Are Forbearances Overblown?

In recent months many housing economists and the housing industry press have been focusing on the enormous increase in the number of loans in forbearance as a result of the COVID-19 pandemic.  As of July 12, 2020, the Mortgage Bankers Association announced that the share of loans in forbearance stood at 7.8 percent, which is several multiples of its normal level of less than 1 percent.  Many in the industry believe that this elevated level of forbearance rate is a predictor of a massive wave of mortgage defaults.  While the increase in forbearance rates are certainly concerning and it indicates a change in payment patterns, the degree to which it can be a predictor of defaults and foreclosures is far less certain. 

The actual number of forbearances is unknown.  Having discussed the forbearance rate with a variety of stakeholders, SP Group believes that the forbearance number reported by the industry is distorted.  There are borrowers who are in forbearance who actually have continued to make their scheduled payments.  A recent survey by LendingTree found that almost 70 percent who applied for forbearance under the CARES act didn’t need the help. Presumably the forbearance arrangements that they have made with their servicers are “just in case” they need to resort to them.  Nonetheless, they are being included in the forbearance data. 

Informal arrangements not captured in forbearance numbers.  Some servicers are engaging in informal or “handshake” forbearance.  These are situations where cooperative borrowers are in contact with their servicer and the servicer agrees to not take any immediate collection steps and the borrower agrees to make partial payments and maintain contact for what is anticipated to be a short period of time before he/she can get back to work and resume scheduled payments.  These “handshake” forbearances, if cured within 90 days, are never counted.  These types of forbearances distort the forbearance picture in terms of assessing the number of loans that are truly at risk of default.

Effective loss mitigation options available for forborne loans. The other major reason that today’s reported forbearance rates are less likely to be an effective predicter of defaults and foreclosures is that unlike the period in 2008 housing crisis, servicers are much more prepared to provide effective loss mitigation solutions and to work with borrowers.  HUD/FHA has published Mortgagee Letter 2020-22 that informs mortgagees of the full suite of COVID-19 Loss Mitigation Options available to Single Family borrowers affected by the COVID-19.  In addition, borrowers today have significantly greater equity in their properties and the fundamental affordability of the loan terms is more established and based on sound underwriting than it was in 2008 and 2009.  Based on the clarity of the policy directives from HUD/FHA, the experience that servicers gained during the 2008-2009 crisis regarding efficient operation of a loss mitigation asset management effort and the fact that today’s borrowers have more equity in their homes than in the prior crisis, we believe that the resolution rate for loans that are currently in forbearance will be substantially greater than during the prior crisis.

Alternative Metrics Worth Considering for Evaluating Portfolio Risks

Given the noise in the forbearance data, SP Group recommends considering alternative metrics for assessing portfolio risk of delinquencies and defaults.  One example of such a metric is the Serious Delinquency Rate (SDQ) that measures the percentage of loans that are more than 90 days delinquent.  When looking at seriously delinquent loans, factors such as loan to value (LTV), combined loan to value (CLTV), borrower credit scores, debt-to-income (DTI) should be considered for identifying loans that present a higher risk of foreclosure in the seriously delinquent pool. 

Another measure that cannot be ignored during this pandemic is the unemployment data – the spike in furloughs and layoffs that began in March was initially expected to be temporary but is now showing signs of permanence in some industries.  When assessing a residential loan portfolio for default risk, it is important to identify those loans where the underlying borrower income is dependent on employment in high risk industries (such as retail/hospitality/mining and oil), or those loans that have collateral located in high impact areas that may be more susceptible to home price declines due to their dependence on high risk industries (examples include some areas in Nevada and Florida). 

SP Group has studied more than 1,000 housing markets and has developed risk profiles, distress indices and recovery estimates to provide investors and portfolio managers with support for strategic business decisions involving single family portfolio risk nationwide.