A change in buyout plans at Fannie Mae, Freddie Mac
admin | October 2, 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.
For investors worried loans in forbearance might one day trigger a surge in buyouts from MBS pools, Fannie Mae and Freddie Mac have provided some policy relief. Beginning in 2021, the GSEs will no longer buy out loans that become four months delinquent, according to a September 30 announcement. The GSEs instead will buy out loans when they get permanently modified, referred to foreclosure or at 24 months delinquent, among other things. Delaying buyouts will slow prepayment speeds, although the difference should be small. Except for the most highly leveraged MBS, this change should have only a small effect on MBS valuations.
The GSEs noted several events that will trigger the buyout of a delinquent loan under the new policy. A loan must always be bought out when it reaches 24 months delinquent, but most loans will typically be bought out sooner if it is
- Paid in full
- Repurchased by the seller or servicer
- Permanently modified
- Subject to a short sale
- Subject to a deed-in-lieu of foreclosure, or
- Referred to foreclosure.
For many loans, these events will occur after the loan reaches four months delinquent, delaying the buyout, and some loans may even cure and avoid a buyout altogether. Both effects should be a positive for MBS valuations, although the amount is likely to be very low except for the most leveraged MBS.
The new policy historically would have added 5.2 months to buyout
Historically loans reached these triggers an average 5.2 months after first becoming four months delinquent (Exhibit 1). This estimate was derived using loans in the Freddie Mac credit dataset that first became four months delinquent between January 2015 and August 2018. Each loan was tracked until it eventually reached a buyout trigger, prepaid voluntarily, or became 24 months delinquent. Some loans cured, which was defined as being less than 90 days delinquent after 24 months.
Exhibit 1: Buyouts could occur an average 5 months later
Loan modifications accounted for 51.6% of buyouts but added an average six months to the buyout timeline. The next most common reason was foreclosure referrals, which accounted for 31.6% of buyouts. But these happened much earlier, on average adding only 2.8 months to the buyout timeline. Roughly 8% of loans cured, avoiding buyout altogether, while another 7% prepaid voluntarily.
A higher cure rate after Covid-19
Following Covid-19 forbearance, the cure rate should be far higher since borrowers will be evaluated for payment deferral. This will allow borrowers that can resume making their original mortgage payment to defer at no interest up to 12 missed payments until the mortgage is paid off. The GSEs have also introduced payment deferral programs outside of Covid-19. One is always available but will defer at most two missed payments, while the other is for natural disasters and allows deferring up to 12 missed payments. These programs should increase the number of loans that cure.
A 1/32 to 2/32 impact on TBA
However, these changed are not likely to materially affect MBS valuations. Exhibit 2 shows a “what-if” scenario using today’s TBA stack. Each TBA is assumed to have 3.5% of its balance eligible for buyout. In one scenario, all those loans are bought out in 4 months, while in the other scenario 90% of those loans are bought out in 9 months. The price change ranges from 1/32 to 2/32s, and 3.5% delinquent loans is historically quite high for GSE pools. Certain pool types, like low FICO pool, may have higher delinquency rates and benefit more from the change.
Exhibit 2: The effect on MBS prices should be very small
Limited the risk of a surge in buyouts
The GSEs likely made the change in response to a potential, albeit small, risk that they would be required to conduct huge buyouts as loans exit Covid-19 forbearance. Under the old policy a loan exiting forbearance that is not cured—whether the borrower repaid the delinquency, was placed in a repayment plan, received payment deferral—or placed in a trial modification plan would immediately be bought out of the pool. Large buyouts would place a severe liquidity burden on the GSEs.
It is possible that many GSE borrowers exiting Covid-19 forbearance will qualify for payment deferrals, under which repayment of the entire delinquent balance will be deferred at zero interest until the loan is paid off. These loans can remain in their MBS pools, which is in the interest of investors and the GSEs. The new buyout policy gives servicers some operational leeway to evaluate borrowers as they exit forbearance and ensure as many borrowers as possible can begin payment deferral plans. The effect of the new policy on post-Covid buyouts ought to be small for loans that do not qualify for payment deferrals. Servicers may have a little more time to evaluate borrowers for modification or foreclosure, which could delay buyouts of those loans by a couple of months. A pool may carry a little better due to the delayed buyout but ultimately this should have little effect on valuations.
The GSEs have also taken care to mitigate concerns that this change could set the stage for massive buyouts in the future. That scenario happened once before. In late 2007 the GSEs stopped buying out loans once they reached four months delinquent, and the delinquent loans accumulated in pools for two years. In 2010 the GSEs reinstated the 4-month delinquent buyout policy with almost no advance warning to investors, causing massive prepayment speeds as those delinquent loans were bought out almost immediately. This time the GSEs have committed to: (i) maintaining the new buyout policy for at least two years, (ii) providing six months advance notice before making a change, and (iii) stating that future policy changes would not apply to loans already delinquent when that policy becomes effective.
Servicers’ advancing obligations remain the same, but changes are forthcoming
Servicers’ obligation to advance delinquent principal and interest (P&I) did not change with this announcement. Fannie Mae requires servicers to advance up to four months of delinquent P&I for most loans. However, many cash window loans do not require the servicer to advance any principal and interest. Freddie Mac always requires the servicer to advance four months of interest, but never principal.
But the GSEs did mention that changes are forthcoming regarding the obligation to advance the guarantee fee and the timing of reimbursement of delinquent P&I. Fannie Mae stated they are considering stopping guarantee fee advancing when the loan becomes four months delinquent, just like the P&I requirement. Fannie Mae currently reimburses when the loan is bought out of the pool, which is going to be later than before. Freddie Mac’s reimbursement often occurs at the time of the new buyout triggers, so this announcement does not change Freddie’s timing. However, they mention they are working with Fannie Mae and the FHFA on this issue and it is likely they would mirror any changes made by Fannie Mae.