Servicing risks tied to Veterans Administration-backed loans has left some firms exposed to losses that, among other things, create challenges when it comes to trading the underlying MSRs, but some market participants are showing interest in doing something to improve the situation.
Several firms have been trying to find a way to mitigate the kind of VA servicing risk that has resulted in a situation where “certain vintages have not traded for awhile, or at extremely distressed prices,” according to Frank Pallotta, executive vice president of Loan Value Group.
Servicers would like to “at the very least, stop the bleeding” when it comes to those losses, he said.
Being in a world where these VA loan risks are not a barrier to a secondary market trade is “hopefully, where I think we'd all like to be,” said Pallotta. But the first step—and the main reason servicers have been contacting his company—is to reduce the losses, he said.
Although VA loans continue to have relatively favorable delinquency rates compared to FHA product—6.58% versus 12.09%, based on 3Q MBA numbers—VA insurance on loans has historically had generally about a 25% coverage maximum and a 44 basis point servicing fee as opposed to 100% coverage and a 44 bp servicing fee for FHA product.
Originally, it was thought that the VA insurance coverage maximum would be enough to cover losses, but the housing bust changed all that, especially since VA downpayments can be low. Today, for example, on a $100,000 loan a VA servicer collects $440 per year. If an underwater VA loan goes to REO, where a 40% lifetime loss severity in liquidation has been possible lately, that loss could be $40,000. Of that amount, the VA covers $25,000, creating a $15,000 liability for the servicer.
In other words, while the frequency of losses can be low (and relatively favorable) the severity of losses is a problem. This leads to illiquidity in certain vintages such as 2005-2008, the years when housing prices generally peaked. But other vintages associated with steep declines in property values are affected as well, Pallotta said.
In general, “the trading of VA servicing rights has been fairly low,” said Jason Kopcak, head of whole loans at Cantor Fitzgerald. “The default risk on this paper makes the purchasing of servicing rights unattractive for a buyer.”
To get a sense on the scope of the concern, consider LVG estimates based on industry averages and data from this publication's MortgageStats.com affiliate. These show that for the top 10 Ginnie Mae servicers, projected VA-loan related losses appear to currently range from $39 million to almost $651 million per servicer, depending on size.
Compounding the problem is a lack of government loan rescue programs applicable to VA loans and securitization barriers that arise to due their inclusion in Ginnie Mae pools, Pallotta said. The fact that government budgets are tight, and that VA is an institution loath to change, also doesn't help.
Given these restrictions, Pallotta has suggested to servicers a low-cost cash reward system for VA borrowers who promise to stay current on their mortgage for the loan's duration. Every loan that doesn't liquidate saves them many thousands of dollars, on average, he said. Pallotta said rewards, so far, have lowered delinquency rates by as much as 50% for certain at-risk LTVs in the overall mortgage market, but have not had enough of a track record to register when it comes to defaults. “They have no other way to address these borrowers,” he said. Servicers, Pallotta added, are “really not allowed” to.
“There's no capital markets outlet because they're underwater,” said Pallotta. “There's no refinancing alternative for the VA borrower who is underwater.” Part of this is due to restrictions in the pooling and servicing agreements for GNMA securitizations, he added.
Mark Garland, president of MountainView Servicing Group, said because VA default insurance risk (sometimes called “no-bid” risk because in underwater liquidations the VA does not bid for the property) has been heightened since the downturn, some players have been going through the complicated exercise of splitting off VA exposure from Ginnie Mae pools and trying to sell off only the FHA piece. It can be done, he said, but it's not easy.
Generally speaking, the secondary market continues to accept that some VA exposure is unavoidable in Ginnie Mae servicing rights and offset it either through price concessions or the traditional practice of the seller agreeing to cover the risk for a two- or three-year period. This was done even before the downturn, but certainly can be more of a concern since it occurred. Garland also noted that prior to the downturn the risk tended to be more regional, and after it was more national, on average. Concerns about counterparty risk also have increased. “That protection is only as good as the seller's ability to stand behind it,” Garland noted.
The demand and price for servicing rights has been low because of the capital- and labor-intensive nature of the business, as well as its low margins, Kopcak noted. In contrast to the peak of the market crash three years ago—when no MSRs traded—activity has improved, but the pools of servicing trading have been primarily from sellers getting out of the space or attempting to reduce their exposure.
“There have been several pools of agency and FHA servicing rights that have traded as a result of banks and insurance companies getting out of the business,” Kopcak said, but he added, “We don't expect the pricing and market for servicing rights to improve materially in the near future...The price buyers are willing to pay [has been] materially lower than what sellers may be used to receiving.”
