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.
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.