COVID-19 has triggered unpredictable fractures in both personal and business finances. To help manage the risk of mortgage defaults, US legislators have called for forbearance measures that give individuals temporary relief from rent and mortgage payments.
“Everybody wants to support these forbearance issues, but these edicts come with a deep liquidity and operational price for mortgage servicers,” said Grant Thornton Risk Advisory Services partner and mortgage industry leader Matthew Cooleen.
As the Financial Times
noted, “If unemployed borrowers exercise their right to forbearance – as authorised by the recently passed stimulus law – servicers still must make the principal and interest payment to bondholders.” Only one million homeowners were expected to sign up for forbearance, but millions
have already applied. The Financial Times said that this one-way flow of cash has dried up the available liquidity at mortgage servicers, and is the primary reason Moody's downgraded its outlook for US non-bank mortgage lenders from “stable” to “negative.”
Liquidity was listed as the top concern among attendees at a recent Grant Thornton webinar for mortgage servicers.
“The liquidity and operational risks obviously stem from the advancing that the servicers are required to perform under their pooling and servicing agreements—principal and interest, taxes and insurance, property preservation, corporate advances and more,” Cooleen said. Mortgage servicers need to quickly find liquidity to meet their needs.
“Servicers need to think of liquidity holistically, to be proactive – and that means a couple of things,” Cooleen said. “Mortgage services need to take a proactive approach to both stress testing and balance sheet evaluation.”
Be proactive with stress testing
To quickly and effectively establish stress testing cases that examine your upcoming needs and weaknesses, you can use a high-level model.
“If you’re able to stress test your portfolios at a base case-level basis, that’s terrific and God bless you. Most people don’t have the ability to do that,” Cooleen said. Companies really need to stress using extreme default levels. Mortgage companies need to break their existing portfolio into four parts: the Freddie, Fannie, Ginnie portfolio and private label security (PLS) portfolios.
For each part of the portfolio, stress testing can start with a base case and then develop a tailored range of factors to consider. For instance, estimating base to severe peak delinquencies for the four types of mortgages, servicers could consider:
Freddie Mac: 3% base to 6% severe peak delinquencies
Fannie Mae: 4% base to 8% severe peak delinquencies
Ginnie Mae: 10% base to 20% severe peak delinquencies
PLS: 18% base to 32% severe peak delinquencies
These ranges are only a starting point that can also evolve based on other factors. “We want to look at what economists are saying about unemployment. We know that historically, the unemployment spike tracked the delinquency spike of the mortgage portfolio. Most importantly, I think you need to get granular here because not everybody has the same portfolio mix,” Cooleen said.
Once you establish a stress case customized to your portfolios, you also need to ensure it’s customized to your liquidity needs and consider what happens at the end of forbearance. “For example, if you have advanced facilities versus MSR financing facilities – or other types of HUD buyout or Ginnie Mae facilities – you need to be able to model those. You need to understand exactly how the agencies are allowing some of the liquidity to come back in, and you need to be very clear about how you’re doing that.”
“Overall, I think the bottom line here is that you need to be aggressive. This isn’t the time to underestimate your scenarios and your portfolios,” Cooleen said.
Be proactive about your balance sheet
“Now is the time when you really need to dig deep and work on finding the cash that’s hidden in your own balance sheet – and believe it or not, we see that quite a bit.”
— Grant Thornton Risk Advisory Services Partner and Mortgage Industry Leader Matthew Cooleen
Apart from stress testing, mortgage servicers need to take a proactive look at their balance sheets. “Now is the time when you really need to dig deep and work on finding the cash that’s hidden in your own balance sheet – and believe it or not, we see that quite a bit,” Cooleen said.
Balance sheet cash optimization exercises can help you discover hidden cash like cash deposits sitting with counterparties or other value that you could call back. Look for untapped tax receipts and opportunities to improve cash positions resulting from provisions in the recent CARES Act, such as a chance to defer payroll taxes to increase cash flow. Grant Thornton Financial Services Tax Leader and CPA Doreen Griffith expanded on payroll taxes, saying “The employer portion of social security taxes, that 6.2 percent, can be deferred from the date of enactment for the CARES Act through the end of 2020. Half will be due before the end of 2021 and the other half will be due before the end of 2022. Now, yes, you still owe the social security taxes, but it is all about getting current liquidity and then being able to pay for it later.”
Servicers should also take a fresh look at scratch-and-dent assets on their balance sheets. Cooleen explained, “Before, you’d say, ‘OK, I’m happy with the risk on the scratch-and-dent assets that I have sitting on my balance sheet’ – and you may still be, but are those really priority assets? Typically, you either have them financed or you have them just sitting on your balance sheet financed by your general cash. That’s probably not a great idea. Go out and get bids for those assets. The liquidity is probably a higher priority for you at the moment than sitting on your scratch-and-dent assets.”
Lastly, operations can offer hidden opportunities like accelerating Ginnie Mae deliveries. “Maybe come up with some efficiencies in dealing with your HCM buyouts, accelerating your servicing advanced claims,” Cooleen said. “A lot of times, companies just have a very slow turn from the time they advance to the time they get that money back. What are some of the terms of your contracts that you can extend out?” There may also be cash locked up in typical operating costs. While the initial move to enable remote work led to increases in certain servicing costs, companies should be scoping out corresponding areas where costs can be eliminated or suspended. Given higher volumes of activities such as processing forbearance requests, servicers should also be working to retrain and reallocate resources from tasks which can be deferred.
“It’s really about digging deep and looking at your financial balance sheet to focus on how you can maximize your cash position going forward,” Cooleen said.
Don’t just manage the change – document it
COVID-19 has caused a rush of external factors and internal decisions that are creating change for mortgage servicers, and the most successful organizations are taking control of the changes.
“You need to have a strategy for change management, really documenting your changes for everything. Next, you need to be testing, and documenting the testing. You’re making sure that these changes are effective – that they’re accurate. That’s very, very important,” Cooleen said.
Managing change at this scale can be time-consuming, so call upon all of your resources. “What we’re seeing across all servicers is it’s ‘All hands on deck.’ So, use your internal auto group. Use your risk group. If you have an ombudsman group, use them; Have them challenge the process that you’re going through,” Cooleen said.
Change documentation also serves as material that you can communicate with internal stakeholders and external partners. “I think you can reach out to your regulators, even to your investors, your banks, your industry folks and just say, ‘Look, here’s what we’re doing.’ Give people the confidence that you really know what you’re doing, it’s proactive and it’s conservative,” Cooleen said.
“You cannot underestimate how many people, after the last mortgage crisis, said ‘I just wish we had a better trail of what we did to prove how we did this,’” Cooleen said.
Learn from the past, listen to your customers and talk to your regulators
“We all know how this ends,” Cooleen said. “After a stressful consumer credit cycle hits, and then calms, regulators, state attorney generals, consumer groups and consumers all swoop in as Monday morning quarterbacks, criticizing mortgage servicers for all that they did not do.” Documented consumer complaints act as breadcrumbs and evidence trails in the trial of public opinion.
But what if that were not the case? What if you can turn this on its head and use those breadcrumbs as proactive real-time feedback that enables a wave of swift changes within servicing organizations? To do that, learn from your past and:
- Document and trace all operational edicts changes by GSEs, the government, states and others
- Test that all changes are flowing through operations properly and in a timely manner
- Review all consumer complaints with a listening ear and gather statistics from call centers
- Survey consumers affected, listening to what they are saying and adjusting course accordingly
- Predict what consumer harm looks like and what will said after the fact – be audacious in your predictions
- Chart out a proactive roadmap for immediate remediation and operational excellence
- Talk to your regulators and state attorney generals, and let them know what your doing – ask for their input
When you tap into, listen to and act upon the voice of the customer, you take a proactive strategy for both offense and defense from a risk perspective. “Servicers want to do what’s right,” Cooleen said. “By basing their operational strategy on founded consumer concerns and sharing their tactical plans, they can get out in front – and stay out in front – of what will be a heavily scrutinized post-crisis environment. They need to stay safe and stay the course.”
Partner, Risk Advisory Services
RAS Mortgage Industry Leader
+1 212 542 9602
Doreen L. Griffith
Partner, Financial Services Tax Leader
CPA (Arkansas, California, Hawaii, Illinois, Texas)
+1 214 561 2394