Uncategorized

The GSEs clarify handling of loans in forbearance

admin | April 24, 2020

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. This material does not constitute research.

Evidence that forbearance will weigh on prepayment speeds continues to build. Fannie Mae, Freddie Mac and the Federal Housing Finance Agency confirmed on April 21 that loans on COVID-19 forbearance would remain in pools for the duration of the forbearance, up to 12 months. Fannie Mae also announced that its servicers would only need to advance principal and interest up to four months, matching Freddie Mac. This opens the door to slowing prepayments in the near term as the number of loans in forbearance increases since these loans are unlikely to refinance. But prepayment speeds could eventually increase after forbearance if the GSEs need to buy out any loans that cannot be brought current or placed on a repayment plan.

Changes for servicers

Before the April 21 announcement, Fannie Mae required servicers to advance principal and interest for most delinquent loans while those loans remained in a pool, but Freddie Mac only required servicers to advance at most four months of interest. This meant that a decision to leave loans in pools for the duration of a forbearance plan would place a tremendous burden on Fannie Mae’s servicers. Fannie Mae helped the servicing industry by reducing its advancing requirement to only four months. This change also ensures that any decision regarding the handling of forbearance would have a comparable impact on the two GSEs and their servicers.

Some differences remain between the two GSE’s advancing requirements. Freddie Mac servicers only advance interest, not principal. And most loans sold to Fannie Mae’s cash window do not require the servicer to advance any principal or interest. Fannie Mae also reimburses servicers for advanced principal, interest, taxes, and insurance on a faster timeframe than Freddie Mac. But these differences shouldn’t affect MBS valuations.

Loans on forbearance will remain in pools

The GSEs also confirmed that they will leave loans on temporary forbearance in pools for the duration of the plan, which can extend up to 12 months. This should slow prepayment speeds. Most loans on forbearance will likely find it difficult to come up with the cash to bring their loan current before refinancing and should also have difficulty providing income and employment verification for the new loan.

However, once forbearance ends, prepayment speeds could increase due to buyouts of delinquent loans. The loan will remain in a pool if the borrows can bring the loan current, qualifies for a repayment plan, or qualifies for the GSEs’ payment deferral programs. But all of these options will be difficult for borrowers after a long forbearance period. Consider a borrower that uses 12 months of forbearance. A repayment plan targeting a 50% higher payment, which is the largest payment the GSEs typically allow, would require roughly two years to pay back. However, that payment would represent a huge increase in DTI and the GSEs typically prefer repayment plans no longer than 12 months. The GSEs’ payment deferral program only works for borrowers less than 60 days delinquent. How many loans remain in pools will depend heavily on whether the GSEs are willing to offer extremely long repayment plans.

Borrowers with loans on repayment plans would also have a large incentive to refinance. A new loan would allow the borrower to spread the delinquency over the entire term of the new loan, lowering the mortgage payment even if new two loans had the same note rate.

If a loan cannot be cured then it will proceed through the typical loss mitigation waterfall and usually be modified or liquidated. These loans will be bought out of the pool. Loans will remain in the pool during a modification’s trial period, usually three or four months, but will be bought out after the trial period is completed.

Data from past natural disasters suggests the cure rate on loans that use at least six months of forbearance could be low. Hurricane Maria, which struck Puerto Rico in 2017, offers some insight. Freddie Mac 100% Puerto Rico pools peaked at 849 seriously delinquent loans—loans more than 120 days delinquent—in May 2018, roughly six months after the hurricane hit. Over the following six months, prepayments spiked; 1,071 loans prepaid and the number of seriously delinquent loans dropped by 690. Typically, fewer than 200 loans prepay in a 6-month period in Puerto Rico, which suggests that most of the seriously delinquent loans required a modification or were liquidated.

admin
jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.