The COVID-19 pandemic has spread like wildfire throughout the world, hobbling the global economy. The resulting market disruption is being felt by many businesses and consumers, including residential mortgage servicers and borrowers. The virus has also resulted in a majority of the U.S. population under some form of shelter-in-place or similar order, with nonessential businesses closed and millions of people being furloughed or laid off in different sectors of the economy. An even less rosy picture is painted by the numbers, with the March 2020 unemployment rate at 4.4%, according to the U.S. Bureau of Labor Statistics. For the three weeks ending April 4, a record 16 million Americans filed claims for unemployment benefits, according to the U.S. Department of Labor. S&P Global Ratings projects the unemployment rate to dramatically increase in the second quarter, to 10.1%, then moderate to 6.9% in the third quarter. Our recent U.S. Biweekly Economic Roundup noted: "We had earlier expected a cumulative 16.5 million jobs lost by May when all is said and done with social distancing, but job losses are coming at a faster pace and sooner than we initially thought. Unfortunately, they could be much greater and, while once unthinkable, we now expect over 20 million jobs lost by May." (see "The Beginnings Of A Sudden-Stop Recession," April 3, 2020).

S&P Global Ratings recently surveyed its ranked U.S. residential mortgage servicers, all of whom have indicated they have successfully deployed their disaster recovery and business continuity plans in response to the COVID-19 pandemic. While we view this collective accomplishment favorably, we recognize this is only the beginning of the unfolding crisis for U.S. residential mortgage servicers. While we are not taking any pandemic-related ranking actions at this time, we believe significant operational and financial challenges lie ahead for servicers' already strained resources, concerning:

• The large amount of borrower requests for loss-mitigation assistance,
• The number of experienced staff necessary to handle the call volumes and advancing delinquencies,
• The sufficiency of servicer technology and tools used for borrower contact and loss mitigation, and
• Servicer liquidity necessary to fund required advances and its impact on RMBS.

Enormous Borrower Requests For Loss-Mitigation Assistance

The initial challenge for servicers is addressing the expected deluge of borrower requests for loss-mitigation assistance. The Mortgage Bankers Association published a survey on April 7 highlighting, by investor, the substantial increases in forbearance requests by borrowers--Ginnie Mae: 4.25%; Fannie/Freddie: 1.68%; Other (private-label, portfolio, etc.): 2.86%. The U.S. government's Coronavirus Aid, Relief, and Economic Security Act (CARES Act) afforded borrowers with federally backed (government sponsored enterprise [GSE], Federal Housing Administration [FHA], Department of Veterans' Affairs [VA], U.S. Department of Agriculture [USDA]) loans an initial 180-day period of forbearance as a mortgage payment assistance option and certain protections for credit reporting and foreclosure. However, some servicers will begin with an initial 90-day period,with other servicers even providing a full 180-day period. Servicers will have to reassess the borrower's continued hardship and need for a further extension, up to a possible 360-day period. The CARES Act announcement also created confusion among many borrowers who assumed that any forbearance amounts would be forgiven. Regulators, such as the Consumer Financial Protection Bureau (CFPB), have sought to educate borrowers on the basics of forbearance to correct this misunderstanding. This confusion has already contributed to the inundation of servicer call centers and will likely continue.

The CARES Act also did not address nongovernment-serviced loans (e.g., private-label, whole loans) or any specific options afforded to these borrowers. We believe, however, that servicers of these loans will provide a similar initial forbearance option analogous to options they have provided in previous natural disaster events.

Borrowers who have an extended forbearance period (more than 180 days) will, in all likelihood, require a longer-term solution to resolve delinquencies resulting from forbearance, as mortgage payments could increase dramatically even if the servicer tries to push out the repayment plan. A loan modification or some other form of workout option (e.g., balloon note due upon payoff or maturity) might be the preferred route. Regardless, servicer resources will be further strained, as any loss-mitigation alternative will require financial documentation from the borrower so the servicer can analyze the account and see the best option that fits the borrower's circumstances. The culmination of all the borrower assistance required throughout this process will be a monumental challenge for servicers.

Staff Adequacy To Handle Call Volumes And Accelerating Delinquencies

The forbearance and other mortgage payment assistance alternatives require the borrower to contact their servicer first, which will result in a severe influx of borrower calls and requests. In a normal environment--or even in an event such as a natural disaster--a servicer is staffed to handle some increase in call volumes. However, the velocity of this pandemic, suddenly unemployed borrowers, and borrower confusion around the forbearance option available in the CARES Act have created exceptional volumes of contact for servicers. The number of these calls and requests are expected to further rise as delinquency rates increase as a result of the projected heightened levels of unemployment throughout the year.

Servicers' response capabilities are further hampered by the widespread governmental lockdowns on their staff that are requiring the creation of a remote working environment, which is new and uncertain for some staff. Most servicers we surveyed indicated 90% or more of their staff are working from home, including call center agents. Staff not typically acclimated to working from home presents its own distractions, which could result in reduced productivity and challenges with call quality. This combination of working from home and increased volumes of assistance requests could cause significant delays in responses to borrowers. These factors will contribute to extraordinary hold times and abandonment rates for borrowers as servicers attempt to address borrower requests. In turn, this could result in borrowers becoming frustrated at the long delays and simply giving up on contacting the servicer, instead waiting for the servicer to contact them so they can explain the extenuating circumstances surrounding the delinquency.

The remote working issues are not isolated to U.S. staff. Government lockdowns are in effect in India and the Philippines, where many servicers have outsourced staff or captive staff completing back-office functions, and certain servicers have customer-facing call center staff. It's unclear at this time whether offshore staff will face outsized challenges compared to their U.S. counterparts. However, some considerations for these staff could be access to reliable home internet connections, adequate technology to complete work functions, and secure connections to protect the privacy of confidential information.

An additional complication for servicers could be the lack of adequate experienced staff for this new delinquency cycle and predicted economic recession. Servicers have generally been reducing staff, including collections and loss-mitigation call agents, while investing in technology during a period of record-low delinquency rates. If workloads increase, as anticipated, servicers will likely need to redeploy existing staff or add higher-skilled agents and possibly other later-stage default staff. We expect considerable difficulty for some servicers in sourcing, hiring, and training frontline agents using a virtual environment, as this is not a typical practice during normal times. As during the Great Recession, servicers may also be challenged in retaining staff: The increased call volumes and anxiety communicating with distressed customers could lead to higher voluntary and involuntary turnover rates within call centers. This could have a domino effect should borrowers require further workout activity in the future, as dramatically increased caseloads might potentially affect staffing in the loss-mitigation area.

Even if servicers and their employees successfully navigate through the aforementioned challenges, they will still need to reassess borrower options toward the end of their forbearance period. These could include a further extension of the forbearance, full reinstatement, a repayment plan, deferral, or possibly a loan modification. Servicers have automated much of this evaluation process, often through a paperless process and efficient software workflow applications. Despite such technology improvements, contact with an agent is still required if a borrower's delinquency progresses. Additionally, later-stage delinquency relief options, such as loan modifications, will require formal agreements and other documentation, which necessitates more intensive communication with borrowers, higher-skilled staff, and contracted vendors that provide services such as document production, escrow analyses, and notarization services. The high amount of forbearance requests already made by borrowers is certainly a harbinger of the levels of loan modification requests to come.

Servicers that were created post-Great Recession have never experienced a downturn and delinquency cycle, and are untested in these kind of circumstances, which raises another concern. That said, these servicers are typically led by industry-experienced senior and middle management who have weathered high-delinquency environments in the past at other servicers.

The culmination of these factors could also lead to increased complaints from borrowers to federal and state regulators, which in previous years has led to fines and settlements. A collective of regulatory bodies released a joint statement acknowledging the CARES Act and the impact of the pandemic. The statement provides servicers flexibility around the timing of certain borrower notices and certain CFPB servicing rule requirements related to short-term loss-mitigation options. While we believe this statement is a positive step from regulators, the extent of regulatory reactions from this event and from servicer issues and resulting borrower complaints is particularly unclear at this point. If there are systemic widespread issues or violations of consumer rights, the industry could find itself in a similar position as in the wake of the Great Recession, subject to fines, civil penalties, and consumer relief provisions.

Servicer Technology And Tools Used For Borrower Contact

Borrower contact with servicers primarily occurs through call centers, with many servicers also having websites and/or mobile apps to receive secure messages and provide borrowers self-service options. This may be an area of positivity for many servicers in this crisis, as servicers have been making improvements since the Great Recession to enhance process automation and the use of software workflows, especially in the areas of later-stage delinquency and loan-modification processing.

Servicers have been migrating their call center technology to the cloud, enabling greater connectivity and flexibility for remote access by staff. There have also been enhancements to servicer telephone integrated voice response (IVR) units to improve the flow of menu and self-service options available to borrowers. We have also observed certain servicers using their websites to provide a complete self-service process to request a forbearance. However, it is uncertain whether borrowers will use these options or if they will still choose the familiar comfort of contact with an agent, which would add to call volumes.

Personal contact with a servicer provides some borrowers with a greater feeling of security than an automated online process. During the financial crisis, many servicers used existing bank branches, satellite offices, and homeowner events to encourage personal contact with borrowers affected by the housing crisis. The personal contact and ability to drop off workout-related documents was helpful, but this method of interaction may not be possible during the current pandemic due to mandated social distancing.

Servicer Liquidity Necessary To Fund Required Advances

The economic stress induced by the coronavirus has created a monumental challenge to servicer liquidity. The massive amount of forbearance occurring will result in servicers being required to advance these funds in most cases to investors even when the borrower does not pay. Depending on the duration of this pandemic, the number of borrowers requesting assistance, and the length of the plans they need, servicers will need vast sums of capital to meet these advancing requirements. Fortunately, U.S. banks appear to be well positioned to meet these requirements at this point. (See "Most U.S. Banks, Helped By Fed Actions, Are Well Positioned To Meet Corporate Borrowers' Demand For Cash," March 24, 2020).

Nonbank financial institutions, on the other hand, generally have constrained balance sheets and limited access to liquidity considering the large sums necessary. Congress passed the CARES Act, which does not expressly provide a liquidity facility or other source of capital for residential mortgage servicer advances. The CARES Act did establish a $454 billion emergency fund for the Secretary of the Treasury. However, it's unclear whether this fund would provide a facility or other source of funds for servicers. Additionally, the Troubled Asset-Backed Loan Facility was revived from the Great Recession era and provides funding for certain servicing advance receivables, but these terms are still being finalized. The Federal Reserve and Treasury are the responsible parties for providing more clarity, but have so far abstained from acting. The inaction appears to be predicated on determining servicers' actual liquidity needs based on the forbearance numbers experienced. With the April 1 payment date passed and those delinquent funds due to be advanced subsequently, the May 1 payment date looms as more servicers' liquidity dissipates.

For loans in U.S. residential mortgage-backed securities (RMBS) transactions, the role of servicers typically includes both the operational aspect of servicing the loans backing the RMBS and the advancing function of nonpayment from mortgagors to (1) the securitization trust (in the form of principal and interest payments), (2) property taxes to the respective municipality, (3) hazard insurance premiums to the respective insurance provider, and (4) property preservation expenses. In terms of advancing obligations for the RMBS trusts, notwithstanding the expected financial burden to certain servicers, most RMBS transaction constructs include a backstop to provide principal and interest advancing if the underlying servicer fails to do so. This backstop provider (in many cases a master servicer) typically has an investment-grade rating. Therefore, the presence of another entity to fulfill the principal and interest advancing obligation for the RMBS could dampen the liquidity impacts to RMBS as a result of an increase in temporary forbearances under COVID-19. The RMBS sector also includes a subsector of servicer advance receivables securitizations for which a portfolio of advances (effectively advance receivables) by the servicer may be securitized as a form of liquidity for the servicer (see "Credit FAQ: The Role Of Servicer Advances In U.S. RMBS Amidst COVID-19," April 8, 2020).

The Federal Housing Finance Agency has indicated that liquidity relief or a facility will not be provided to servicers for GSE loans. If servicers cannot fund necessary advances, the GSEs could possibly be in a dire scenario, forced to transfer the servicing to another servicer with greater financial wherewithal. However, we have observed that servicing transfers during previous crisis periods are disruptive to borrowers, servicers, and the general servicing of the loan. Additionally, there is a fine balance to be had in transferring loans to a different servicer, ensuring the transferee has both the operational capacity and sufficient liquidity for advancing responsibilities. The lack of a funding facility, most notably for nonbanks, could create a grim and unnecessary disruption scenario to servicers and borrowers alike.

Ginnie Mae announced that it has established a pass-through assistance program, which will help issuers advance shortfalls of principal and interest amounts equal to the difference between available servicer funds and the scheduled payment amount to investors. This program is applicable to Ginnie Mae's insuring agency partners (FHA, VA, and USDA). While this will provide servicers some relief, it does not include additional advances necessary for delinquent property tax and insurance amounts.

Uncertainty Abounds

The COVID-19 pandemic provides new and unique circumstances and challenges for servicers for which the outcome is still uncertain. While the CARES Act announced new borrower mortgage assistance programs, it has yet to be seen how effective they will be in mitigating the crisis. The full extent of the virus, the number of affected borrowers, and the adequacy of necessary staff and processes to service them are also still unknowns. In addition, a complete picture of servicer financial sufficiency is unclear, especially for certain nonbank financial institutions. One optimistic consideration is that the Great Recession has helped servicers enhance their processes and technology, which will certainly be put to the test over the course of this year and next. Only time will tell if these enhancements will be enough to handle an event of this scale, but lessons learned since the credit crisis and the new borrower assistance programs have provided servicers with a head start in managing the current dilemma.

Related Research

• U.S. Biweekly Economic Roundup: The Beginnings Of A Sudden-Stop Recession, April 3, 2020
• Credit FAQ: Most U.S. Banks, Helped By Fed Actions, Are Well Positioned To Meet Corporate Borrowers' Demand For Cash, March 24, 2020
• Credit FAQ: The Role Of Servicer Advances In U.S. RMBS Amidst COVID-19, April 8, 2020