Mortgage Delinquency, Forbearance and COVID-19
The economic destruction unleashed by the COVID-19 pandemic has lead to a surge in the unemployment rate which in turn will lead to a number of homeowners being unable to make their current mortgage payments. Paradoxically, the government's CARES stimulus package has the potential to catapult the mortgage delinquency rate much higher than it would ordinarily be as borrowers in federal loans have been granted a fairly straightforward path in asking for and obtaining payment relief without any corresponding damage to their credit. The number of borrowers that avail themselves of this relief has important consequences for the servicing community because mortgage servicers are still responsible for advancing monthly principal and interest payments to investors and also for advancing amounts to pay for property taxes and insurance premiums when they remain unpaid by the borrower. While these advances will eventually be repaid by the relevant Agencies, a prolonged wave of delinquencies that is above and beyond the already extremely elevated levels of delinquency one would associate with the current economic scenario is likely to overwhelm a number of non-bank mortgage servicers who do not readily have access to long-term sources of liquidity. The danger that this situation represents for some servicers has been been recognized in Ginnie Mae-backed mortgages with GNMA announcing the implementation of a liquidity facility on March 27th through which mortgage servicers will be able to apply for advances in order to make scheduled payments to investors. On the other hand, no such facility has been countenanced for GSE-backed mortgages so far with the apparent assumption being that these borrowers are unlikely to apply for payment relief in large numbers and also that servicers should be adequately capitalized to deal with this scenario in any case. Here, we explore estimates for how many borrowers in GSE-backed are expected to apply for payment relief as this will play an important role in deciding whether a liquidity facility is eventually established or not.
CARES and Mortgage Forbearance
The CARES Act provides that single-family and multifamily homes that are backed by a federal mortgage loan may request forbearance of up to a year. Forbearance occurs when a lender or a servicer grants a borrower a form of payment relief -- either a temporary pause on their mortgage payments or the ability to make lower mortgage payments for a defined period of time. These missed payments have to be made up at some future date. The idea is that forbearance is intended to deal with a temporary hardship and anticipates the borrower bouncing back as opposed to a more invasive restructuring of the contractual terms of the mortgage which assumes that the borrower will be unable to meet the original schedule of payments for the foreseeable future. Under CARES, any borrower experiencing direct or indirect financial hardship related to the coronavirus is able to request 6 months of forbearance, regardless of their existing delinquency status. This period can be extended another 180 days at the request of the borrower. During this period of forbearance, no fees or interest will be applied to the borrower. Furthermore, there is no reporting of delinquencies to credit reporting companies so no damage accrues to the borrower's credit scores. Forbearance counts as a delinquency because the borrower is not making their full monthly payments and the servicer’s promise to hold off on foreclosure does not release the borrower from their contractual obligation to make complete payments. As noted above, the terms of the mortgage note are unchanged in a forbearance -- there is no permanent legal modification of the mortgage obligation. CARES offers a relatively hassle-free path to obtaining a forbearance. All that is required is a conversation with the mortgage servicer in which the homeowner has to attest to financial hardship caused directly or indirectly by COVID-19 but no further documentation is required to prove such financial hardship. At the end of forbearance, servicers will attempt to structure a repayment plan for the borrower by tacking on the missed payments to the regularly scheduled mortgage payments over a period of time (depending on the borrower's ability to pay).
Estimating the Future Level of Mortgage Forbearance
Our estimate of the future level of mortgage forbearance starts with the simple observation that this number should be bounded from below by the number of homeowners who would have experienced delinquency in any case because of the economic crisis. Ordinarily, mortgage delinquency is a fraught choice as it leads to a damaged credit record and may also result in the servicer trying to institute foreclosure proceedings. Neither deterrent applies in the current situation whereas we also have a relatively smooth runway to applying for a forbearance. To estimate delinquency rates, we first collect a range of projected unemployment numbers for 2Q and then forecast the delinquency numbers associated with these unemployment rates by looking at the historical relationship between changes in the unemployment rate and mortgage delinquency. Note that our estimates are specifically focused on GSE-backed loans because that's where we have the lack of a liquidity facility.
By slicing-and-dicing the potential population of workers whose jobs are at risk because of social distancing measures, economists at the St. Louis Fed came up with a band of projected unemployment rates at the end of the 2Q which ranges from 10.5% to 40.6% ( https://www.stlouisfed.org/on-the-economy/2020/march/back-envelope-estimates-next-quarters-unemployment-rate).
We now model the historical relationship between changes in unemployment rates and changes in delinquency rates. Right now, publicly available time series on delinquencies for GSE-backed mortgages only extend back to 2011. As a reasonable proxy, we use a time series for delinquency rates on single-family residential mortgages held in commercial bank portfolios that extends back to 1991. The figure below shows that the relationship between delinquency and unemployment varies over time and the upshot is that what happens to mortgage delinquency is a function of how housing-focused the recession is. The Great Recession was caused by a housing crisis which eventually spilled over to the entire economy so it makes sense that the two rates climbed in lockstep in that time period. At least initially, we expect the relationship to be less strong in the current economic scenario.
The next figure shows that there's a reasonably strong relationship between 3-month changes in unemployment rate and mortgage delinquency with a straight-line regression yielding a slope of 0.69. However, note that we're in unprecedented territory because we've rarely if ever had the national unemployment rate change by such dramatic amounts in the course of three months. There's suggestive evidence in the plot that for larger changes in unemployment rates we may see a one-to-one relationship with delinquency.
Putting all of this together, the forecasted change in unemployment rates between now and 2Q ranges from 7% to 37% (starting from 3.5%). Using a range of slopes from 0.51 to 0.85, gives us an estimated change in delinquency rates ranging from 3.6% to 31.5%. The total delinquency rate on 30-year Freddie Mac mortgages is currently approximately 1.25% which suggests that the 2Q delinquency rate will range from 4.9% to 32.8%. Thus, we expect the forbearance rate to be at least 5% by the end of 2Q with a central estimate of 18%.
Recent Data on Mortgage Forbearance
The Mortgage Bankers Association (MBA) initiated a weekly survey of forbearance and call center activity starting the week of March 2nd, 2020. Currently, MBA's survey data covers 26.9 million loans serviced as of April 5th, 2020, representing almost 54 percent of the first mortgage servicing market. The sample size is expected to increase in the coming weeks as more servicers respond to requests for participation (see https://www.mba.org/2020-press-releases/april/mba-survey-share-of-mortgage-loans-in-forbearance-continues-to-climb). The table below shows that the forbearance rate on GSE loans has exploded from 0.25% to 2.44% in a matter of one month. Our calculations suggest that these numbers will continue to increase steeply over the coming months.