April 30, 2020
With the end of the month here, millions of Americans are wondering how they’ll pay their rent or mortgage, especially as companies continue to lay off or furlough staff and the number of unemployment claims continues to rise each week.
There are already wider impacts due to late and missing rent and mortgage payments, including changes to lending conditions for new borrowers, government interventions, financial penalties, eviction notices, and longer contract terms. But missed rental payments don’t just affect the homeowners. Due to the complex web of financing Americans use to fund its housing market, missed rental payments are rippling across the economy, where they’re felt by banks, federal lending agencies, and investors in the $9 trillion market for mortgage-backed securities.
In the past six weeks, unemployment claims across the US have risen to 30 million, but the St. Louis Federal Reserve estimates up to 47 million jobs could be lost due to the Covid-19 pandemic. The implications of these historic declines are evident in data from the National Multifamily Housing Council, which showed nearly a third of the renters of 13.4 million rental units initially did not pay their rent during the first five days in April. However, “91% of apartment households made a full or partial rental payment” by April 26.
So what happens if more tenants are unable to pay their rent, or opt not to pay as part of a rent strike? The answer is complicated due to the ways residential and commercial mortgages are approved, serviced, sold, traded, backed, and regulated by the federal government.
Landlords who are private individuals might negotiate with a tenant for a late payment, a temporary reduced payment, or a payment plan. Several cities and states have instituted moratoriums on evictions, but there have been news reports of landlords filing eviction notices to tenants anyway.
If the landlord is an individual with a federally-backed mortgage, and rental income is for their normal payments, the landlord can request forbearance through a program under the Coronavirus Aid, Relief and Economic Security (CARES) Act. Forbearance, which does not require proof of hardship from the Covid-19 shutdown and can reduce or pause mortgage payments for up to a year. Homeowners who are not landlords can also apply.
If forbearance is granted to a homeowner or landlord, the new payment schedule won’t negatively affect the borrower’s credit score or result in additional late fees or penalties. On April 27, the Federal Housing Finance Agency (FHFA) issued a statement emphasizing that borrowers will not have to repay the missed payments in a lump sum. Investors and other participants in the secondary mortgage market will continue to receive income from federally-backed mortgages through government intervention from the Fed.
“There is no ‘buck stops here.’”
If the mortgage for the rental property is a commercial loan, however, the situation is much more complicated due to how those loans are securitized and sold to bondholders—each of whom own a piece of the debt—as well as third-parties without a vested interest in the loan’s final outcome. “The problem with that is there is no ‘buck stops here,’ in terms of there being a person responsible for the performance of that loan,” said Ryan Swehla, principal and co-founder of the real estate brokerage and property investment company Graceada Partners, based in Modesto, California.
After a bank issues a mortgage, it is bundled with hundreds of other mortgages and sold to investors through a security that is structured like a bond with periodic payments. This secondary mortgage market gives banks the liquidity needed to issue more loans, but is also why third-parties are involved. The main buyers of these home loans are government-sponsored entities, like the FHFA’s Fannie Mae and Freddie Mac, as well as government agencies like the US Department of Veterans Affairs. Other buyers of mortgage-backed securities include institutional investors, corporations, and individuals.
The biggest difference between a bank or a direct lender and these third-parties, who are solely focused on the payments, is the banks and direct lenders ultimately want to figure out what is the best possible outcome for that loan, Swehla said. “A lot of times that does mean working with the borrower, it does mean helping navigate through a particular situation or circumstance.”
A changed landscape after 2008
Jeffrey Taylor, a board member of the national real estate industry organization the Mortgage Bankers Association (MBA), said the passage of Dodd-Frank regulations after the 2008 financial crisis significantly changed what kinds of mortgages could be approved, which reduced default rates and delinquencies. “The books have been pristine,” said Taylor, who is also co-founder and managing director of the mortgage and financial services firm Digital Risk.
Investors in mortgage-backed securities that are supported by the government, through Fannie Mae and Freddie Mac, will continue to receive regularly scheduled payments, such as the coupon payments for bonds, even if mortgage holders are granted forbearance under CARES, Taylor said. Government interventions have helped prevent any serious negative impact for investors of mortgage-related bonds and other kinds of mortgage-backed securities so far by ensuring cash flows continue.
Liquidity is important for the issuance of new loans. Concerns about it due to forbearance programs and the possibility of missed payments in the mortgage market have already prompted some lenders like JP Morgan Chase to increase the minimum credit scores and down payments for new residential mortgage applicants.
The number of mortgages in forbearance is now at 3.5 million or 7%.
The most recent report from the MBA says the number of mortgages in forbearance is now at 3.5 million or 7%, and the share of FHH and VA loans in forbearance is even higher, at 10%.
In an even more pessimistic and serious scenario, if the number of mortgage holders who want to participate in a forbearance program rises to 25% (approximately 12.5 million loans), there would be an estimated $100 billion in delayed payments and reductions in liquidity, Taylor said.
On April 22, the FHFA announced Fannie and Freddie’s assistance to the mortgage market would extend to buying home loans that have gone into the government’s forbearance program just after their closure. Some new mortgage holders suddenly couldn’t make their payments and requested forbearance, a move that would normally prevent their loan from being sold to Fannie and Freddie and removing the debt obligation from their lender’s balance sheets. There are several conditions and eligibility criteria, but the move should help lenders by increasing liquidity.
There are also concerns about the viability and payments from multifamily and commercial loans. Industries such as the restaurant, retail, airline, and travel have been greatly declined and some have halted entirely. Both Taylor and Swehla said these commercial loans and the related securities are liable to be hit much more significantly than the 2008 crisis due to the extent many companies and industries are now unable to pay rent on storage facilities, office buildings, warehouses, and retail space.
A frozen market
The values for existing commercial mortgage-backed securities (CMBS) have plummeted, and unlike the residential mortgage industry there is no relief for investors due to a lack of government involvement, Swehla said. “The CMBS market has completely frozen up,” he said.
Taylor said the impact of the forbearance program enrollments will result in banks and mortgage lenders adjusting and refinancing to account for modification requests from homeowners for how they will pay the suspended or deferred payments. “Some people will be able to pay it back over a shorter period of time, like a year,” he said. “Most people who have this on [their] balance sheet will be rewriting the mortgages and just adding the payments onto the end of the mortgage, or some sort of a balloon payment along the way.”
“There’s always more optimistic scenarios where a person said, ‘I went into forbearance for three months; the job is up and cranking again; I don’t want to add time on my mortgage; I want to pay the house off,’” Taylor said. In this scenario, a homeowner could meet with their loan servicer or their bank to structure a deal that would enable them to pay the difference off more quickly.
In less optimistic situations, Taylor said loan modifications might result in the reduction of the mortgage principal to help avoid a default.
Even with historic unemployment rates, any declines in national residential real estate prices are also expected to be relatively modest and short due to tight inventory levels, Taylor said.
While Swehla has already observed major declines in missed rent payments from retailers (an estimated 40%), he said the amount of missed rent payments from rental tenants is relatively small because their homes are the last thing people want to lose. “They’re going to do everything that they can to navigate through being able to stay in the home that they’re in.”
“We’re at the tip of the iceberg.”
There is still a lot of uncertainty in regards to how long the health crisis from the Covid-19 pandemic will affect the ability for millions of people to return to work. Mortgage holders who are looking to take advantage of low interest rates and opportunities to refinance are also dependent on lenders with enough capacity to process the applications and the belief that payments will be made under the new terms.
Ultimately, Swehla’s concern is for rental tenants who are in properties underwritten by commercial mortgages without government support. “We will see distress coming down the pipeline in the commercial market,” he said. “We will absolutely see more defaults and with that, more properties going through some stage of distress. That’s why we’re at the tip of the iceberg because that has not played out yet. But it’s on the horizon.”