A new White Paper by the Milken Institute says that the private-label residential mortgage-backed security (PLS) industry must find a way to “self-govern” by collaborating on a set of uniform guidelines.
“Accomplishing this will evidence PLS's responsible evolution since the Great Recession,” the paper states. “Failure could lead to confusion, disagreements, errors, and litigation that arise from differing contractual interpretations and competing priorities. Failure could also harm consumers and further erode PLS's standing as a viable component of home financing.”
The paper—authored by Eric Kaplan, Michael Stegman, and Theodore Tozer—said the recent CARES Act provides mortgage forbearance relief for federally-backed mortgages only.
“While various states, including New York, have enacted new measures that extend mandatory forbearance to non-agency loans, they all require shorter periods of forbearance than the CARES Act prescribes,” the analysis said.
While the CARES Act does not address non-agency loans, many within the PLS industry have acknowledged the importance of providing forbearance relief to borrowers impacted by COVID-19.
“At the same time, these parties expressed concern as to whether tax laws fundamental to PLS allow forbearance relief similar to the type the CARES Act requires,” the paper states.
On April 3, 2020, the Structured Finance Association (SFA), requested guidance from the Internal Revenue Service (IRS) and the U.S. Department of the Treasury on the tax treatment of COVID-19-related mortgage loan payment forbearance under PLS trust structures.
Several days later on April 13, the IRS issued Revenue Procedure 2020-26, which confirmed that such measures generally would not violate special tax rules applicable to PLS, “effectively clearing the way for servicers to offer forbearance relief options to borrowers affected by COVID-19 whose loans are pooled in PLS transactions.”
“Following the resolution of this gating legal question, the first task for PLS parties to consider before providing forbearance relief is to evaluate the governing PLS transaction documents—particularly, the pooling and servicing agreement or equivalent contract—to determine whether the documents allow or condition the contemplated forbearance,” Milken states.
Milken’s White Paper says PLS may face scrutiny if the governing deal document or loss mitigation panels do not provide COVID-19-related relief similar to that of the CARES Act.
“For deals that allow forbearance, there are critical structural issues that industry stakeholders must resolve to ensure fair, consistent treatment of forbearance relief within PLS trust structures. Failure to achieve consistency could open the PLS deals—and various PLS trust participants—to a wave of litigation that would likely have an outsized adverse reputational impact relative to PLS's small market share in the post-financial crisis capital markets,” the paper states.
Kaplan, Director, Housing Finance Program, Milken Institute, told MReport that while the forbearance periods may end soon, not all borrowers are going to go back to employment or achieve the same income levels prior to the pandemic.
He said there could be a large portion of borrowers who will come out of forbearance and into default or even bankruptcy. Kaplan added that any repayment methods need to be sustainable for the borrower.
Kaplan said while many government agencies—the Federal Housing Administration, the Department of Housing and Urban Development, Veteran Affairs, and the GSEs—have loss mitigation policies, he questions whether they will be flexible enough for borrowers who may need a year, or even two, to repay forbearance amounts.
He added communication, options, and clarity on those options will be a large focus moving forward.
Earlier confusion caused many borrowers to think a lump-sum payment would be needed coming out of forbearance, but the Federal Housing Finance Agency said borrowers in forbearance with Fannie Mae and Freddie Mac-backed mortgages are not required to repay missed payments in one lump sum.
While there is more concrete language on the agency side, Kaplan said it is “murky” on the non-agency side and “starting to come under focus.”
“Seems odd to me that homeowners in forbearance would be subject to foreclosure. It doesn't make sense to me,” he said.