Last week was difficult for members of the mortgage industry, especially for those members of the residential lending community who've been working in the world of mortgage finance for more than a decade. As in the late 1990s and the 2008 financial crisis, lenders and servicers are learning once again that the government market of the Federal Housing Administration and Ginnie Mae is the only reliable one for agency mortgage loans.
The government-sponsored enterprises or GSEs, Fannie Mae, Freddie Mac and the Federal Home Loan banks, are again backing away from the market. In the 1990s and the 2008 crisis, lest we forget, the private mortgage insurers and ultimately the GSEs retreated from their legal obligation to repurchase defaulted loans, seeking instead to give them back to the lenders.
The more astute operators in the mortgage industry knew there again would be problems with the GSEs when the bull market in housing ended, but today the situation is even more serious for banks and nonbanks alike.
The Federal Housing Finance Agency seems determined to keep the GSEs out of the fray as COVID-19 pushes unemployment rates to levels not seen since the 1930s. With unemployment in the mid-teens in April and likely to move significantly higher, the rate of defaults in one-to-four family loans could easily exceed the 2009 peak level for charge-offs by the end of the year.
Bank-owned one-to-four family mortgages peaked at 2.5% charge-offs in the fourth quarter of 2009 while loans sold into mortgage backed securities were higher. With subprime loans, you added a zero to the loss severities. This time, the numbers could be far higher across the board. The rate of small business failures and job loss in the services sector could take unemployment and homelessness to levels not seen in the U.S. for almost a century.
While the banking system and nonbank mortgage servicers can deal with the operational load of the coronavirus crisis, preserving the conventional loan market will depend upon the GSEs honoring their legal obligation to repurchase genuinely defaulted loans and the MIs paying out on mortgage insurance claims. Unfortunately, FHFA Director Mark Calabria seems to think he can stiff the mortgage servicers for the cost of dealing with the natural disaster called COVID-19, a position that is in striking contrast to the helpfulness and urgency shown by the FHA and Ginnie Mae in recent weeks.
It seems a bit churlish for the FHFA not to support the GSEs to help lower the cost of government loan forbearance on the very mortgage servicing strips that the GSEs ultimately own. Michael Bright, former Ginnie Mae president and CEO of the Structured Finance Association said last week, "The administration, including FHFA, has advocated for this forbearance and should be willing to pay for its own programs rather than expecting private American companies to pick up the tab, with potentially bad outcomes for homeowners and taxpayers."
The GSEs, after all, are responsible for reimbursing servicers for expenses. Typically, Fannie and Freddie will buy 120 to 150 day delinquent mortgages out of conventional MBS at 100 cents on the dollar, and pass the loan to a special servicer. Everyone knows the GSEs don't have the cash to repurchase loans in a crisis of the magnitude now facing the industry. The GSEs did not have the cash in 2008 and, to Director Calabria's point, their first quarter results should show the same in 2020.
The best thing FHFA can do is to allow the GSEs to operate exactly the way they did before this crisis began — buy loans out in normal course and focus on bringing liquidity to a broad cross section of smaller issuers in the conventional ecosystem. The big banks and nonbanks can handle the load, but only if Director Calabria stops attacking the industry in public. Comments last week by Director Calabria
With such harsh negative views coming from a federal regulator, markets are viewing the servicing small-bank and nonbank assets as toxic, making loan origination uneconomic for anyone but the big banks and larger nonbank aggregators, and killing any liquidity in mortgage servicing rights. The decision last week by JPMorgan Chase to limit warehouse lines to government and conventional loans is directly attributable to the comments by Director Calabria that he would not support conventional servicers. How are these comments helpful?
But more than the cost of dealing with
During 2020 and 2021, the $11.5 trillion MBS sector could be forced to absorb 5% to 6% charge-off rates across GSE and prime jumbo exposures and well into double digits for FHA/VA/USDA and the scant few below-prime residential loans outstanding. Assume that the banks hold the best quality prime loans in credit terms, then comes the GSEs, then the FHA market. That still gives us $200-250 billion in prospective loan repurchase costs for the GSEs over the next two years. If loan loss rates go higher into double digits, then all bets are off and even the very liquid, well capitalized money center banks will suffer.
Rather than fighting with members of the mortgage industry, we think the FHFA director and his FSOC counterparts need to sit down with the Treasury and fashion an emergency capital plan for the GSEs. Treasury needs to help the GSEs plough through possible double-digit loan defaults. As with the projections for the rate of infection of COVID-19, we can hope that the default wave now forming will be mitigated by preventative measures and cash from Washington — but the unemployment numbers strongly suggest otherwise.
Instead of going to Treasury for yet another "bailout," Director Calabria instead seems to think the private servicers can bailout the GSEs through potentially unprecedented levels of principal and interest advancing relative to any past crisis. It is probably time for the Trump administration to put aside the idea of ending the conservatorship for the GSEs next year. Instead, we need to focus on how Fannie Mae and Freddie Mac will be able to finance what could be several hundred billion dollars in loan buyouts from MBS investors over the next two years.
