Both the government and the mortgage industry have faced an uphill battle when adapting to the practical and economic realities of the COVID-19 pandemic. With so many X factors, it's the unexpected is almost all that can be expected A new report from Bloomberg delves into a new change related to coronavirus relief that could benefit banks but negatively impact investors in mortgage-backed securities.
The COVID-19 health crisis has put millions of impacted homeowners at risk of delinquency and foreclosure, fueling an “upheaval” in the mortgage market. Now, Bloomberg reports, banks and other lenders are beginning to act on the understanding that this allows them to buy home loans at below-market prices.
According to Bloomberg, "The earnings would come from an unanticipated side-effect of Congress’ decision in March to allow homeowners affected by the pandemic to delay loan payments for as long as a year, combined with arcane regulations governing mortgage-backed securities."
This so-called ‘loophole’ is possible, in part, due to Ginnie Mae regulations, Bloomberg reports. Ginnie rules allow banks and other lenders to buy loans out of mortgage securities at their par value when a borrower hasn’t made payments for 90 days, Bloomberg explained.
Investors value most of those loans at 5% to 10% above par, reportedly, "meaning the purchases result in an immediate writedown for the bond holders and a potential profit for the lender when they’re able to resell the loan.”
Former Ginnie Mae President Ted Tozer, now a senior fellow at the Milken Institute, told Bloomberg, “The banks are setting themselves up for a huge windfall. It’s almost pure profit.”
According to Bloomberg, sources from the lending and banking industry argue that the process is often risky and that it “has more to do with accounting issues than trying to score a quick profit.”
Bank of America mortgage security strategist Michael Khankin, for one, expounded on the "risk" idea, noting that lenders that engage in extensive buyouts do face a potential downside.
“This is not a riskless transaction,” said Khankin, who noted borrowers might default while a lender holds the loan or government agencies could change the rules again for when mortgages can be re-securitized.
How accounting factors in: Rules force lenders to put loans on their balance sheets if they have an option to buy the mortgages “in the money,” meaning that exercising it would turn a profit, explained Bloomberg.
On Wells Fargo’s Q2 earnings call last month, CFO John Shrewsberry said that accounting requirements influenced its loan purchases.
Wells Fargo spokesman Tom Goyda said the bank regularly buys delinquent loans out of Ginnie pools to manage balance sheet impacts and to reduce expenses.
Why the pandemic-prompted buyouts are different than in other situations: Loan buyouts aren’t new but now it’s about the uniquely large number of homeowners who’ve opted to delay their monthly payments because lawmakers have protected them from foreclosures.
In general, those borrowers are expected to start paying their mortgages again. That means that, unlike during the 2008 financial crisis, lenders that buy delinquent loans might be able to easily resell them at premium prices as the mortgages become current.
The outlet goes on to report that “Wells Fargo in July and August bought $19 billion of loans out of Ginnie securities for $1.5 billion less than the loans’ market price, according to Dhivya Krishna, head of research for hedge fund Metacapital Management LP, which invests in Ginnie mortgage bonds.”
As for U.S. Bancorp, it bought $5 billion of such loans for $380 million less.
Other lenders have made smaller purchases, but some bond investors say that increasingly high delinquencies and nonpayments due to COVID-19 will cause these buying opportunities to blossom in coming months.
Now, if the economy rapidly improves in coming months, and homeowners, in large numbers, exit forbearance, said opportunities will dwindle.