How non-public funding of mortgage advances holds up

At the start of the pandemic, there were concerns that enough private sources of cash were available to help mortgage service providers keep pace with their evolving responsibilities.

“A lot of pre-financing was required for servicers in April. But then it didn't work out that way, ”said Sujoy Saha, director and senior analyst on Standard & Poor's mortgage-backed securities team.

Funding availability has not been an issue so far, but it could be, Rudene Haynes, a partner who specializes in structured finance and securitization at law firm Hunton Andrews Kurth, told attendees at a virtual event earlier this month.

"While the pandemic has been terrible and shameful in many ways, it has not reached a level that will adversely affect servicers unable to find funding," she said at the Information Management Network's ABS East conference, adding the Limitation: "Knock on wood."

With increasing infection rates, there is still the risk that the balance between supply and demand for advance financing for servicers will be disturbed by an increase in crime or forbearance – at least until widespread vaccinations can be achieved.

"If we see a huge increase in arrears and the need for progress increases sharply, we may see a need for a federal facility that would help me to maintain confidence in the market," said Susannah Schmid. Partner in the Chicago office of Mayer Brown's banking and finance practice.

However, market performance after the initial shock of the pandemic has been relatively strong so far.

"The level of indulgence has not been as high as people in the market thought," said Jeremy Schneider, senior director of Standard & Poor's mortgage-backed securities team. Some are as low as 3%. The highest in the small securitized non-QM market are the senior teenagers.

The fact that most forbearance rates are lower has helped ensure that funding is sufficient to cover service providers' responsibility for making prepayments to investors when borrowers fail to make payments. However, several other factors have also kept supply and demand in balance.

These include government interest rate intervention, several temporary public contingent liabilities, a strong current account balance sheet on finance facilities and booming refinancing that has served as a source of money for many mortgage lenders.

Early on, there were numerous concerns about whether Wall Street companies would refuse to provide upfront finance to servicers due to lack of recent experience of a difficult environment. In the end, the financiers were happy to offer it because they knew the arrangements had done well during troubled times like the Great Recession.

Hunton Andrews Kurth's coverage of transactions over the past few decades anecdotally suggests that, according to Haynes, there has not been a single loss in pre-financing deals for servicers.

In addition, companies were happy with the funding because it is structured to give investors payments before any other creditors, she said. Providers are usually investment banks such as Credit Suisse or Barclays.

On the demand side, visibility is limited when used by smaller private companies. However, it is clear from ratings agency reports on securitized deals – such as a new home deal due to close on Wednesday – that most, if not all, of the major non-banking service providers are using it. In addition to New Residential, companies with advance financing options include Ocwen, Mr. Cooper, PennyMac and Select Portfolio Servicing.

Typically, nonagency transactions that are structured with a floating rate finance note are the securitization instruments used for this purpose. Term notes are issued over time to help reduce the variable funding grade, Schneider said.

At least two new transactions have been completed since the pandemic: Ginnie Mae pre-financing from Mr. Cooper and PennyMac. PennyMacs was in the works before the coronavirus outbreak in the US.

"We haven't seen a large increase [in servicing pre-financing] in COVID in and of itself," said Schneider.

This suggests that there is no shortage of this funding today, but neither the market nor federal officials are likely to completely rule out the risk of it not being available when needed.

The US mortgage market is largely funded by government-related securitisations. This market could be undermined if the service providers were unable to meet missing payments from borrowers and ensure that securities investors continue to get their money.

The Biden government could choose to address the risk of possible disruption with public backing for pre-funding, as the industry has suggested. However, it is more likely that the first step is aimed at preventing an increase in forbearance with consumer relief.

"This new government is possibly a little more receptive to government aid policies that are more aimed at homeowners, which would then help to reduce the need for intervention at the service level," said Schmid.

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