Last year's update in the Federal Housing Administration's "waterfall" of actions servicers must take when borrowers go delinquent is creating
Under the previous pandemic rules, distressed FHA-insured borrowers could repeatedly request assistance with partial claims that reduce payment size by pushing a portion of the debt owed to the end of the loan as subordinate liens.
DLS Servicing, which provides systems that help other companies process loans, initially found more than 50% of distressed products that now had to go into trial modifications under the new rules have had incomplete documentation, and 26% to 28% have been referred to foreclosure.
"The larger servicers can absorb those kinds of volume spikes more easily. Smaller servicers, the problem is they tend to play catch-up. They don't usually have the data analytics, they don't have the forecasting and so all of a sudden they find out that their foreclosures go up when they look at their referral list," DLS President and CEO Donna Schmidt said.
FHA and Ginnie Mae, a government mortgage-securitization guarantor, have noted that the trial mods stemming from the rule
Ginnie has made some adjustments for the trial mods in its delinquency reporting, which points to bigger concern beyond just managing the workflow that also could impact small servicers in particular: managing the responsibility for advancing payments for borrowers when in arrears.
The liquidity challenge
Managing advancing responsibilities is the biggest challenge as FHA rule changes take effect, according to Ted Tozer, former president of Ginnie Mae.
"In the past, when a borrower went delinquent, you could put them into forbearance or a mod and basically get your money back as far as advances pretty quickly," he said.
The new rule has changed that.
"With a trial period, the borrower might be delinquent for 60 days before getting a mod established, then you're going to have to go through 90 days worth of proof the person can make those new mod terms before you can actually do anything that would make the mod permanent and re-pool it," Tozer said.
That could mean making advances for multiple months on a loan rather than one.
"So the big issue I see is the liquidity issue, but what's even more important is that if the borrower fails the trial period, which a lot of them are, that means you have got to move them toward foreclosure," he said.
New risks when mods fail
Under the old program, servicers could immediately pursue another modification after a failed one and recoup their money quickly. Now, Tozer said, they may have to advance funds for months or longer.
Home equity is strong overall, but borrowers who bought near the peak of their local market have less of a cushion, leaving them fewer options to sell their way out of trouble and avoid foreclosure.
"The concern I have, with the leveling off of home prices for the last year or so, is that a lot of these borrowers are not going to sell their house. They're going to sit on it and go to foreclosure unless the FHA does something to encourage short sales," Tozer said.
Ginnie Mae's considerations
While Ginnie is currently looking to distinguish the trial mods from other types of delinquencies, it will have to factor how high delinquencies will get as it works with issuers.
"If they're hitting a delinquency threshold, Ginnie may decide that the number is too high, and require them to buy loans out of the pool," Tozer said. "These lenders are already using up their liquidity for advances, requiring purchase is going to use up cash even quicker."
That situation could force Ginnie Mae as well as issuers to make some tough decisions.
Ginnie Mae faces a difficult balancing act, Tozer said: forcing issuers to buy out delinquent loans too soon could push some over the edge financially, while allowing those loans to remain in pools drives up delinquency rates. Either way, smaller lenders with limited access to liquidity are at greater risk than their larger competitors.
Ginnie does not want to see issuers burn through their cash, but in some cases it may be inevitable, so waiting may not make sense.
"It's one of those things where you look at what the best thing is to do when you see that it's not going to turn out well anyway," he said. "You look at what's the best, bad solution."
Liquidity options
Ginnie will be more likely to put pressure on mortgage companies to raise cash as delinquencies rise, so Tozer advises working on having multiple sources of liquidity to meet advancing obligations sooner rather than later through servicing sales or otherwise.
Servicing sales do require Ginnie's authorization, so it's best to ensure it's available before counting on them as a source of liquidity. As much as Ginnie likes to see issuers liquid, it may have other considerations in deciding whether to greenlight a sale.
At least one company, Onity, has recently
The deal predates the FHA delinquency issue and Onity confirmed the changes to it did not appear to be related to the impact of the waterfall rule change on the company. But it does illustrate that servicing sales submitted for approval may not always go through in their current form.
Companies have to think hard about what types of liquidity they turn to, particularly if they are subject to scrutiny by rating agencies or as a public company, and also in terms of meeting the secondary market's counterparty requirements.
Small to midsized players may also consider what's been a high appetite for servicer acquisitions in the market and how long it may run. At the time of this writing, Two Harbors and its RoundPoint servicing unit were in the midst of
Ginnie's last-resort financing is best avoided, Tozer said, because tapping it signals distress to creditors and could cut off other liquidity sources.
Staying engaged in policy discussions could also help, particularly efforts to speed up FHA's short sale approval process, which can take weeks, he suggested.
"Hopefully FHA can really streamline the decision process so when a servicer calls, they can get a good answer relatively quickly," Tozer said.
FHA continues to closely monitor the rollout of the new loss mitigation waterfall, including through regular communication with mortgage servicers across the country. It expects near-term delinquency reporting to remain elevated as many borrowers are working through trial payment periods and has found performance on new FHA endorsements remains well within historical norms.
Managing workflow
Meanwhile, Schmidt has some strategies she suggests for servicers managing the trial mod workload, and one of them is to identify portfolio pain points by understanding both the rule's impact and other factors that could compound it for certain loans.
Beyond home-price fluctuations and partial claim history, rising escrow costs for housing expenses can also strain borrowers.
While some states like California, Florida and New York have caps on property tax increases, that cost, rising expenses related to that obligation, the price of homeowners insurance or both have risen in several areas, Schmidt noted.
Debt-to-income levels in addition to loan-to-value ratios should be monitored for distress to reduce the number of newer loans from adding to the existing backlog of trial modifications to process, Schmidt suggested.
"They're going to have to invest in some kind of technology to help them be more proactive in the front end. They didn't need to do that before. Now they're going to have to, because the combination between the DTI and the pig going through the python means they have got to try to keep people current if they can, because once they break into meeting loss mitigation assistance, their options are limited," she said.
The handling of trial mods is not one-size-fits-all, so automating the distinctions can help servicers sort through the workload, with many vendors adapting pricing options for the budgets of smaller players struggling with costs.
Some of the variations in trial mod processing that technology may help handle include "three months for delinquent loans, four months for imminent delinquency, and then six months for successor-in-interest amounts," said Sapan Bafna, CEO of Outamation.
Considerations for servicers adding technology include training and onboarding time that minimize disrupting limited resources already contending with a mountain of workflow. Whether the system is configurable and how fast it will adapt to the next rule change is another factor.
Servicers also should allow for data transfer time, said Jane Mason, CEO of Clarifire.
"I would say if the key for the smaller servicers is getting their access to their data in the right format," she said.
Mason also suggested keeping an eye on how escrows can impact distressed borrowers, prioritizing proactive outreach and tracking the numbers of FHA trial mods and outcomes as Ginnie and other business partners that servicers work with use in their scorecards.
A payment on a borrower's plan in the middle of the month when escrow changes could be disrupted if servicers do not immediately connect the two and stall loans, she said.
"There's a lot of confusion about escrow so that the borrower doesn't understand it half the time. Why did it change? Why is it more now? So I think that complexity of that causes people, or borrowers, to back off and just say, 'I don't understand this. I can't do this,'" Mason said
A backlog some say will clear soon
Another thing to consider is that while there are some external factors playing into the rule-related uptick in trial modifications such as higher escrows and signs of economic strain in some cases, the impact of the pandemic backlog should be temporary.
Onity indicated in its earnings call that there is a light at the end of the tunnel.
"We've improved our communication frequency of early intervention and introduced digital tools to assist borrowers. We continue to expect FHA delinquencies will normalize by the end of the second quarter," said Glen Messina, the company's president, CEO and chair.
Tozer said the fact that higher FHA delinquencies stem more from a pandemic backlog rather than being a more open-ended issue provides some comfort.
"This is kind of cleaning out a lot of some loans that probably should have gone through foreclosure and gotten dealt with years ago," Tozer said. "Even though we're seeing these, double-digit delinquencies, I just take solace in saying, 'Well, in reality, if these loans had been dealt with in a more timely manner. They wouldn't look quite so bad as they do today.'"
