There is justified concern within the investor community regarding the residential mortgage loans currently in forbearance and their ultimate resolution. Although most of the 4M loans in forbearance are in securities backed by the Federal Government (Fannie Mae, Freddie Mac or Ginnie Mae), approximately 400,000 loans currently in forbearance represent collateral that backs private-label residential mortgage-backed securities (PLS). The PLS market operates without clear, articulated standards for forbearance programs and lacks the reporting practices that exist in Agency markets. This leads to disparate practices for granting forbearance to borrowers and a broad range of investor reporting by different servicers. COVID-19 has highlighted the need for transparent, consistent reporting of forbearance data to investors to support a more efficient PLS market.
Inconsistent investor reporting leaves too much for interpretation. It creates investor angst while making it harder to understand the credit risk associated with underlying mortgage loans. RiskSpan performed an analysis of 2,542 PLS deals (U.S. only) for which loan-level foreclosure metrics are available. The data shows that approximately 78% of loans reported to be in forbearance were backing deals originated between 2005-2008 (“Legacy Bonds”). As you would expect, new issue PLS has a smaller percentage of loans reported to be in forbearance.
Not all loans in forbearance will perform the same and it is critical for investors to receive transparent reporting of underlying collateral within their PLS portfolio in forbearance. These are unchartered times and, unlike historic observations of borrowers requesting forbearance, many loans presently in forbearance are still current on their mortgage payments. In these cases, they have elected to join a forbearance program in case they need it at some future point. Improved forbearance reporting will help investors better understand if borrowers will eventually need to defer payments, modify loan terms, or default leading to foreclosure or sale of the property.
In practice, servicers have followed GSE guidance when conducting forbearance reviews and approval. However, without specific guidance, servicers are working with inconsistent policies and procedures developed on a company-by-company basis to support the COVID forbearance process. For example, borrowers can be forborne for 12-months according to FHFA guidance. Some servicers have elected to take a more conservative approach and are providing forbearance in 3-month increments with extensions possible once a borrower confirms they remain financially impacted by the COVID pandemic.
Servicers have the data that investors want to analyze. Inconsistent practices in the reporting of COVID forbearances by servicers and trustees has resulted in forbearance data being unavailable on certain transactions. This means investors are not able to get a clear picture of the financial health of borrowers in transactions. In some cases, trustees are not reporting forbearance information to investors which makes it nearly impossible to obtain a reliable credit assessment of the underlying collateral.
The PLS market has attempted to identify best practices for monthly loan-level reporting to properly assess the risk of loans where forbearance has been granted. Unfortunately, the current market crisis has highlighted that not all market participants have adopted the best practices and there are not clear advantages for issuers and servicers to provide clear, transparent forbearance reporting. At a minimum, RiskSpan recommends that the following forbearance data elements be reported by servicers for PLS transactions:
- Last Payment Date: The last contractual payment date for a loan (i.e. the loan’s “paid- through date”).
- Loss Mitigation Type: A code indicating the type of loss mitigation the servicer is pursuing with the borrower, loan, or property.
- Forbearance Plan Start Date: The start date when either a) no payment or b) a payment amount less than the contractual obligation has been granted to the borrower.
- Forbearance Plan Scheduled End Date: The date on which a Forbearance Plan is scheduled to end.
- Forbearance Exit – Reason Code: The reason provided by the borrower for exiting a forbearance plan.
- Forbearance Extension Requested: Flag indicating the borrower has requested one or more forbearance extensions.
- Repayment Plan Start Date: The start date for when a borrower has agreed to make monthly mortgage payments greater than the contractual installment in an effort to repay amounts due during a Forbearance Plan.
- Repayment Plan Scheduled End Date: The date at which a Repayment Plan is scheduled to end.
- Repayment Plan Violation Date: The date when the borrower ceased complying with the terms of a defined repayment plan.
The COVID pandemic has highlighted monthly reporting weaknesses by servicers in PLS transactions. Based on investor discussions, additional information is needed to accurately assess the financial health of the underlying collateral. Market participants should take the lessons learned from the current crisis to re-examine prior attempts to define monthly reporting best practices. This includes working with industry groups and regulators to implement consistent, transparent reporting policies and procedures that provide investors with improved forbearance data.
COVID-19 creates a need for analytics in real time
Regarding the COVID-19 pandemic, Warren Buffet has observed that “we haven’t faced anything that quite resembles this problem” and the fallout is “still hard to evaluate.”
The pandemic has created unprecedented shock to economies and asset performance. The recent unemployment data, although encouraging , has only added to the uncertainty. Furthermore, impact and recovery are uneven, often varying considerably from county to county and city to city. Consider:
- COVID-19 cases and fatalities were initially concentrated in just a few cities and counties resulting in almost a total shutdown of these regions.
- Certain sectors, such as travel and leisure, have been affected worse than others while other sectors such as oil and gas have additional issues. Regions with exposure to these sectors have higher unemployment rates even with fewer COVID-19 cases.
- Timing of reopening and recoveries has also varied due to regional and political factors.
Regional employment, business activity, consumer spending and several other macro factors are changing in real time. This information is available through several non-traditional data sources.
Legacy models are not working, and several known correlations are broken.
Determining value and risk in this environment is requiring unprecedented quantities of analytics and on-demand computational bandwidth.
Need for on-demand computation and storage across the organization
“I don’t need a hard disk in my computer if I can get to the server faster… carrying around these non-connected computers is byzantine by comparison.” ~ Steve Jobs
Front office, risk management, quants and model risk management – every aspect of the analytics ecosystem requires the ability to run large number of scenarios quickly.
Portfolio managers need to recalibrate asset valuation, manage hedges and answer questions from senior management, all while looking for opportunities to find cheap assets. Risk managers are working closely with quants and portfolio managers to better understand the impact of this unprecedented environment on assets. Quants must not only support existing risk and valuation processes but also be able to run new estimations and explain model behavior as data streams in from variety of sources.
These activities require several processors and large storage units to be stood up on-demand. Even in normal times infrastructure teams require at least 10 to 12 weeks to procure and deploy additional hardware. With most of the financial services world now working remotely, this time lag is further exaggerated.
No individual firm maintains enough excess capacity to accommodate such a large and urgent need for data and computation.
The work-from-home model has proven that we have sufficient internet bandwidth to enable the fast access required to host and use data on the cloud.
Cloud is about how you do computing
“Cloud is about how you do computing, not where you do computing.” ~ Paul Maritz, CEO of VMware
Cloud computing is now part of everyday vocabulary and powers even the most common consumer devices. However, financial services firms are still in early stages of evaluating and transitioning to a cloud-based computing environment.
Cloud is the only way to procure the level of surge capacity required today. At RiskSpan we are computing an average of a half-million additional scenarios per client on demand. Users don’t have the luxury to wait for an overnight batch process to react to changing market conditions. End users fire off a new scenario assuming that the hardware will scale up automagically.
When searching Google’s large dataset or using Salesforce to run analytics we expect the hardware scaling to be limitless. Unfortunately, valuation and risk management software are typically built to run on a pre-defined hardware configuration.
Cloud native applications, in contrast, are designed and built to leverage the on-demand scaling of a cloud platform. Valuation and risk management products offered as SaaS scale on-demand, managing the integration with cloud platforms.
Financial services firms don’t need to take on the burden of rewriting their software to work on the cloud. Platforms such as RS Edge enable clients to plug their existing data, assumptions and models into a cloud–native platform. This enables them to get all the analytics they’ve always had—just faster and cheaper.
Serverless access can also help companies provide access to their quant groups without incurring additional IT resource expense.
A recent survey from Flexera shows that 30% of enterprises have increased their cloud usage significantly due to COVID-19.
Cloud is cost effective
“In 2000, when my partner Ben Horowitz was CEO of the first cloud computing company, Loudcloud, the cost of a customer running a basic Internet application was approximately $150,000 a month.” ~ Marc Andreessen, Co-founder of Netscape, Board Member of Facebook
Cloud hardware is cost effective, primarily due to the on-demand nature of the pricing model. A $250B asset manager uses RS Edge to run millions of scenarios for a 45–minute period every day. Analysis is performed over a thousand servers at a cost of $500 per month. The same hardware if deployed for 24 hours would cost $27,000 per month
Cloud is not free and can be a two-edged sword. The same on-demand aspect that enables end users to spin up servers as needed, if not monitored, can cause the cost of such servers to accumulate to undesirable levels. One of the benefits of a cloud-native platform is built-on procedures to drop unused servers, which minimizes the risk of paying for unused bandwidth.
And yes, Mr. Andreeseen’s basic application can be hosted today for less than $100 per month
The same survey from Flexera shows that organizations plan to increase public cloud spending by 47% over the next 12 months.
Alternate data analysis
“The temptation to form premature theories upon insufficient data is the bane of our profession.” ~ Sir Arthur Conan Doyle, Sherlock Holmes.
Alternate data sources are not always easily accessible and available within analytic applications. The effort and time required to integrate them can be wasted if the usefulness of the information cannot be determined upfront. Timing of analyzing and applying the data is key.
Machine learning techniques offer quick and robust ways of analyzing data. Tools to run these algorithms are not readily available on a desktop computer.
Every major cloud platform provides a wealth of tools, algorithms and pre-trained models to integrate and analyze large and messy alternate datasets.
Tracking Mortgage Delinquency Against Non-traditional Economic Indicators by MSA
Traditional economic indicators lack the timeliness and regional granularity necessary to track the impact of COVID-19 pandemic on communities across the country. Unemployment reports published by the Bureau of Labor Statistics, for example, tend to have latency issues and don’t cover all workers. As regional economies attempt to get back to a new “normal” RiskSpan has begun compiling non-traditional “alternative” data that can provide a more granular and real-time view of issues and trends. In past crises, traditional macro indicators such as home price indices and unemployment rates were sufficient to explain the trajectory of consumer credit. However, in the current crisis, mortgage delinquencies are deteriorating more rapidly with significant regional dispersion. Serious mortgage delinquencies in the New York metro region were around 1.1% by April 2009 vs 30 day delinquencies at 9.9% of UPB in April 2020.
STACR loan–level data shows that nationwide 30–day delinquencies increased from 0.8% to 4.2% nationwide. In this chart we track the performance and state of employment of 5 large metros (MSA).
Indicators included in our Chart of the Month:
Change in unemployment is the BLS measure computed from unemployment claims. Traditionally this indicator has been used to measure economic health of a region. BLS reporting typically lags by months and weeks.
Air quality index is a measure we calculate using level PM2.5 reported by EPA’s AirNow database on a daily basis. This metric is a proxy of increased vehicular traffic in different regions. Using a nationwide network of monitoring sites, EPA has developed ambient air quality trends for particle pollution, also called Particulate Matter (PM). We compute the index as daily level of PM2.5 vs the average of the last 5 years. For regions that are still under a shutdown air quality index should be less than 100 (e.g. New York at 75% vs Houston at 105%)
Air pollution from traffic has increased in regions where businesses have opened in May ’20 (e.g. LA went up from 69% in April to 98% in May). However, consumer spending has not always increased at the same level. We look to proxies for hourly employment levels.
New Daily COVID-19 Cases: This is a health crisis and managing the rate of new COVID-19 cases will drive decisions to open or close businesses. The chart reports the monthly peak in new cases using daily data from Opportunity Insight
Hourly Employment and Hours Worked at small businesses is provided by Opportunity Insight using data from Homebase. Homebase is a company that provides virtual scheduling and time-tracking tools, focused on small businesses in sectors such as retail, restaurant, and leisure/accommodation. The chart shows change in level of hourly employment as compared to January 2020. We expect this is to be a leading indicator of employment levels for this sector of consumers.
Sources of data:
Freddie Mac’s (STACR) transaction database
Opportunity Insight’s Recovery Tracker
Bureau of Labor and Statistics (BLS)’ MSA level economic reports
Environment Protection Agency (EPA)’s AirNow database.