Kicking a Barrel of Dynamite
By: Greggory B. Oberg, Esq.
Over the last month plus, we've all been inundated with issues relating to borrower repayment of loans in servicing. Some of that is because it's not a simple topic. More of it is because there is--at least in my opinion--an intense game of "kick the can" between the various interconnected stakeholders in the Mortgage industry. I'm sure similar occurs in other industries, but I can only speak to what I know.
For possibly the first time in U.S. History, the SH*T is flowing UP hill. Borrowers are being provided with a needed subsidy on the backs of the banks and investors, who are poised to lose up to 12 months (or more) of interest income they'll never be able to recoup under current laws. Add that to Schedule/Schedule payment arrangements with investors, escrowed tax and insurance obligations which the servicer must float, and a large dose of uncertainty and uncontrollable risk from COVID...you start to see the picture.
We're not kicking a can, we're kicking a barrel of dynamite. Or playing "hot potato" with a live grenade. Choose your metaphor, but the resulting reality is the same. If something doesn't fundamentally change the rules of our game, an explosion is imminent, and the collateral damage will not be negligible.
The Bigger Picture: GSE and "Federally Backed" Mortgages
I don't need to tell you that we're not in Kansas anymore; life is WEIRD, right? We're fortunate to be "essential" and able to continue to provide for our families, but it certainly has not been business as usual. Many others are not as fortunate. Some economists have predicted--as recently as Late April--that unemployment could match the 25% watermark from the Great Depression. As mortgage lenders, our ability to continue to operate safely is dependent on people continuing to pay their mortgages.
Not sure where this concept originated from anymore, but almost as soon as the idea of a Pandemic became "real" in the collective consciousness, momentum for forbearance of mortgage payments began to grow. This was largely guided by GSE "soft power" to regulate the industry, and was quickly preempted by federal law.
When the CARES Act passed in March, we had the playbook, at least generally speaking, for how to handle borrowers in Federally Backed mortgage loans. Without going into all the investor-specific details (we may hit that next week, TBD), the general state of play with GSE loans at this point is to follow CARES timelines/requirements where on point, and fill the gaps with traditional GSE Selling/Servicing Guidance.
In sticking with the "kick the can" approach, we essentially will pause the flow of income for X months, and hope things get better. When things return to somewhat "normal" conditions, you'll be running every one of these loans through GSE Loss Mitigation/Modification procedures in some form or another.
Enter State Regulators and Legislatures
But CARES does not cover the entire market for mortgages, as privately held portfolio assets in certain circumstances are functionally untouched by both GSE Guidance and CARES Act. In short--while the federal government can give everybody a check--they CANNOT regulate every private transaction. At least not directly.
I cannot begin to lay out the entire interwoven fabric of the mortgage industry and which regulators or quasi-governmental entities pull on what threads. Federal public policy and legislation plays a role, as do the administrative/executive agencies tasked with interpreting and enforcing such legislation. We know the GSEs and the connectivity to the federal government, and can see how they exercise force in influencing policy.
But mortgage banking is more or less old school property law--an area traditionally left to the State in conflicts with federal power. So naturally then, states have some ability to reach into their bag of tricks and regulate conduct on the basis of their compelling interest in property within the state. This is all a long way of saying "look for state actors to play increasingly bigger roles as we move forward."
Solutions to this financial circumstance will, in short, vary from state to state, investor to investor, and even borrower to borrower. There are multiple roads, and very little in the way of maps. And in many cases, more info may not actually make things clearer.
As an example of state action which somewhat complicates matters, let's take a look at the recent MA legislation addressing (among other tangentially relevant topics) borrower forbearance in the Commonwealth.
Mass. H.B. 4647
I've been following various versions of the language which became H.B. 4647 §5 since sometime shortly after St. Patrick's Day. Section 5, broadly, contains three subsections.
First, §5(a) substantially prohibits most mechanisms which are required on the path to foreclosure. Note holders or similar may not (1) cause notice of sale to be published; (2) exercise the power of sale; (3) exercise the right of entry; or (4) initiate a judicial or non-judicial foreclosure. I'm not a foreclosure expert, but I don't see how this operates as anything short of a complete bar on foreclosure until the expiration of §5(a).
Second, §5(b) creates a right to forbearance in borrowers whose loans are secured by Residential Property in the Commonwealth (although the language did not go as far as previous proposals). As defined, this will include 1-4 family owner occupied primary residences. There does not appear to be any consideration given to the priority of the lien, so second liens are likely included.
Section 5(b) is somewhat instructive in terms of how we begin to put the pieces back together once the governor's state of emergency is lifted.
fees, penalties, etc. shall not accrue. You essentially must pretend all contractual payments were made; despite the lack of cash in the bank's pocket;
payments forborne are added to the end of the term of the mortgage; and
negative information reading payments in forbearance shall not be furnished to CRAs.
At first glance, the payment application requirement seems to end the discussion of how to handle those forborne payments. Despite the use of "shall" in that provision, §5(b) continues to say that "[n]othing ... shall prohibit a mortgagor and mortgagee from entering into an alternative payment agreement."
Presumably then, as long as you don't violate "fees and penalties" prohibition, you can freelance somewhat. Not sure I'd recommend it with the seismic shifts we're seeing on a weekly basis from all angles of the industry.
Third, §5(c) stresses that mortgagors are NOT relieved of any obligations. This should be an obvious point, but many state and federal regulators have stressed the need to include some variation of this statement in forbearance documentation delivered to borrowers. Somehow, the crazy idea that we'd just forgive some payments got spread around, and now we've got to combat that misunderstanding. Unfortunately, there is a UDAAP risk in NOT addressing this given the prevalence of such notice across various lenders. I don't like it, but it's technically there.
Finally, a note on the expiration of this section. Per §7 of H.B. 4647, the entirety of §5 will expire "120 days after [April 20, 2020] or 45 days after the [MA] COVID-19 Emergency is lifted, whichever is sooner."
Where Do We Go Now?
Hate to say it, but for the literally hundreds of hours I've spent reading, discussing, and writing about this situation, the answer is still basically the same one I was giving in late March. Hang on for dear life, and pray we're thrown a life preserver.
We don't know how long these forbearances will last, but theoretically could be up to a year without any further legislative action at the federal level. While we can recapture that interest paid at a later date (the how is TBD still), time value will never be recovered. If I forbear $1000 of interest in this crisis, you've got to assume you're getting only that 1k back...and that you might be waiting 25 years to recoup it under the default MA position provided in §5(b). I'm not a banker, but I'd much rather have $1000 today than $1000 in 25 years.
The longer this drags out, the more obligatory escrow costs lenders will be required to float. The recoupment there is also somewhat unclear, but it appears to be some variation of an escrow analysis shortage. Best case, that's easily 24 months before you're recovering tax and insurance payments made on forborne accounts. Liquidity is a massive, yet unaddressed concern.
And the "getting our money" portion of this is less than certain in my opinion; it remains to be seen the long term economic impact of this disaster, and consequently the impact it may have on default rates, property values, etc.
But I do think one thing is clear: the burden is much more likely to sit upstream than on the borrower. For the sake of the community lenders we work with, let's hope the explosion occurs higher up the chain where larger entities or the government are more capable of absorbing the hit. Either way, get used to paying a LOT more attention to the servicing side of the house.