The capacity crisis in mortgage originations is being precipitated in part by a lack of competent underwriting talent relative to demand. With pipelines bulging, the cost of an underwriter has virtually doubled in the last six months and loan cycle times have extended dramatically, exceeding 80 days (up from 45).
Underwriters provide the critical thinking skills necessary to determine if a borrower is eligible for a loan. Underwriters must successfully complete their analysis or there is no loan—none.
To determine if a borrower is eligible for a loan, an underwriter must detect and resolve inconsistencies (i.e., anomalies) that occur within the infrastructure of a loan. Underwriters look for anomalies across the three elements of loan infrastructure:
- the borrower’s application
- data about the borrower (paystubs, bank statements)
- investor guidelines—the criteria a secondary market investor will use to determine if the loan is eligible for purchase.
Anomalies abound. It is virtually axiomatic that every loan contains anomalies so serious that the loan cannot be granted until the anomalies have been resolved. Resolving anomalies in accordance with generally accepted underwriting principles is what underwriters do. That’s their job.
For example, a borrower’s application states that he/she makes $10,500 in gross income per month. However, the borrower’s income documents (paystubs) demonstrate that he/she only makes $9,350. Further, the borrower cannot meet the investor guidelines and qualify for the loan unless he/she makes in excess of $10,100 in gross monthly income. An underwriter must resolve the preceding anomalies or there is no loan.
To add insult to injury, each loan presents a unique set of anomalies; no two loans have the exact same set, and most differ substantially. Often anomalies are stubborn, hard to resolve, often requiring an abundance of adaptive and dynamic thinking to wrestle to the ground.
Moreover, assuming that Malcolm Gladwell was correct, the mortgage industry cannot meet current or future demands for underwriting talent. Gladwell asserts that it takes 10,000 manhours to develop a complex skill such as underwriting. That’s five years of training per competent underwriter.
Undersupplied on Underwriters
We need thousands of new underwriters now and it takes five years to make just one! This is the essence of a bad situation.
Additionally, we are about to turn a bad situation into a worse situation. The industry is about to dramatically increase the complexity of underwriting.
The problem is actually part of the solution, and that’s the current, protracted period of extensive forbearance programs. In early 2020, the federal government mandated that mortgage holders grant forbearance to borrowers who were negatively impacted by the pandemic. As posted on the Fannie Mae website:
“If you own your home and are experiencing financial hardship as a result of COVID-19, you may be able to receive a forbearance plan.
Entering into a forbearance plan can give you some financial breathing room. A forbearance plan doesn’t erase the amount you owe on a mortgage, but it temporarily suspends or reduces your mortgage payment until your hardship is over. At the end of the forbearance plan, you must repay what you missed, but necessarily not all at once.
Talk with your servicer about your situation, so they can help you and give you the best mortgage relief option for your situation.”
My question: how many borrowers currently on a forbearance plan (there are millions of them) currently believe that they must repay the past-due interest, plus resume normal monthly payments? Or did they believe that the interest/past due payments would be forgiven, no longer owed? If it’s the latter, then there may be a problem.
A related question: how many secondary market executives have specified the investor guidelines that are to be followed to administer (re-underwrite) loans that are in forbearance? Answer: virtually none. No fun, not a bit.
Not one loan currently in forbearance can emerge until the secondary market crafts the guidelines necessary to re-underwrite loans in forbearance. Moreover, once those guidelines have been developed, it is highly likely their structure will be complex and arduous, as opposed to simple and straightforward.
To add to the problem, the borrower will not react well to having a larger mortgage to pay. The borrower backlash may be substantial, making the capacity crisis multidimensional. In such an instance, adding additional personnel to attempt to resolve any misunderstanding can unexpectedly increase the cost of production/loan resolution.
To address the forbearance problem, one solution may be for industry policymakers to shift their attention from the dynamics of the primary market to those of the secondary market.
Secondary Market Considerations
In the U.S., over 97% of all loans manufactured are sold on the secondary market as mortgage-backed securities (MBS). The sale of a mortgage loan into an MBS means that the governing law switches from U.S. state and federal law to international securities law.
The primary market is dominated by U.S. politics and law, and its constituents are largely U.S.-licensed mortgage lenders. Here, state and national politics run supreme. However, once you enter the domain of the secondary market, the dynamics are much different. In the secondary market, U.S. politics takes a back seat to world economic issues and world economic players, such as pension funds, mutual funds, or insurance funds.
A loan manufactured in Peoria, Illinois, under the governance of Bank of America is rolled into an MBS pool to be issued by Fannie Mae or Freddie Mac and “sold” on the international, secondary money markets. Here bonds serviced by this MBS can be purchased by any appropriate investor, be it a pension fund from Germany or a mutual fund from China, for example. There can continue to be variances: perhaps the former is promised an interest rate of 8% and a return of principal in five years, while the latter is quoted an interest rate of 6% and a maturity of 10 years.
These quotes relate directly to the cashflow needs of the respective buyers in Germany and China, and their needs relate directly to how their businesses are run; these needs have very little to do with U.S. mortgage politics.
This sale alters the dynamics of the loan forever. An MBS security is a matrix that transforms loan-level cashflow into an intricate web of interconnected cashflows that feed a portfolio of bonds with specific interest rates and maturities. This structure has been designed to create an investment vehicle that can effectively service the interest rate and maturity needs of the international investment community. And the needs of this community are dominant.
To get the support of the international investment communities and access to their trillions of dollars of potential investment funds, the creators of these securities had to ensure the international investors that their interest rate and maturity needs would be strictly upheld by the structure of the security.
In particular, all loans must be kept current, even if the borrower could not service the loan. The international community must be paid as specified, which means that the interest rate covenants of the security must be upheld, regardless. The mortgage servicer is the entity stuck with funding shortfalls due to delinquency. Mortgage servicers and others in this space exist, ultimately, at the pleasure of the international money, which does not feel a need to invest in U.S. mortgages, per se. Their needs are directly tied to their interest rate and principal needs.
In this domain, the welfare of international money players governs. In this arena, there is one principle: money goes where it is treated best. Here, the politics of interest forgiveness (U.S. desired political outcome) will most likely yield to the powers of interest forbearance (the needs of the international money players). Mortgage borrowers will in some way be required to pay back the deferred interest. The interest rate expectations of those who purchase MBS securities will be upheld in the end, and the political influence of mortgage borrowers will be secondary.
The MBS industry is dependent upon the international investment community. The MBS industry must cater to the needs of the international community in order to continue to attract their capital, which is necessary to fund U.S. mortgages. International capital can go elsewhere with a stroke of a pen or a phone call. The international community holds no commitment to funding the U.S. mortgage market. None.
Hence, the international community holds the trump card. Therefore, every solution, at the borrower level, falls to the mortgage originator and servicer, despite the sale of a mortgage loan and the creation of the MBS shifting the controlling interest from state and federal lending laws (the primary market) to international securities law.
To resolve the forbearance problem, the industry must address the needs of the secondary market; those folks who invested their capital based upon the financial projections for the loan at the time of origination. These projections did not include any postponement of interest due to forbearance, for example.
The sale of a loan into the secondary market, usually as an element of an MBS, alters the dynamics of the loan forever. The sale marks the transition of the loan from the purview of federal and state law (often subject to the whims of politicians) to one subject to the securities laws and the many different, international flavors thereof.
An MBS security may be purchased by an entity in China or Germany, neither of which has much interest in the politics of the U.S. These investors are simply interested in getting their interest income as specified and their principal returned, also as specified. Any other interests, such as the politics of forbearance, are beyond the scope of the international MBS investor. Also, there is a body of law to support their perspective.
What this means is as follows: any attempt to simply forgive the interest owed during forbearance is highly likely to be rejected outright by the worldwide investment community that the U.S. needs to fund its mortgage industry. These investors cannot be ignored, nor are they easily persuaded.
Hence, any forbearance recovery guidelines in all likelihood must address postponed interest that must be repaid.