The end of forbearance and the capital markets

Did the CARES Act postpone an inevitable correction in the housing market?

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One of the great questions facing the housing markets in 2021 is what will happen when the mortgage forbearance programs under the CARES Act expire. When this act was originally passed on March 27, 2020, there were notable concerns that these measures would merely postpone an inevitable correction in the housing market once the programs expired.

Since that time however, a powerful fiscal and monetary response brought mortgage rates to a record low and boosted household savings. In addition, an increase in the prospects for ongoing work-from-home arrangements combined with a growing preference for less dense living arrangements has led to a massive boost in the number of families looking to move.

The result has been an extraordinary acceleration in home price growth. According to the Federal Housing Finance Agency purchase only house price index, it took almost six years during the bubble period from 1998 to 2004 for home price growth to accelerate from 5% to 10% on a year-over-year basis. In 2020 the same result took just five months, an extraordinary market impulse.

With prospects increasing for a new first-time homebuyer tax credit and student loan debt forgiveness in a decades-tight housing market, concerns have shifted away from a wave of foreclosures weighing on markets to an overshoot in prices and a subsequent hard landing.

How this will all play out depends to a large degree on developments in the mortgage market. Of course, the regular dynamics of the market are in play: Fed policy, changes in inflation expectations, etc. But the wonderful thing about the securitized mortgage market is the great variety of types of securities available to investors that allow them to allocate their capital based on nuanced views about future market developments. There are hundreds of thousands of pools to choose from, including those specified pools, custom pools from single-issuers, those containing loans made in single states, low balance loans or modified loans, along with a myriad of others.

Nearing the end of forbearance

Up until the expiration date, forbearance is entirely up to the borrower. When it is over, the household will either 1) become current, 2) negotiate a modification or 3) sell the house and move. During the global financial crisis, the latter option caused a great deal of distress to households and the overall financial system due to the large number of underwater borrowers. This time is vastly different as home price increases continue to accelerate. Even in the FHA market, which is dominated by high LTV borrowers at origination, we estimate that only about 3% of borrowers in the FHA book have a current LTV greater than 95. Borrowers have a great deal of incentive to hang on to their homes.

While some borrowers may become current when forbearance expires, this will not be easy for many, as payroll employment in February 2021 stood 9.5 million jobs below the similar figure a year earlier. Moreover, 4.1 million people have been unemployed 27 weeks or longer. Structural change in the economy during the pandemic will make it difficult for many to return to the labor force quickly after the pandemic fades. Given these circumstances, we turn our focus to the workout options “…concerns have shifted away from a wave of foreclosures weighing on markets to an overshoot in prices and a subsequent hard landing.” available to delinquent borrowers. The GSEs have various borrower assistance plans, while for Ginnie Mae there is a new innovative capital markets instrument called RG pools.

RG pools were unveiled last December and consist entirely of loans that were bought out of traditional pools and cured with partial claims (a partial claim is a second lien with a single balloon payment made at the time the first lien is eliminated). According to the Ginnie Mae pool rules, such loans are eligible for resecuritization once they have gone six months without a missed payment, but not into any existing pool type. Hence the RG pools.

As of March 17, 2021, this program is miniscule, with just 6,000 loans across six issuers. But FHA neighborhood watch data shows issuers have made 188,000 partial claims through FHA since the onset of the pandemic, and the number is still increasing. This trickle could turn into a flood of loans into the RG program once these loans successfully make six payments.

What happens after forbearance?

What will happen when forbearance expires? Some of the 800,000 loans currently in forbearance might receive a partial claim and enter the pipeline into the RG pools, and some of them might be modified or receive other loss mitigation treatment. This development presents a new challenge to servicers who will have to closely watch what their peers are doing and sharpen their skills in working out troubled loans.

This creates a lot of questions. First, how will these pools perform? From a standpoint of prepayment speeds, at first, servicers may not give these borrowers a high priority, although over time that may change. Anecdotal evidence suggests that investors are comfortable that speeds will not be too fast for now and price these accordingly. From a standpoint of involuntary buyouts based on delinquencies this is an even tougher question. Traditionally, modified loans perform worse than the general population.

For example, total delinquencies of modified loans in the FHA book are 23.3%, greater than 11.6% of others for March 2021. Consequently, involuntary prepayment speeds of modified loans are much higher than others within the first few months after they are delivered into the pools. But forbearance and partial claims are very different from the old normal mods and may well perform differently, we will have to see. With interest rates off their lows, involuntary buyouts look to be a bigger factor in driving performance than voluntary prepayments.

Second, what impact will we observe should a wave of modifications transpire when forbearance expires on the Ginnie program itself? If the numbers are big enough, speeds in multi-issuer pool types may rise, raising investor concerns. In addition, individual servicers may see benefits from more frequent modifications, weighing on the performance of the RG program. These are factors that will have to be monitored closely, but mid-stream policy corrections can serve to mitigate these concerns as needed. Over the course of the pandemic, Ginnie Mae has shown itself to be very capable of taking creative action in a crisis, with capital markets innovations ranging from the release of loan-level forbearance data in July 2020 to the new data disclosures providing greater visibility into the share of loans from low- and moderate-income Census tracts in their pools.

This article was pulled from the HousingWire Magazine May issue. To read the the rest of the issue, go here.

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