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  • Sharad Chaudhary

Mortgage Delinquency and Forbearance, Part II

As widely anticipated, the delinquency rate on mortgage loans jumped dramatically in May factor date data across the different Agencies because of the surge in unemployment rates resulting from the COVID-19 pandemic and the resulting damage on borrowers' ability to service their debts. Delinquency levels currently range from 12.6% for FHA loans to 3.8% for FHLMC 30-year loans (Here we are tracking the fraction of all borrowers who are delinquent, we obtain slightly different answers if we express this fraction in terms of delinquent balances). The CARES Act provides some relief for these borrowers by allowing them to apply for a forbearance plan that offers payment relief for up to one year (an initial forbearance plan for a period of up to 180 days may be extended for up to an additional 180 days at the request of the borrower) but leaves one area unaddressed - who is responsible for forwarding these missing payments to the Agency MBS investors who are guaranteed full and timely monthly payments. Without a backstop, non-bank mortgage servicers, who frequently only have access to short-term sources of liquidity, would be required to potentially forward payments for millions of borrowers for months and only get paid back in due course by the Agencies.

While Ginnie Mae provided a servicer liquidity facility by late March the initial supposition by the regulator of the GSEs (FHFA) appeared to be that servicers of Fannie Mae/Freddie Mac loans would not need any external support because, among other reasons, the number of borrowers who were expected to apply for forbearance was expected to be on the low side. This assumption about the projected level of forbearance was rapidly dashed as the table below shows. Based on an MBA survey of servicers, as of May 10th, ~6.25% of all GSE borrowers was in forbearance. Another estimate from Black Knight, a mortgage data and analytics company, has the fraction of GSE mortgages in forbearance at 7% as of May 12th.

As it has become clear that a much higher than expected number of borrowers will avail themselves of forbearance, there have been several responses from the the GSEs and FHFA:

  • April 21st, 2020. Servicer advances were limited to a maximum of four consecutive missed monthly payments with the remaining payments being assumed by the GSEs.

  • March 2nd, 2020. Some borrowers sought payment forbearance shortly after closing on their single-family loan and before the lender could deliver the mortgage loan to the Enterprises. Under prevailing rules, mortgage loans either in forbearance or delinquent are ineligible for delivery. The GSEs' new temporary purchase program allows the delivery of loans in forbearance that may be no greater than 30-days delinquent.

  • May 13th, 2020. A new payment deferral option was introduced which allows borrowers, who are able to return to making their normal monthly mortgage payment, the ability to repay their missed payments at the time the home is sold, refinanced, or at maturity. Essentially, this option converts a borrower's missing mortgage payments into a zero-interest second lien. This new option is in addition to other options that include reinstatement, a repayment plan, or loan modifications based on individual situations. The deferral option is available to borrowers who are delinquent for up to 12 months.


How High Will Forbearance Levels Go?

The change in unemployment rates from 3.5% to 14.7% has corresponded to an increase in forbearance levels (for GSE mortgages) from 0.25% to 6% (as of the end of April), giving us a slope of 0.50%, on the low-end of the historical relationship between unemployment and delinquency but broadly in line. With the forecast for the end-2Q unemployment rate converging to 20-25%, it appears that forbearance levels for conforming mortgages should level off at 10%. Alternatively, we can also simply try to extrapolate the trends we see in the MBA and Black Knight data which suggest that the forbearance level will plateau at 7% since in recent weeks the rate of increase in forbearances has been dropping sharply. Whichever way we cut the data, it is clear that although forbearance levels are much higher than initially projected by the regulator, they are also much lower than what several stress case projections assumed. While part of these lower expectations can be put down to a decrease in the width of confidence intervals for the 2Q unemployment rate, it also seems that (so far) the uptake in forbearance plans is lower than what some market participants expected on the GSE front. While there was some thought that borrowers would proactively apply for this plan to get liquidity relief since the hurdles to qualify for forbearance instituted by the CARES Act are so low, this clearly doesn't appear to have happened at a level which would impose significant stress on certain servicers.


The Disconnect Between Delinquency and Forbearance

If 6% of all GSE borrowers were in forbearance at the end of April, why is the delinquency level on Freddie Mac pools close to 4%? Initially, the assumption was that the disconnect resulted from (1) lagged reporting, (2) loans that went into forbearance right after closing only recently being allowed in GSE pools, and (3) the level of forbearance being disproportionately higher in reperforming loans which do not show up in the Freddie Mac aggregates above etc. However, a recent survey by LendingTree calls into question this assumption by suggesting that almost 70% of the borrowers who applied for forbearance could still make their monthly payments and some of these borrowers are potentially continuing to do so.


Delinquency and Agency MBS Prepayments

The increase in forbearance/delinquency has important consequences for Agency MBS prepayments. GSE and FHA mortgage holders are not allowed to refinance when they are delinquent (VA borrowers can). On the other hand, 120+ delinquent loans being purchased out of Agency MBS pools are seen as prepayments by MBS investors (The introduction of the payment deferral option should decrease the pressures on servicers/GSEs to buy out loans since it gives borrowers an easier path to remaining current). The upshot then is that it is important to monitor credit-performance related metrics on Agency pools going forward. One important statistic is the delinquency percentage of a pool, the greater the percentage of delinquent borrowers the lower the propensity to refinance. The figure illustrates this dependence for FHLMC 30-year pools.

Another very important statistic is the level of buyout-related prepayments for GSE pools and GNMAs. Despite the build up in delinquencies, we expect the buyout rate to remain low until the economy improves as both the GSEs and individual servicers will want to conserve balance sheet.

A final metric that is useful to track are the roll rates in and out of various states of delinquency. For example, it is often very useful to see the rate at which the pipeline to serious delinquency is being built up and flushed; we profile these rates for Freddie Mac pools below. As we can see, the flow into (netRollToSD) and out of (buyout Rate) serious delinquency have been well matched for the past year or so but we expect these rates to diverge as the flow into serious delinquency increases and servicers hold off on buying out these mortgages.

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