MReport May 2021

TheMReport — News and strategies for the evolving mortgage marketplace.

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30 | M R EP O RT FEATURE My question: how many bor- rowers currently on a forbearance plan (there are millions of them) currently believe that they must repay the past-due interest, plus resume normal monthly pay- ments? Or did they believe that the interest/past due payments would be forgiven, no longer owed? If it's the latter, then there may be a problem. A related question: how many secondary market executives have specified the investor guidelines that are to be followed to admin- ister (re-underwrite) loans that are in forbearance? Answer: virtually none. No fun, not a bit. Not one loan currently in for- bearance can emerge until the sec- ondary market crafts the guide- lines necessary to re-underwrite loans in forbearance. Moreover, once those guidelines have been developed, it is highly likely their structure will be complex and arduous, as opposed to simple and straightforward. To add to the problem, the borrower will not react well to having a larger mortgage to pay. The borrower backlash may be substantial, making the capac- ity crisis multidimensional. In such an instance, adding ad- ditional personnel to attempt to resolve any misunderstanding can unexpectedly increase the cost of production/loan resolution. To address the forbearance problem, one solution may be for industry policymakers to shift their attention from the dynamics of the primary market to those of the secondary market. Secondary Market Considerations I n the U.S., over 97% of all loans manufactured are sold on the secondary market as mortgage- backed securities (MBS). The sale of a mortgage loan into an MBS means that the governing law switches from U.S. state and federal law to international securities law. The primary market is domi- nated by U.S. politics and law, and its constituents are largely U.S.-licensed mortgage lenders. Here, state and national politics run supreme. However, once you enter the domain of the second- ary market, the dynamics are much different. In the secondary market, U.S. politics takes a back seat to world economic issues and world economic players, such as pension funds, mutual funds, or insurance funds. A loan manufactured in Peoria, Illinois, under the governance of Bank of America is rolled into an MBS pool to be issued by Fannie Mae or Freddie Mac and "sold" on the international, secondary money markets. Here bonds serviced by this MBS can be purchased by any appropri- ate investor, be it a pension fund from Germany or a mutual fund from China, for example. There can continue to be variances: per- haps the former is promised an interest rate of 8% and a return of principal in five years, while the latter is quoted an interest rate of 6% and a maturity of 10 years. These quotes relate directly to the cashflow needs of the respective buyers in Germany and China, and their needs relate di- rectly to how their businesses are run; these needs have very little to do with U.S. mortgage politics. This sale alters the dynam- ics of the loan forever. An MBS security is a matrix that trans- forms loan-level cashflow into an intricate web of interconnected cashflows that feed a portfolio of bonds with specific interest rates and maturities. This structure has been designed to create an invest- ment vehicle that can effectively service the interest rate and ma- turity needs of the international investment community. And the needs of this community are dominant. To get the support of the inter- national investment communities and access to their trillions of dol- lars of potential investment funds, the creators of these securities had to ensure the international inves- tors that their interest rate and maturity needs would be strictly upheld by the structure of the security. In particular, all loans must be kept current, even if the borrower could not service the loan. The international community must be paid as specified, which means that the interest rate covenants of the security must be upheld, regardless. The mortgage servicer is the entity stuck with funding shortfalls due to delinquency. Mortgage servicers and others in this space exist, ultimately, at the pleasure of the international money, which dooes not feel a need to invest in U.S. mortgages, per se. Their needs are directly tied to their interest rate and principal needs. In this domain, the welfare of international money players governs. In this arena, there is one principle: money goes where it is treated best. Here, the politics of interest forgiveness (U.S. desired political outcome) will most likely yield to the powers of interest for- bearance (the needs of the inter- Assuming that Malcolm Gladwell was correct, the mortgage industry cannot meet current or future demands for underwriting talent.

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