An early look at CRT loan modifications
admin | February 12, 2021
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.
Modification activity on loans referenced in GSE CRT has been extremely limited to date. But as forbearance plans reach their end, the incidence of loan modifications will likely increase. An analysis of recent modification activity suggests that loans with high WACs and lower FICO scores and higher DTIs may be at greater risk of modification, potentially putting deals backed by high LTV collateral issued in 2108 and 2019 at greater risk of modification losses than other cohorts.
Investors in Fannie Mae and Freddie Mac CRT largely continue to wait and see what the ultimate performance of borrowers exiting forbearance plans will be. Actions recently announced by the Federal Housing Finance Agency to extend maximum forbearance from 12 to 15 months will push the potential end of forbearance out a few more months. But these plans will expire at some point. And while policies to defer payments missed while a borrower was in forbearance will certainly alleviate potential burdens to re-performing borrowers, these policies will not be sufficient to get all borrowers to resume making their payments. As a result, the incidence of loan modifications looks likely to increase. And while modification activity has been muted to date, an analysis of recent modification activity may provide some insight as to what loans may be at greater risk of future modification than others.
The incidence of modifications on loans referenced in GSE CRT has been extremely modest. Of the nearly eight million active loans referenced in GSE CRT, just over three thousand have received a modification in the past six months. Admittedly the sample may be small, but a look at the status of loans when they were modified and the characteristics of those loans may provide valuable insight.
Insights on modified loan attributes
Comparing modification activity across the two programs shows that exactly 45% of borrowers modified in the past six months were in forbearance at the time of modification in both CAS and STACR deals. For context, Fannie Mae data show that only 6.08% of loans referenced in CAS have ever been in forbearance. And Freddie Mac data show 6.65% of loans by current balance have ever been in forbearance. Since these populations contribute disproportionately to modified loans, forbearance is clearly a flag for modification risk.
Phase of delinquency also increases the chance of modification. Over the observation period, Fannie Mae modified more early stage delinquencies than Freddie Mac as 21% of loans modified in CAS deals were 90 days or less past due while just 10% of loans modified in STACR deals were early stage delinquencies. More delinquent loans referenced in STACR deals get modified at 150-day or 180-day marks. Roughly one third of loans were modified after being more than six months delinquent across both CAS and STACR deals.
Balance and WAC matter. The average balance of loans modified by Freddie Mac trusts were slightly larger than those modified by Fannie Mae as the average balance of loans modified in STACR deals was just under $300,000 while loans modified in CAS deals had average balances of roughly $275,000. Loans modified in both programs were higher WAC loans, as modified loans in STACR deals had an average WAC of 4.44% while those in CAS deals had an average WAC of 4.57%.
Loan size and WAC should be the primary attributes that will drive modification losses in CRT. Rate reduction modifications flow through CRT trusts on a monthly basis as the difference between the original WAC and the modified loan rate. These losses flow through the deal reverse sequentially, first reducing interest on the first loss class to zero after which the first loss bond will begin to take principal write downs. Given this, modifications on higher WAC loans may result in greater running losses to CRT trusts if the rate is materially reduced. Loan balance will also be a factor in potential future losses associated with modified loans, as larger loans may require greater nominal amounts of principal forbearance to re-perform. Losses associated with principal forbearance in CRT deals can come in two forms. First the lost interest on the non-performing balance of the loan will flow through the trusts as a running loss similar to a rate reduction modification. Forbearance does not generate a principal loss in CRT trusts when it is granted but can ultimately result in one if the forbearance is not recovered when the reference loan leaves the pool.
Looking across other attributes of modified loans, the two programs are once again very consistent. Modified loans in both programs had an average WALA of 45 and an average DTI of 40, while loans modified in STACR trusts had slightly higher FICOs and LTVs than those modified in CAS deals. (Exhibit 1)
Exhibit 1: Comparing attributes of modified loans in CAS and STACR
A look at impacted deals
Trusts that have seen an elevated incidence of modification to date have included 2018 vintage high LTV deals as well as deals backed by non-traditional collateral, such as HARP collateral, and may be at greater risk of more modifications in the future. More seasoned deals may be showing elevated modifications more so as a result of those loans having rolled further up a traditional expected loss curve and may be less susceptible to further modifications going forward (Exhibit 2).
Exhibit 2: Sizing up modifications across CRT trusts
Modified loans in the deal with the largest amount of modifications to date, STACR 2018-HQA2 had substantially higher LTVs than those of the broader modified cohort with a weighted average LTV of 94, a higher average loan balance than the cohort at just over $333,000, a 4.47% WAC and an average DTI of 40. It appears that loans that hit the trifecta of high WAC, LTV and DTI may be more likely to be modified than others. Late vintage 2018 and 2019 CAS and STACR deals backed by high LTV collateral have some of the largest populations of high DTI loans and they, along with deals backed by off the run collateral such as HARP loans may be at greater risk of modification losses going forward than others.
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