A surge in repurchase claims against mortgage originators may be imminent as aggregators and servicers face nonpayment of debt obligations and liquidity shortfalls resulting from an increase in residential mortgage loans put in forbearance. In the coming weeks, it is likely that an unprecedented number of borrowers will avail themselves of mortgage relief provided under the CARES Act. As that number rises exponentially, aggregators and servicers, who are responsible for advancing funds on certain types of loans, will be looking for ways to minimize their losses and transfer risk.
Under Section 4022 of the CARES Act, borrowers of residential loans that are either insured or guaranteed by the federal government, or owned or securitized by government-sponsored entities (“GSEs”), such as Fannie Mae or Freddie Mac, may request postponement of their mortgage payments. This section provides that if a borrower submits a request to the loan servicer, affirming that he or she has a financial hardship that directly, or even indirectly, results from COVID-19, the servicer is obligated to grant the borrower a 180-day forbearance on mortgage payments. This forbearance can be extended up to a period of an additional 180 days, which means that borrowers may effectively defer payments on their mortgage for up to a year. No proof of hardship is required, only an attestation. The loan does not have to be in default status, or even be delinquent, for the borrowers to obtain such relief. During the forbearance period, in addition to not paying principal and interest, borrowers are not responsible for any fees or penalties.
While the CARES Act provides substantial relief to borrowers, it does not provide relief to servicers, such as those who service residential mortgage-backed securities and generally have an obligation to advance delinquent principal and interest payments and make certain other advances in order to ensure that their investors continue to receive payments on their investment. Indeed, the Act is silent about the collateral obligations that the servicers may have to the investors of these mortgage loans and other third parties.
After the passage of the CARES Act, relief to servicers was made available, but it is limited in nature. Last month, Ginnie Mae announced that it would be creating a Pass-Through Assistance Program through which servicers, who service mortgage-backed securities and are required to remit principal and interest payments to investors, may request that Ginnie Mae advance the difference between available funds and the scheduled payment to investors.
In addition, the Federal Housing Finance Agency (“FHFA”) announced that it is allowing the GSEs to buy loans that go into forbearance, but under very limited circumstances. A loan must have been closed between February 1 and May 31 and cannot be delinquent for more than 30 days. And last week, the FHFA addressed servicer liquidity concerns by announcing a four-month advance obligation limit for loans in forbearance, which means that servicers are no longer facing an undefinable number of payments they would have to advance. Notwithstanding these measures, given the extraordinary number of loans that may be put in forbearance for up to a year, there is no question that the CARES Act’s mortgage relief will have a massive financial impact. Aggregators will also be experiencing similar effects due to these payment deferrals.
This will incentivize aggregators and their servicers to find ways to put back their loans to mortgage originators and reduce their losses. One way they may attempt to do so is through early payment default (“EPD”) provisions in their contracts with mortgage originators. EPD occurs when a loan becomes delinquent during the first three months of origination, or defaults during the first year. Lenders may require automatic repurchase, as EPD provisions generally state that a mortgage seller shall repurchase the loan at “purchaser’s option.” Fannie Mae and Freddie Mac have both stated that they will not request automatic repurchase for loans entering EPD status. However, they require EPD loans to undergo “quality control” review to determine compliance with their guideline requirements, leaving the door wide open to the probability of repurchase requests for other reasons. PennyMac, one of the largest private aggregators, warned its correspondent originators earlier this month that it may force mortgage originators to buy back a loan that goes into forbearance within 15 days of PennyMac’s purchase of the loan.
Given that aggregators and their servicers will suffer serious liquidity shortfalls resulting from loans going into forbearance, PennyMac will almost certainly not be the only aggregator making these demands. A huge spike in repurchase claims is probable, though unjustified in this circumstance. Originators and brokers should not face the disturbing prospect of receiving repurchase or indemnification claims related to forbearance even though such forbearance was mandated by the CARES Act. But most originators and brokers have faced similarly illogical buyback and make-whole demands for many years now, and presumably, therefore, recognize that potentially strong legal and factual defenses are available to them.