The case for supporting nonbank mortgage servicers
For many of us who have been around for a while, it seems as if we have seen this movie before. An economic downturn leads to increased mortgage borrower delinquencies. That becomes a progressively increasing obligation for the servicers to make principal and interest advances to cover the delinquencies, even though those servicers have no beneficial ownership interest in the loans.
But this time, the actors are different and the plot will develop much more quickly.
Last time, delinquencies rose as economic circumstances progressively deteriorated, almost like rising floodwaters breaking out of their riverbank. Concurrently, prepayments slowed progressively. That gradually put pressure on nonbank mortgage servicers' need to continue advancing principal and interest to securities owners, because they weren't able to borrow from prepayments to do so.
Most servicers had commercial bank lines set up to fund their advances and became "net borrowers" in order to meet their obligations. Those advancing obligations can continue for years until defaulted loans are ultimately resolved through a foreclosure sale. During the last crisis, nonbank mortgage servicers were primarily servicing private-label securitizations and so the government-sponsored enterprises — overlay, although present, was much less significant.
As financing needs became more pressing and the wave of delinquent borrowers rose, commercial banks simultaneously began backing away from the servicing advance finance market.
A group of nonbank mortgage servicers collaborated to form the Independent Mortgage Servicer's Coalition. My firm represented them and we knocked on doors in Washington looking for government assistance to stay ahead of the increasing advancing obligations.
After numerous attempts at government-sponsored financing solutions, eventually the Federal Reserve provided the much-needed relief by expanding the TALF 1.0 (Term Asset Backed Securities Loan Facility) program to include the funding of servicing advance-backed securities, one form of an asset-backed security.
(Through TALF the Federal Reserve provided nonrecourse, non-mark-to-market term loan financing for buyers of ABS).
Something interesting happened as soon as TALF was expanded. The nonbank mortgage servicers did not immediately move toward TALF funding but instead sought increased capacity from their commercial bank funding sources, who were willing to lend because they had a takeout in the securitization market should their financing lines default. Over time, delinquencies receded as loan modifications and eventually refinancings took root, and no nonbank mortgage servicer failed simply because it could not fund its servicing advance obligations.
However TALF may not be the fix that it was 10 years ago; further action is definitely needed. First, if rising flood waters were the right analogy last time around, this time a tsunami is probably a more accurate description of the wave of delinquencies about to come. The related advancing obligations may be offset somewhat by prepayments in March to fund April advancing obligations. Securitizations generally allow servicers to use prepayments, which are held for a month, to advance scheduled monthly payments before using their own funds.
But in May there is likely to be a serious and immediate need for advance financing capacity not currently available in the market. Getting a TALF transaction done in time to accommodate this need is highly unlikely, because of the need for a rating. Adding to the challenge, over the last 10 years a significant amount of GSE servicing has moved from banks to nonbanks. Forbearance policies announced by the GSEs with the expectation of continued principal and interest advancing provide few options for servicers.
Put simply, Congress acted admirably by working quickly to protect Americans from the potential personal financial crises that can result for certain borrowers who fail to make their mortgage payments when due.
However, that much-needed government assistance on the asset side is also needed on the liability side. Nonbank mortgage servicers can fund government support, but that support should be funded by taxpayers generally. The Paycheck Protection Program is a great example of the government providing relief to the small businesses that are keeping their employees on the payroll while they are closed for business. The government is not asking small business to fund paycheck protection on their own. We need something similar for the nonbank mortgage servicers that are keeping the same employees who are benefitting from paycheck protection in their homes.
Without a dedicated government-funded servicing advance facility that is developed quickly to address the immediate need, there is a potential for nonbank mortgage servicers to fail as a result of a lack of funding for servicing advances.
That did not happen during the last crisis when the risks were lower, and it certainly shouldn't happen this time around. Last time, the big banks still had operational capacity capable of absorbing servicing if a nonbank mortgage servicer were unable to continue meeting its financial obligations. Those operating platforms have been largely dismantled as banks moved servicing with the cooperation of the GSEs to the nonbank mortgage servicers. Therefore, a lack of government support for nonbank mortgage servicers could result in a lack of servicing support for borrowers who are going to need loss mitigation strategies and loan modifications to get back on their feet.