Forbearance recoveries revisisted
admin | October 12, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The forbearance option in legacy non-agency MBS continues to become more valuable. Recoveries on each $1 of forbearance originally recorded as a loss have averaged more than $0.60 in the last six months. As average home prices keep rising above pre-crisis peaks, the percentage of forbearance recovered keep growing even as the notional amount of forbearance returned each month remains steady. But collateral type and servicer matter a lot.
Lots of forbearance left
Since late 2016 forbearance recoveries have totaled nearly $900 million or just over 50% of forbearance on prepaid loans. Approximately three quarters of recoveries came from re-preforming loans with the remainder from non-performing. RPLs show higher recoveries, averaging 54%, with NPLs at 43%. In terms of absolute monthly recoveries, RPLs average $25 million with NPLs at $9 million.
Exhibit 1: Average monthly forbearance recovery for RPLs and NPLs
Forbearance recoveries still have meaningful upside. An estimated $15 billion in outstanding reported forbearance still sits in trusts that record forbearance as a loss. Approximately 80% of the loans carrying those balances look likely to either prepay or pay off at maturity, bringing the potential scope of recoveries to just under $12 billion. Not surprisingly, most of the outstanding forbearance attaches to subprime loans, which have $8 billion of outstanding forbearance. Outstanding forbearance on Alt-A loans totals $3.2 billion with an additional $2.7 billion on Option ARM loans.
Recovery percentage varies across collateral
Forbearance recovery percentages vary significantly by collateral type with cleaner profiles showing significantly higher percentages. Recovery percentages on Alt-A and Option ARM loans since September of 2016 have averaged upwards of 65%. Subprime recoveries over the same period, despite average LTVs in line with liquidated Alt-A and Option ARMs, have averaged just 38%.
Exhibit 2: Forbearance recovery percentages vary by credit despite similar LTVs
One potential explanation for this difference is the size of the forbearance balance relative to the size of the performing balances on loans that have abated since 2016. Recovery percentages tend to rise when the amount of forbearance is small. Recoveries average 75% when the forborne balance is less than 10% of the performing balance. If the forborne amount exceeds the investor balance recovery rates drop into the 20%s.
Subprime loans which exhibited the lowest recovery rates also exhibited the highest amount of forbearance, although not by much compared to other credits. Forborne amounts on subprime loans averaged 31%, only a point higher than average amounts on Option ARM loans and seven points higher than those of Alt-A loans. Another plausible driver of lower forbearance recoveries on subprime loans is they exhibited significantly lower average loan balances than those of Option ARM and Alt-A loans. While a prepayment of the investor balance in its entirety is prerequisite to a forbearance recovery, it is not by definition a voluntary prepayment. This means that there could be liquidations where the proceeds of the liquidation were sufficient to satisfy both the investor balance and a portion of the forborne amount. In the case of liquidations on lower loan balance subprime loans, fixed costs associated with liquidations could have a larger impact on recoveries than Option ARM and Alt-A loans, whose average loan balances were nearly double those of subprime ones.
Exhibit 3: Forborne amount matters when gauging recoveries
Following the forbearance
Knowing the factors that drive forbearance has little value without knowing where the forbearance is buried. Roughly $11billion of reported forbearance comes from just 25 shelves. The CWALT shelf has the largest nominal amount of reported forbearance, totaling nearly $1.3 billion, it only represents 5% of the outstanding performing balance. Forborne balances are greater than 20% of performing balances on both the BSMF and CBASS shelves. Countrywide and BSMF shelves also had some of the greatest recoveries of shelves analyzed, with more than 50% of forborne balances being recovered at abatement over a roughly two year observation.
Exhibit 4: Screening for forbearance opportunities across shelves
Looking at the opportunity at the servicer level on both a historical and forward looking basis shows a sizable variance in performance and potential upside. Consistent with the shelf analysis much of liquidated and outstanding forbearance is localized to Bank of America, which accounts for over 20% of forborne balances that abated during the two year observation. Nationstar and Ocwen each accounted for roughly 16% of liquidated forbearance balances during the period. SLS has recorded the highest average recovery to date at 81% but on a small sample of loans accounting for less than 1% of total liquidations. Of major bank servicers, Chase has posted the highest average recovery at 71%, an 11% better recovery than Bank of America despite identical LTVs and populations of non-performing loans across both servicers.
Exhibit 5: Stacking up recoveries by servicer
Looking forward at the opportunity set across servicers, Bank of America also has the largest nominal amount of outstanding forbearance totaling $4.5 billion. Bank of America serviced loans have one of the lowest amounts of forbearance relative to performing balance of all major servicers at 28% but one of the higher average LTVs at 66%. We estimate that 82% of Bank of America serviced loans with forbearance will either prepay or pay off their performing balance at maturity. Other major servicers with significant amounts of forbearance that can potentially be recovered include Ocwen with over $2.5 billion in outstanding forbearance, AHM with roughly $1.4 billion, EMC with $1.3 billion and SPS with $1.25 billion. Comparing the profile of outstanding forbearance across these servicers suggests that loans serviced by Ocwen may offer the best recoveries. We estimate that loans serviced by all four servicers will have nearly identical survivorship rates between 81% and 82%. Outstanding Ocwen loans have a 54 mark-to-market LTV, right on top of their loans that liquidated and recovered 60% of the forborne balance. Outstanding Ocwen Loans have a modestly higher percentage of forbearance than loans that liquidated, 37% and 30% respectively. By comparison, forborne balances across the other three servicers are greater than 40% of the performing balances with comparable or significantly higher LTVs.
Exhibit 6: Stacking up outstanding forbearance by servicer