last night reading the auction results from non-performing loans and then looking up the buyers to see which publicly traded companies might mostly focus on NPLs. I wanted to buy calls on companies that focus on NPLs, anticipating they would have a higher volume in coming months. Most are either private, or they securitize the loans and aren’t exposed, or they are too diversified in other aspects of real estate to anticipate the NPL volume helping share price. I don’t have a great play here. If someone wants a fun research project, go try to find a company who services NPLs, is publicly traded, and is not well-diversified. Although I did not find them buying recent auction pools (I only looked at ’19) I did take a position in [an option with an underlying value too low for this post to get approved] because they focus on NPLs and at an auction long ago they received 90% of the NPLs being offered by the GSEs. The premiums were cheap and their share price is 30% of what it was in February.
There are some banks with significant mortgage servicing rights, but I think the Feds are more likely to let the non-bank lenders fail.
If anyone has any suggestions on positions to take based on this info, please do comment with it. I know we had some MBS guys and other people in the mortgage industry comment on the last post, would be interested for more input.
TL:DR : Fed says you don’t have to pay your mortgage, lenders agree quickly to forbearances, borrowers will be expected to pay in full at the end of the period – but they aren’t understanding that, on a large scale. COOP 5p 10/16 (but maybe wait for a bounce the premiums are nuts) REM 15p 10/16
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.