03 April, 2020
Published April 3, 2020
There are two primary concerns for the mortgage industry in regard to the pandemic: one is the secondary market losing liquidity and the primary market drying up; the other is the possibility that the pandemic will cause a wave of unemployment and lack of cash on hand, which will cause a wave of delinquencies and defaults that could result in another housing crisis. To address the first concern, the Federal Reserve has stepped in to ensure the liquidity of the secondary mortgage market by buying unlimited quantities of agency mortgage backed securities on the secondary market, which also keeps the primary market liquid because lenders then have a place to sell their assets.
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) package will work in several ways to address the second concern by helping the areas of the economy that are hardest hit by the pandemic to prevent another housing crisis. It will greatly expand and enhance unemployment insurance during the pandemic, provide a one-time stimulus payment to most households, as well as relief to small businesses to keep making payroll while workers are forced to stay home. Additionally, the CARES Act will deliver separate relief for large corporations, an “employee retention” tax credit, and allow companies to defer social security payroll tax. The allocation of funding to hospitals, nursing homes, FEMA, election assistance for states, and $500 Billion for loans to large businesses, state and local governments is also included. Let’s take a look at each of these components to see how they might impact the mortgage industry.
Unemployment Insurance
Unemployment insurance will be expanded in several ways. First, people will be eligible for benefits for up to four months rather than three. Second, it expands coverage to those that are not traditionally covered, including gig workers like Uber drivers. Third, it pays what workers would normally get in that state plus an additional $600 per week. This will help to replace income of those who are laid-off or furloughed so they can hopefully continue with their lives and pick up where they left off when this is over.
Mortgage Specific Measures
The CARES act will allow up to six months of forbearance with a borrower option for less, and the ability to reassess and potentially extend for additional six months. Borrowers of any delinquency can take advantage of this forbearance, and all federally-backed[1] loans are eligible for this program. The costs of this forbearance program will be carried largely by the federal agencies and government-sponsored entities, but there is some possibility for strain, particularly to non-bank mortgage servicers. As long as the mortgages were current as of December 31, 2019, banks will not have to recognize loan modifications related to COVID-19 as troubled debt restructurings. There is also a 60-day foreclosure moratorium on all federally-backed loans.
Stimulus Payment
There is a one-time stimulus payment of $1,200 per adult and $500 per child, which will be directly delivered to most of the public. The amount is based on income from the 2019 tax returns – or 2018 when 2019 is unavailable – and the amount is decreased by 5% for every dollar above $75,000 for individuals, $112,000 for head of household, or $150,000 for married filing jointly. Those without children making more than $99,000 (or $198,000 for a couple) will not see a stimulus check. These checks must be distributed by December 31, 2020, but the hope is that most Americans will receive their checks in three weeks.
Small Business Economic Relief Package
A $377 Billion program was created for small businesses with less than 500 employees to keep producing payroll while workers are forced to stay home. It will take the form of loans up to $10 million that can be used for payroll and other business expenses[2]. The government will pay off the loan balance as long as the companies either do not lay off workers or rehire the workers that have already been laid off. Once a business receives the loan, they will have two months to use the money to avoid repaying it. Businesses would receive these loans from banks, who will then be reimbursed by the Treasury or repaid by the company as appropriate. It is estimated that this portion of the relief bill could keep 50% of Americans employed!
Employee Retention Tax Credit
This provides a tax credit that is available to businesses that had operations either fully or partially suspended due to an order from a governmental authority limiting travel, commerce, or meetings during the applicable calendar quarter, or those that suffer a significant decline in gross receipts compared to the same quarter of the previous year. The CARES Act creates a fully refundable tax credit equal to 50% of the first $10,000 “qualified wages” per employee, per quarter, where “qualified wages” is all wages for tax exempt organizations.
Deferral of Social Security Payroll Tax
Companies can defer paying the 6.2% social security payroll tax. This is potentially a big help, especially for those companies that are trying to keep employees but are seeing temporarily decreased revenue streams. This could make a difference in what fraction of the workforce may get laid-off or furloughed, or if pay cuts are enacted.
Guaranteed Subsidized Loans to Larger Industries
$454 Billion will be in subsidized lending to large industries, which can hopefully be leveraged into $4.5 Trillion in lending to distressed businesses, states, and municipalities. These will take the form of loans with no interest for the first several months, but several conditions were placed on executive compensation, stock buybacks, and other actions. These loans and their interest must be repaid in full but are designed to keep hard hit industries healthy and functioning through the pandemic. Businesses controlled by President Trump, his family, or members of Congress would be ineligible.
Airline Industry Grants
This includes $25 Billion in direct grants to the passenger airlines and another $3 Billion grants to airline contractors providing ground staff, $4 Billion in grants to cargo haulers, and an additional $25 Billion in loans to pass for national security purposes. Taxpayers will be compensated for the grants either through warrants, equity, or other financial instruments to provide appropriate compensation.
Health Care and Health Care Workers
Perhaps one of the most important parts of the bill overall, this allocates $100 Billion to heal care institutions battling the crisis, and more money to other places such as FEMA’s Disaster Relief Fund, FEMA Grants, health agencies, and nursing homes to ensure that they have the proper support, equipment, and protection. There has also been a lot of news in the past several days about automakers starting to produce face shields, ventilators, and respirators, as well as clothing companies that are making masks.
Many of these measures help with household wealth and liquidity during this crisis. Some of the likely effects on the mortgage market include:
- Greater pull through as more people are able to stay employed thanks to the government assistance, such as the small business economic relief package and guaranteed subsidized loans to larger industries impacted by the pandemic.
- Less delinquencies, even though institutions have been encouraged to work with borrowers on short-term forbearance options. The extra cash on hand for distressed households is likely to decrease delinquencies.
- The Treasury will be working with the Federal Reserve to magnify the impact in stabilizing the economy, providing up to $4 Trillion in liquidity. One of the largest impacts it has had has been in buying unlimited quantities of agency mortgage backed securities to keep the market liquid as part of its Quantitative Easing effort.
Almost all of this is really good news for the mortgage market that requires a robust and healthy economy to function. The optimistic view is that the CARES Act is enough – it’s huge – to keep the economy from seizing up during the shutdown and that we are all able to return to work and normalcy soon. The pessimistic view is that the economy will be shut down for too long and that by the time we can re-open, there will be a global recession that plunges the U.S. further into a recession exacerbated by another housing crisis.
The truth may well be somewhere in the middle, and we may well continue to see the government act in an attempt to thwart the economic devastation of the pandemic. It may become much more challenging if global demand starts declining dramatically.
Sources & References
[1] GNMA, FNMA, or FHLMC loans
[2] Insurance, rent, utilities, mortgages are some examples