Could Housing Payment Delays Spark MBS Issues For Mortgage ETFs?

Just last week the regulator for mortgage companies Fannie Mae and Freddie Mac released news of a tolerance initiative for borrowers who can’t pay their loans because of financial hardships resulting from the effects of the coronavirus.

The Department of Housing and Urban Development, which includes the FHA loan program, announced the same information, prompting a potentially massive sense of relief for borrowers, who can now postpone payments without penalty.

According to the Fannie Mae website, the following options are available:

“If coronavirus has caused job loss, income reduction, sickness, or other issues that impact your ability to make your monthly mortgage payment, relief options are available.

There is one unforeseen side effect of this forbearance, however, which could cause significant issues. The mortgage servicers, the companies that collect monthly payments, are required to pass those payments on to the investors who own those loans in mortgage-backed securities even if the borrowers don’t pay, as well as to have to pay insurers and tax authorities, putting them under considerable duress if borrowers fail to make payments.

Under normal circumstances, servicers have the cash reserves to whether this delay in payments if it occurs on a smaller scale, but the industry is now facing a potentially massive wave of skipped mortgage payments.

“Nobody predicted the demand this would place on servicers, so they need an ability to have the liquidity to make it happen, and if there’s not some kind of ability through a liquidity facility, then the servicers won’t be able to meet their obligations to the investors and the whole process will break down,” said Bob Broeksmit, CEO of the Mortgage Bankers Association.

“The risk to the servicing industry is that the demands on advancing these payments to the investors will outstrip their cash ability to do so,” he added.

To seek aid for the potentially damaging issue, the Mortgage Bankers Association sent a letter late Sunday to Federal Reserve Chairman Jerome Powell and Treasury Secretary Steven Mnuchin, requesting help for mortgage servicers.

“While a mortgage servicer might have some additional flexibility for loans held on its balance sheet, advancing is required for loans that back Fannie Mae, Freddie Mac, or Ginnie Mae MBS – which constitute over 60% of the mortgage market,” Broeksmit wrote in the letter.

“Widespread, national borrower forbearance at the levels being proposed in response to the COVID-19 outbreak, however, extends well beyond any servicer advance obligations previously envisioned, and is beyond the capacity of the private sector alone to support,” he wrote.

While the Vanguard Mortgage-Backed Securities Index Fund ETF Shares (VMBS) has yet to show signs of strain due to the information, with the fund up roughly 0.5%, even as stocks continue to tread lower, the First Trust Low Duration Opportunities ETF (LMBS) is off 1.42% today amid the news.

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