When the Federal Housing Finance Agency announced last month that servicers who collect payments on mortgages backed by Fannie Mae and Freddie Mac will only be required to cover four months of missed payments on loans in forbearance, the big question was what happens when that four-month period is over.
That’s because neither the GSEs nor the FHFA said who would pay the remaining principal and interest payments that those servicers are required to send to investors, but it’s not a mystery anymore.
As it turns out, the GSEs themselves are preparing to cover any remaining advances for as long as those loans remain in forbearance.
The GSEs separately revealed this week that they are planning to make payments directly to investors for loans that stay in forbearance longer than four months.
Under the CARES Act, a borrower whose mortgage is backed by either the government or the GSEs who is experiencing a COVID-19-related hardship can request and must be granted forbearance of up to 180 days, which then may be extended by an additional 180 days if necessary.
That created a situation where servicers would theoretically be required to advance the missed payments to mortgage bond investors for as many as 360 days, which caused many servicers and mortgage industry observers to practically beg for the government to set up a federally backed liquidity facility for servicers.
And while some big names believe that could still happen, the FHFA gave servicers some peace of mind when it announced in April that servicers will only have to cover four months of payments.
But with a potential forbearance period of nearly a year and servicers only on the hook for four months of payments, the issue of who would make the remaining payments became a significant one.
But it looks like it will be the GSEs who will be making those payments.
“To provide servicers with stability and clarity regarding their payment obligations and to align our servicer advance requirement with Freddie Mac, FHFA’s instructions require that, effective August 2020, we cease requiring servicers to advance missed scheduled principal and interest payments after four months of missed borrower payments on a loan,” Fannie Mae said in its 10-Q filing with the Securities and Exchange Commission.
“After this time, we will make the missed scheduled principal and interest payments to the MBS trust for payment to MBS holders so long as the loan remains in the MBS trust,” the GSE added.
The phrase “so long as the loan remains in the MBS trust” is an important one considering that the GSEs will not be buying loans in forbearance out of MBS pools.
Under the GSEs’ previous policies, mortgages that are delinquent for more than four months are purchased out of MBS pools by the GSEs. But, under a new policy announced last month, the GSEs will keep loans in forbearance in their respective MBS pools “for at least the duration of the forbearance plan.”
So, loans in forbearance will remain in MBS pools for as long as they’re in forbearance. And, the GSEs are maneuvering to cover those remaining payments, for however long they need to.
Each of the GSEs posted significantly smaller profits in the first quarter than in previous quarters, as each is moving to protect against those credit issues.
“We also maintained excess liquidity during 1Q 2020 due to volatile market conditions caused by the COVID-19 pandemic, which may negatively affect our net interest income,” Freddie Mac said in its 10-Q filing with the SEC. “Additionally, we expect to advance significant amounts to cover principal and interest payments to security holders for loans in forbearance in the coming months.”
In its SEC filing, Freddie Mac said that it expects serious delinquency rates and the volume of loss mitigation activity to “increase significantly” as a result of the COVID-19-related shutdowns and job losses, which will lead to the GSE needing to pay bond holders directly for missed payments.
“The pandemic and forbearance programs also will cause a significant increase in our allowance for credit losses,” Freddie Mac said. “We had a $1.2 billion provision for credit losses in 1Q 2020 due to our forecast of higher expected credit losses from our single-family credit guarantee portfolio as a result of the pandemic, but these estimates are subject to significant uncertainty and may increase substantially in the future depending on the depth and severity of the economic downturn caused by the pandemic.”
Fannie Mae also voiced its concern about the issue in its SEC filing.
“If a large number of single-family or multifamily borrowers do not pay their mortgages as a result of the economic dislocation caused by the COVID-19 outbreak, our servicers may not have sufficient liquidity to advance the missed payments to MBS trusts,” Fannie Mae said. “In such case, we would be required to make the payments, which could require us to obtain substantial additional funding.”
Both of the GSEs have billions of cash on hand, the result of each company being allowed to grow its capital buffer to a total of $45 billion combined. Under the terms of the Preferred Stock Purchase Agreements that went into effect when the government took the GSEs into conservatorship, Fannie and Freddie used to send dividends to the Treasury each quarter that they are profitable.
But that changed late in 2017 when the FHFA began allowing the GSEs to retain some capital.
Then, last year, the government announced that it was increasing the amount the GSEs could withhold from the Treasury. The move all but ended the net worth sweep, at least until the GSEs build up their allowable capital reserves. Under the agreement between the GSEs, the Treasury and the FHFA, Fannie Mae can hold a capital reserve of $25 billion, while Freddie Mac can hold $20 billion.
As of March 31, 2020, Fannie Mae has a net worth of $13.9 billion, while Freddie Mac has a net worth of $9.5 billion.
That means the GSEs can likely cover the missed payments for some time, but each company expressed some concern about their ability to cover the payments for an extended period.
“In addition, we expect our debt funding needs to increase in future periods, as significantly higher rates of loan delinquencies and an increase in forbearances and other loss mitigation activity driven by the COVID-19 outbreak require us to fund greater amounts of principal, interest, tax and insurance payments on delinquent loans and to purchase a larger volume of delinquent loans from MBS trusts,” Fannie Mae said.
“Our allowance for credit losses has increased significantly, and we expect single-family serious delinquency rates and the volume of loss mitigation activity to increase significantly in the near-term as a result of the COVID-19 pandemic and the forbearance programs we have announced,” Freddie Mac said.
“While we expect that the actions we have taken to support the mortgage markets as a result of the COVID-19 pandemic will improve borrower outcomes, these actions may not be as successful as we hope,” Freddie Mac continued. “In addition, these actions may negatively affect our financial condition and results of operations, perhaps significantly. The ultimate success of these programs will depend on the duration and severity of the economic downturn.”