Part 1: Alternative Lenders
Having a “Plan B” contingency plan is a prudent strategy to prepare in advance for the possibility that something goes wrong with Plan A. This is the first in a series that will examine contingency planning for residential mortgages. The initial article takes a closer look at the critical role of alternative loan sources.
Contingency Planning: Alternative Mortgage Providers
According to data supplied by the Consumer Financial Protection Bureau, about 11 percent of mortgage requests were disapproved during 2017. Getting turned down by a lender for a residential mortgage can happen for a variety of reasons, but a happy ending is still possible in many cases. Developing a Plan B beforehand can save time, reduce stress and identify alternatives that are sometimes better than Plan A. While having a contingency plan does not guarantee eventual success, it will help borrowers to navigate more effectively through routine mortgage scenarios such as the following:
Common Reasons for Mortgage Lender Disapprovals — About 70 percent of lender denials are due to three reasons: (1) credit history details, (2) debt-to-income (DTI) ratio is too high and (3) insufficient collateral in the form of an appraisal that does not support the requested loan. This means that about one-third of disapprovals are for reasons other than the top three. Additional key rejection issues include the proposed down payment, length of employment history and inability to document income according to the lender’s standards.
Many Qualified Borrowers Often Encounter Lender Rejections — Many well-qualified borrowers are turned down by traditional lenders such as banks because of ultra-rigid financial requirements that were developed by federal housing agencies. Prime illustrations of borrowers that frequently encounter these difficulties are retired individuals, wealthy borrowers who are not employed, foreign nationals, borrowers with a recent bankruptcy or foreclosure and self-employed individuals.
Different Outcomes with Different Lenders — Just as it is not unusual for someone looking for a job to encounter rejection from multiple prospective employers before finding the perfect job, being turned down for a mortgage should not be “the end of the story” in today’s mortgage market. The shrinking and consolidating nature of the residential mortgage business will be discussed further in part two of this series. But this factor has a direct impact on why borrowers might hear “No” from one or more lenders and still hear “Yes” from another. For example, 465 banks were closed by the Federal Deposit Insurance Corporation (FDIC) during the 2008–2012 period. In the aftermath, many banking institutions have reallocated financial resources to higher-profit opportunities such as leveraged commercial loans. At the same time, banks have liquidated a significant volume of mortgage-related assets such as mortgage servicing rights (MSRs) to meet more stringent Federal Reserve guidelines for capital reserves. To demonstrate how some mortgage roles have been reversed since 2012, New Residential Investment Corp. (NYSE: NRZ) was established in 2013 and is now one of the largest non-bank owners of MSRs in the nation.
Choosing Between Traditional Lenders and Non-Traditional Lenders — First-time home buyers and current homeowners buying a new home for the first time in many years might not realize how much the mortgage industry has changed since the 2007 financial crisis. In 2010, traditional lenders issued about 90 percent of all residential mortgages. With recent changes and shifting consumer preferences, non-traditional lenders now make about half of mortgage loans. This distinction is of critical importance to prospective home buyers — especially for those who have already been told “No” by a traditional lender. An increasingly popular alternative is referred to as a non-qualified mortgage (non-QM) that is available primarily from non-traditional lenders such as NewRez, a nationwide (operating in 49 states and the District of Columbia) subsidiary of New Residential. Non-QM loans can successfully address several of the challenges for borrowers described in the preceding sections. For many home buyers, Plan B realistically becomes Plan A at an early point in the mortgage process.
A reminder — The Residential Mortgage Contingency Plans series will continue with “Part 2: A Shrinking Industry.”
Part 2: A Shrinking Industry
This is the second in a three-part series discussing contingency plans for residential mortgage loans. Part one assessed alternative lenders. This segment will review the consolidating mortgage industry.
Contingency Planning: Industry Changes
A “Plan B mentality” has become increasingly important due to massive changes in the mortgage industry during the past decade. As noted by Laxman Subramaniam during the latter part of 2018, “The mortgage industry is undergoing a huge consolidation to accommodate the low volumes and extreme cost-cutting.” The rapidly shrinking industry means that having a contingency plan is virtually mandatory for investors, borrowers and mortgage company executives. Here are several noteworthy examples:
Increasing Compliance Costs — While regulatory compliance has always been a necessary part of the mortgage business, the industry became the focus of intense scrutiny due to the 2007 financial crisis — and compliance requirements began to make a much bigger impact on the bottom line. Estimated compliance costs for originating a mortgage were about $4300 pre-crisis and are now almost $8500. This is a significant cost increase for any mortgage provider to absorb. The response by some (especially banks) has been to reduce the priority of mortgage lending and to simply avoid the added costs by making fewer mortgages. Within non-bank companies that are mortgage specialists, a shrinking bottom line has influenced Plan B alternatives that include cutting other expenses, analyzing merger possibilities, searching for new ways to increase revenues and reorganizing via bankruptcy proceedings in the most extreme cases.
Lack of Capital Buffers — Mortgage lending is a capital-intensive business. While each loan typically results in positive cash flow for the transaction, overall profits for a mortgage originator depend on controlling longer-term costs (factors such as rising compliance expenses noted above make this a delicate balancing act) and generating a consistent stream of new business. Even in the most healthy mortgage business, business development efforts have a normal ebb and flow that results in irregular timing for new mortgage activity. Mortgage companies without ample capital reserves will frequently have recurring challenges in meeting routine working capital needs when business activity is slow for an extended period. Although banks have been historically viewed as having sufficient capital to weather any mortgage storm, the Federal Reserve imposed new financial requirements after the financial crisis and banks were forced to sell many mortgage-related assets. Without sufficient capital resources, mortgage industry participants have been forced to pursue a Plan B strategy.
Changing, Consolidating and Shrinking — The mortgage industry is predominantly a legacy business that has resisted substantial changes for several decades. A major reason for the status quo mentality is the previous dominant role played by banks and other traditional lenders. By not making changes when needed, mortgage providers saved money. But the Great Recession, a foreclosure crisis, a changing housing market and technological advances acted together to facilitate needed changes in the industry. While change is still viewed as an unnecessary disruption by many mortgage providers, New Residential Investment Corp. (NYSE: NRZ) is currently acting as an industry leader by innovating and making mortgages more flexible, accessible and affordable throughout the United States with successful business strategies that include the following:
• Organized as a Real Estate Investment Trust (REIT) — By choosing to be a public company that is listed on the New York Stock Exchange, NRZ has access to multiple sources of capital reserves that include issuing new common and preferred stock.
• Opportunistic Investing — NRZ has adopted an active and opportunistic management style that reflects the increasingly complex nature of residential mortgages. For example, when banks were forced to sell mortgage servicing rights (MSRs), New Residential became a selective buyer and is now one of the largest non-bank owners of MSRs in the nation.
• Capturing Revenues from the Overall Mortgage Process — NRZ is growing rather than shrinking by acquiring mortgage-related assets and companies that facilitate New Residential’s capabilities to capture more revenues during different phases of the residential mortgage process. Two recent examples include the 15th-largest non-bank mortgage servicing company in the United States (Shellpoint) and a nationwide non-bank mortgage originator operating in 49 states (NewRez).
A reminder — The Residential Mortgage Contingency Plans series will continue with “Part 3: Delinquencies.”
Part 3: Delinquencies
This is the final part in a series about residential mortgage contingency planning. The first two articles evaluated industry consolidation and alternative mortgage sources. This segment will analyze mortgage delinquencies by borrowers.
Contingency Planning: Mortgage Delinquencies
The overall mortgage delinquency rate (4.06 percent) was recently at an 18-year low based on 2018 data — this includes payments that are at least 30 days late as well as properties in foreclosure proceedings. When figures are restricted to loans that are at least 90 days late, the rate drops to 1.96 percent (the lowest level since mid-2006).
When borrowers are unable to make required monthly payments, this becomes a problem for multiple parties that include the lender, borrower, mortgage servicing company and investors. While the gravity of the challenge will not always be the same, it is nevertheless a recurring problem that can be eased with advance contingency planning. Here are three Plan B alternatives that are not always equally effective in dealing with the problem:
Foreclosures — The percentage of all mortgages in foreclosure (often referred to as foreclosure inventory) was recently at the lowest level in 24 years (0.92 percent). However, the previous 12 years tell a different story — a national foreclosure rate of 3.6 percent at the peak during 2010–11, with individual states at higher levels. For example, the foreclosure rate in Florida was 12.5 percent in 2011 (more recently at 1.5 percent). During the period 2007 to 2017, the total homes that were foreclosed reached 7.8 million.
• Foreclosure Disadvantages — It is not unusual for foreclosure costs to exceed $50,000 for lenders. The period to complete foreclosures varies widely from one state to another, in part because of differences between judicial (a longer process involving state courts) and nonjudicial foreclosures. The nationwide average is 835 days based on 2019 data. Foreclosure takes 6–9 months in West Virginia, Wyoming, Alaska, Minnesota and Virginia. At the other extreme, it takes 38–58 months in Florida, New Jersey, Arizona, Hawaii and Indiana. Borrowers should expect credit scores to drop by 200–300 points — an impact that will usually be reversed by at least 2–3 years of on-time payments. Lenders might also file a cancellation of debt with the Internal Revenue Service — resulting in potential tax consequences and taxable income.
Short Sales — When a lien holder agrees to a short sale, the lender accepts less than the mortgage balance — for example, a $100,000 mortgage balance and a short sale at $85,000. This saves the time and expense of the foreclosure process. One unusual aspect of the short sale alternative is that it can include home owners who are current in making payments but have a mortgage that is seriously “underwater” (worth less than the amount owed) and want to sell the property as quickly as possible for reasons such as a job transfer to another city.
• Short Sale Disadvantages — Lenders/investors incur a loss (the amount might be either more or less than would result from a foreclosure sale). Borrowers will incur an adverse event on credit reports since lenders report short sales to major credit bureaus as loans settled for less than the amount due, a deed-in-lieu of foreclosure, a settlement or charge off. The tax consequences for borrowers can be similar to foreclosures if a lender files a 1099-C to document debt cancellation.
Loan Workouts and Improved Collections — Unlike the first two Plan B approaches (foreclosures and short sales), this option involves continued home ownership by the borrower. During the 2007 financial crisis and the aftermath, bank-owned mortgage servicing companies predominantly sought asset sales while non-bank mortgage servicing companies attempted to improve collections and arrange mortgage workouts whenever possible. This approach historically produces better outcomes for all mortgage stakeholders. New Residential Investment Corp. (NYSE: NRZ) has emphasized the win-win possibilities of better collections and loan workouts since the company was founded six years ago. Shellpoint Mortgage Servicing is an NRZ subsidiary that also integrates the workout strategy in daily operations as the 15th-largest non-bank servicer in the United States.
• Loan Workout Disadvantages — Re-defaults by borrowers can occur. New mortgage terms can involve a longer loan amortization period as one practical way to reduce monthly payments. Loan modifications due to financial hardship might be reported to credit bureaus, resulting in reduced credit scores — but with impacts that are much less severe than short sales or foreclosures.
FYI About Michael (Mike) Nierenberg and NRZ: Return on Equity
Since the day that New Residential was established in 2013, Mike Nierenberg has served as Chief Executive Officer and President. He has also been NRZ’s Board Chairman since 2016. New Residential’s 2018 return on equity for the whole loan portfolio was 20 percent.