Mortgage Servicers Face Potential Liquidity Crunch

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Due to the evolving economic stresses and operating conditions caused by the coronavirus pandemic, Fitch Ratings recently placed all U.S. mortgage servicers with material servicing advance risk on Rating Watch Negative.

The ratings firm says the economic crisis will likely result in a wave of delinquencies that could, in turn, create a serious liquidity problem for all servicers – in particular nonbanks.

That’s because nonbank servicers that are not adequately capitalized could run into problems advancing principal and interest (P&I) payments to bondholders during the deluge of defaults, Fitch warns.

This liquidity problem could be exacerbated by declining valuations of mortgage servicing rights (MSRs) due to falling interest rates – as well as the increased staffing costs resulting from the rising wave of defaults, among other factors.

Fitch says servicers that “directly evidence elevated disruption risk, that are materially exposed to disruption risk at their subservicers, or use approaches to advancing that are nonstandard, are more likely to have their servicer ratings downgraded.”

The big question is whether servicers are adequately prepared to implement the government’s loan forbearance programs.

The Mortgage Bankers Association estimates that if 25% of borrowers take advantage of the forbearance option for six months or longer, servicers may have to advance between $75 billion and $100 billion of payments.

Industry groups and market participants have been lobbying government officials for a more viable solution to the pending liquidity crunch.

The Federal Reserve’s relaunch of the Term Asset-Backed Securities Loan Facility (TALF) – which will initially provide up to $100 billion in loans fully secured by eligible asset-backed security (ABS) collateral – will provide some relief, however, Fitch believes “there is execution risk for servicers trying to access this facility, as it would require securitization of servicing advance receivables in a short time frame.”

Fitch notes that, in addition to falling rates, unemployment could also be a factor in MSR valuation down the road.

On the bright side, mortgage servicers should be better prepared for the pending wave of defaults, as they are “armed with experienced leadership and better tools and operate within an improved regulatory framework.”

“These factors may help to effectively confront many of the larger issues in the evolving environment,” Fitch says. “Furthermore, numerous government programs have been introduced to help alleviate market stress, and direct aid to mortgage servicers could be forthcoming.”

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