Election won’t impact mortgage industry like CARES Act problems will

It is popular in the days before a U.S. presidential election to write long, detailed analyses about how the election will impact one industry or another. In the case of the mortgage industry, the concerns about dealing with COVID and the CARES Act make mere political considerations pale in comparison.

How we resolve millions of delinquent mortgages due to COVID is the only question that matters. Back in March and April, you will recall, we yelled about the fact that many mortgage firms were on the verge of failure. The Federal Open Market Committee decision to “go big” with open market purchases of U.S. Treasury and agency mortgage-backed securities almost caused the failure of several large, publicly traded hybrid REITs and mortgage lenders.

Lest we forget, margin calls in April and May for the half-trillion-dollar per-month to-be-announced market were more than the net worth of the entire industry. We fixed that problem in June as volumes surged and margin cash was returned by TBA dealers, but the industry and regulators are borrowing from bond investors to float the cost of CARES Act forbearance. This is not a long-term solution.

With the CARES Act, Congress unilaterally imposed costs upon mortgage servicers and other lenders without any thought of compensation. State governments have also imposed moratoria on auto and commercial loans. Congress and the states need to fix this deliberate act of omission before the wave of refinance volumes subsides and the mortgage industry again faces a liquidity crisis due to the CARES Act and unfunded state-level consumer payments moratoria.

So far, the industry has used the escrow float generated by the FOMC’s low interest rates and resulting surge in lending volumes to paper over the cost of COVID. As we noted in The Institutional Risk Analyst (“The Bear Case for Mortgage Lenders”), so long as the volume of mortgage refinance volumes remains strong, the industry will continue to use the float from mortgage prepayments and payoffs to finance CARES Act advances.

The liquidity that so conveniently arises from loan repayments and insurance claims, however, belongs to bond holders. Servicers get to deposit this cash in a bank for about a month, when it goes out to MBS holders. The point is that mortgage lenders and servicers ultimately need to replace such escrowed funds to make payments to bond holders in respect of such prepayments and mortgage payoffs.

As and when the high tide of mortgage refinance volumes falls, the industry’s need for financing will increase substantially and as quickly as it went away in May and June of this year. Astute investors noted in some of the recent public equity offerings that bank credit utilization by several independent mortgage banks seemed a tad low — too low.

As the tide of liquidity goes out, the industry will pull on bank warehouse and nonbank repurchase facilities for additional cash. The FOMC will no doubt respond, again, with greater open market purchases of mortgage backed securities.

But ultimately Congress must do two things to avoid catastrophe: 1) authorize the Federal Reserve System to finance CARES Act advances via the warehouse lender banks. This is the plan proposed by former Ginnie Mae chief Ted Tozer. And 2) Congress must authorize the FHA to make full reimbursement on CARES Act advances and other expenses. Problem solved.

As the year ends and 2021 begins, mortgage investors must decide whether to continue to return the market for mortgage servicing rights. How Congress resolves the mess they created with the CARES Act will be a crucial determinant. With the FOMC imposing negative effective returns on global MBS investors because of the high rate of prepayments, the industry does not need any more of such help from Washington.

If Congress manages to act to fix the CARES Act forbearance mess, that will be good news for banks, IMBs, and also the GSEs, Fannie Mae and Freddie Mac, which should also be reimbursed for the cost of financing missed loan payments and other expenses. As FHFA Director Mark Calabria told Congress earlier this year, if you don’t like the fee increases, then provide funding for COVID-related expenses.

We hear that House Financial Services Chair Maxine Waters appreciates that Congress left a lot of unfinished business when it passed the CARES Act and promptly left town to escape from the risk of COVID. But if Congress fails to act to fix the CARES Act mess it created six months ago, then 2021 could be a very bad year for the mortgage industry indeed.

For both investors and risk professionals operating in the secondary mortgage market, the next several years contain both great opportunities and considerable risks. “We have no issue bringing capital into the MSR asset, the biggest issue is speed,” Matt Maurer of SitusAMC told the IMN MSR conference in New York last week. A new sharp, sudden decline in interest rates by the FOMC could spell another wave of margin calls, prepayments and losses for investors and IMBs.

The good news is that investors such as REITs and private equity funds have raised cash and are again supporting the secondary mortgage market for conventional and government loans, MBS and MSRs. But if we don’t fix the deficiencies in the CARES Act soon, the liquidity in the secondary mortgage market could disappear again. In that event, we’ll be right back to the situation that existed in May of this year with no secondary market liquidity.

Therefore, ask not about the 2020 election or who will be in the White House next year. It does not matter in the grand scheme. The outlook for mortgage production in 2021 is the key question facing policy makers at the Fed and mortgage agencies such as HUD, Ginnie Mae and the Federal Housing Finance Agency. And how and when Congress and the states fund consumer loan forbearance could decide the fate of the entire industry and the U.S. economy as well.