Are You Prepared?
There is no question that few of us are not sad to see 2020 fade into the sunset. The black swan that glided past us was worthy of an Amazon Prime series starring Jack Nicholson, Eddie Murphy, Christian Bale, and Sandra Bullock that might even make Michael Lewis turn his head.
We were ravished by a global pandemic; we saw our mortgage industry produce record-setting volume and profits. We saw liquidity events temporarily drive MSR values down to such low levels that investors wanted to be paid just to take the asset. We witnessed several non-QM correspondent lenders forced out of business and their sellers forced into sub 80 scratch and dent prices. Conversely, we saw independent mortgage bankers return to public equity markets reminiscent of early 2000. So, with all these events now in our rear-view mirror, what is forward looking in the 2021 windshield, and are you prepared?
2020 Mortgage Banking Results:
According to an early December press release from the Mortgage Bankers Association net gains of $5,535 per loan were reported as of the end of Q3 which was up by $1,000 from the previous quarter when the black swan started gliding across the pond. The MBA data and analysis indicated that despite net losses in servicing resulting from both impairment and amortization, mortgage bankers and particularly IMB's were profitable. Ensuing MBA updates regularly reflected slight ticks up or down in both delinquency and forbearance related to COVID-19.
IMB Profits Increase in third quarter of 2020
GNMA Issuance:
GNMA issuance surged in 2020 and eclipsed all other origination years with just over $760B in UPB with approximately 3 million units. Independent mortgage banks (IMB's) lead the way issuing $661B or about 87% while their banking counterparts contributed $102B or about 13%.
Putting the 2020 origination year into context there is almost $2T outstanding of GNMA servicing as of December 31, 2020. The significance and concern this level of GNMA volume raises (particularly) by IMB's is their ability to ultimately meet their advance obligations under the securities when their borrowers become delinquent or go into default.
The FHA and its first cousin GNMA have long been concerned about this counter-party risk and developed on-going risk management metrics to try and get ahead of it. Of course, it is impossible to completely model the future with any certainty. Bad behavior, unforeseen global concerns, cyclical divergence should be nothing more than a tweak in the model for risk adjustment but such adjustments are rarely accurate and even if they are, they do not stop the ensuing event. Political change and changes in tax policy proposed by a new congress and administration can have a significant impact on mortgage rates, job creation, employment stability, and a borrower's ability to re-pay their mortgage.
The EBO:
With this as the backdrop, there are several indications that should cause concern among mortgage banking "C" suite, risk managers, and GNMA investors. Pre-COVID, GNMA early-buy-outs (commonly referred to as EBO's) the rules were reasonably balanced between the competing interests of the borrower, servicer, and ultimately the investor of GNMA securities. But all of that changed at the end of June-2020 with Ginnie Mae's announcement APM-20-07. Laurence Platt of the law firm Mayer Brown wrote an excellent piece on EBO's for the July-edition of Housing Wire providing a thorough background on the changes GNMA made on EBO's and their future eligibility into new GNMA securities.
Here are some possible reasons to re-purchase a loan from a GNMA pool: 1) Assuming you have sufficient capital, and your cost of financing the re-purchase EBO is less than the cost of making the advances, there may be a financial advantage for buying the loan out of the pool once it is over 90 days delinquent; 2) There is a profit to be made when a servicer purchases the delinquent loan from the pool at par rehabilitates the loan with “special servicing” bringing the loan current and making it eligible to be re-pooled, often at premium pricing representing a significant secondary marketing gain on sale; 3) A third reason would be to keep your GNMA delinquency percentages in check. Once the loan is removed from the pool it is no longer considered in your GNMA delinquency percentage calculations. (Note: This is less of a reason currently because COVID forbearances are not negatively counted against your delinquency percentages.) The change was extended by GNMA on how it monitors a servicers delinquency percentage through mid-2021.)
Since a servicer is required to advance the payments’ the servicer must front the cash while the loan is in forbearance or default. Even though these cash-outlays are reimbursable under the GNMA program, advancing is a real drain on cash. By purchasing the loan out of the pool, a servicer can reduce the forward cash-flow impact by not remitting the scheduled P&I. In so doing a servicer has more time to optimize the net-present-value by considering solutions with competing interests of the borrower, the servicer, and MSR investor. Of course, the repurchase of the loan is itself a demand on cash, so third-party financing and trading facilities currently exist for the servicer to provide liquidity for the servicer to exercise that option, but we know that a black swan gliding by can easily change that. Liquidity, "here today, gone tomorrow".
So, are you prepared?
Again, I ask the fundamental question, are you really prepared for the financial and regulatory requirements that EBO's pose? Cash drain, a litany of warehouse line covenants, and balance sheet restrictions compounded by limited access to liquidity that may pose a financial and reputational risk? Here are just a few prudential considerations that you should add to your risk management repertoire.
1. Are you monitoring your quarterly FHA Compare report standings to determine how your originations stack up against others?
2. Have you adequately reserved for credit deficiencies and losses?
3. Is there a willingness to adjust your origination credit tolerance to stay in good standing with the FHA, even at the risk of losing volume? (Remember, an LLPA only is supposed to make the credit risk more tolerable, it does not make it go away) The streets are littered with EBO's and LLPA's.
4. Are you regularly reviewing your correspondent sellers and TPO sources to determine which ones live on the edge of the credit risk curve? Are you the one they view as the free "put"?
5. Are you confident that your servicer/sub-servicers core competencies center around delinquency and default?
6. Does your current servicer have a proven track record to ensure better consumer out-comes while simultaneously working to maximize the net present value of your mortgage assets?
Computershare Loan Services (CLS) is a premier mortgage loan servicer with core competencies in special servicing for managing mortgage delinquency and defaults that help borrowers consider their best possible out-comes while maximizing the NPV for their clients. CLS is a highly rated mortgage servicer by the rating agencies and maintains the highest recognition from the GSE's, GNMA, and FHA.
As you wind down from one of the most tumultuous lending years in history and prepare for 2021, let's have a conversation about your GNMA mortgage servicing portfolio and how to best manage your EBO's, delinquencies, and defaults.
Special thanks to Doug Mayers at Phoenix Capital, Jonathan Grafflin at Essex Mortgage, and Michael Ehrlich at Refinitiv for their professional insights.
https://www.refinitiv.com/en/products/advanced-mortgage-analytics
#computershareloanservices; #refinitive; #garrettmccauley; #phoenixcapital; #themortgagebankersassociation;#theamericanbankersassociation; #CUNA; #acuma; #mayerbrown; #housingwire
@david ida, @toby wells, @shelley duffy, @dana Abernathy, @pete pannis, @michael frantantoni, @tricia migliazzo, @doug mayers, @wayne brown, @pete mills, @randy lightbody, @tom millon, @treacy fenton, @karin good; @victor calandra; @sarahrice; @sara singhas; @andy mignerey; @gillian thompson; @elizabeth a baumeister; @jon ballard; @jon grafflin; @james nader; @kenneth adler;@jodi gaines;@vikrant rai; @michael mccauley; @laurence plat; @hmarchelm; @nitin dave; @don curtis; @stephen a milner; @trinity weekes