In my last comment, "The problem with Ginnie Mae's new restrictions," we asked our friends at Ginnie Mae to change the rules for pooling for repetition of loans or RPLs. The goal of the change: to slow down prepayment rates for Ginnie Mae securities. But as any MBS repo dealer will tell you, the rules aren't the problem.
Servicers buy up criminal government loans early in order to take advantage of the chance of winning when the loan gets back on track or is changed. When the EBO loan goes to foreclosure, this is the least attractive scenario. An industry veteran told NMN: "It makes no sense to determine the spread (for EBOs) if your liquidation costs torpedo the platform …"
Some people in Washington may think that throwing out decades of established industry practice on credit pooling criteria will slow down mortgage prepayment rates, but in fact it doesn't matter at all. As you can see, the main buyers of EBOs and heavily encumbered loans are large banks with large, liquid balance sheets. They're permanently hungry dinosaurs who are starved to earn assets of any kind thanks to our friends on the Federal Open Market Committee.
About 15% of the Ginnie Mae services held by non-bank issuers are currently behind schedule. But banks will be the dominant buyers of EBOs, both their own issues and FHA / VA / USDA credits issued by others.
"Wells Fargo bought $ 14 billion in criminal mortgages this month, causing servicers to track the coronavirus pandemic," said Kate Berry of NMN. "The bank giant was one of the companies that, according to Ginnie Mae investment pools, bought around $ 20 billion in loans from investors overdue for over 90 days."
In fact, many service providers buy overdue loans long before they reach 90 days of insolvency due to intense competition for these assets. For a non-bank issuer, a defaulted loan offers the opportunity to earn a substantial fee if the loan is merged into a new Ginnie Mae security. However, there is no particular need for banks to resell the loans.
Any intent that Ginnie Mae would have to slow down prepayment rates by changing the rules for RPLs seems to be thwarted by the gloomy economic reality of the big banks. By adding several trillions of new liquidity (i.e. deposits) to the U.S. banking system through government bond and MBS purchases, the FOMC has dramatically reduced the return on assets and stocks for the industry. Buying Ginnie Mae's EBOs is a good, risk-adjusted trade for banks.
As mentioned earlier, there is a blatant and growing conflict between the policy goals of the Department of Housing and Urban Development and those of the Federal Open Market Committee, which has cut market interest rates by massive $ 4 trillion free market purchases in just 60 trillion Days. This conflict is largely responsible for the extent to which HUD and Ginnie Mae find the prepayment rates for current coupons to be excessive.
The Mortgage Bankers Association's weekly indulgence and call volume survey over the past few weeks showed that around 40% of CARES forbearance loans remained current and ended the program without an event. Some call these loans "dirty electricity". Around 17% of the loans were resumed and 10% were treated as a partial claim, reports MBA.
If the financing costs are higher, it makes sense for the bank to buy the defaulted loans from the pool and to work with the borrower if the borrower is in default. When the customer pays, the bank simply collects the mortgage payment every month and transfers the surplus, the amount that exceeds the actual cost of financing and servicing the loan.
"These loans were all made before the pandemic and borrowers chose to be lenient under the CARES law," Rick Sharga, president and CEO of CJ Patrick Co., told Kate Berry last week. "These were not non-performing loans before. A large number will make or reinstate payments, and a small number will receive credit modifications or extended leniency."
This is exactly the point that has troubled many people in HUD and Ginnie Mae, as well as in the investment community, namely why should a "Dirty Current" loan, which happens to be in the leniency of the CARES Act, but still pays, will the MBS pool be bought? Shouldn't this loan simply remain in the MBS pool and save the investor from making an advance payment? Someone should ask Fed Chairman Jerome Powell the next time he's on Capitol Hill.
The constant prepayment rate for Ginnie Mae's 3.5% coupons of $ 1.1 trillion was around 40% in June. This bubble rate should increase in the coming months. With coupon spreads of 2% and the current production Ginnie Mae MBS coupons of 2%, this means that consumers can get a mortgage of 3% or better, which is good news for the FOMC and the economy.
But it's bad news for Ginnie Mae and MBS investors who paid five and six point premiums for newly minted government MBS just to get advances at face value. At the current prepayment rate, ongoing MBSs (which theoretically consist of 30-year mortgages) will essentially disappear within a year or so.
Over the next few years, much of the existing MBS will be prepaid due to refinancing transactions, making competition for assets – from big banks, REITS, mortgage banks and funds – even more intense. Banks face rising maintenance costs and high amortization costs for asset maintenance, even if retail production declines. So you have to buy assets again.
In the meantime, non-banks are experiencing one of the most profitable periods in a decade. The gains are mainly due to the FOMC's policies and the associated high rate of advance mortgage payments. With banks offering their swollen balance of government loan EBOs, any effort by Ginnie Mae and others to control prepayments through rule changes can be wasted.