PH COVID-19 Client Alert Series: Impacts on the U.K. Residential Mortgage Loan Market and Related Financings
By Paul Severs & Ed Bellamy
Over the past weeks, the U.K. Government, the FCA, and U.K. Finance (as a representative body of the mortgage lending participants) have announced a number of guidelines to attempt to mitigate the unprecedented effects of COVID-19 on the U.K. residential housing market. Such guidelines present a number of immediate and far-reaching issues, not only to those persons affected by COVID-19, but also to residential mortgage loan originators, investors, and servicers.
Guidelines and Policies
The situation is moving quickly, but to date there have been a number of policy announcements and guidelines issued affecting the residential mortgage loan market, including the following:
On 17 March, the U.K. Government and U.K. Finance issued statements whereby customers were notified that mortgage lenders would support customers who are experiencing COVID-19 related financial issues including a payment holiday of up to three months.Such payment holidays will also be available to buy-to-let landlords where their tenants are experiencing COVID-19 related difficulties.
Such payment holidays are not automatic, but applied on a case-by-case basis to customers up to date with their mortgage payments and impacted by COVID-19.
The FCA subsequently issued guidance to regulated entities whereby it made clear that, considering FCA Principle 6 and MCOB 2.5A.1R, in terms of treating borrowers fairly, “where a customer is experiencing or reasonably expects to experience payment difficulties as a result of circumstances relating to coronavirus, and wishes to receive a payment holiday, a firm should grant a customer a payment holiday for 3 monthly payments, unless it can demonstrate it is reasonable and in the customer’s best interest to do otherwise.” Further that “A customer should have no liability to pay any charge or fee in connection with the grant of a payment holiday under this guidance.”
Where a payment holiday is granted, the scheduled mortgage payment is deferred for a period. The payment holiday should not impact a customer’s credit history and, therefore, the monthly payment changes to zero and such payment holiday will not be categorised as a failure to pay, as nothing is due and payable.
As part of the industry-wide measures, a moratorium on repossessions was announced from 19 March 2020.
The FCA has issued guidelines stating that regulated mortgage lenders and administrators should not commence or continue repossession proceedings against customers. Where a possession order has already been obtained, firms should refrain from enforcing it. Again, the FCA would consider breach of these guidelines as, excepting exceptional circumstances, a breach of FCA Principle 6 and MCOB 2.5A.1R.
Such approach was confirmed by the courts,and on and from 27 March 2020, the court service in England and Wales suspended all ongoing possession actions (either live cases or where applications have been made).
On 26 March 2020, the U.K. Governmenteffectively froze the U.K. residential property market. Only where exchanges have been made on unoccupied properties is it advised that completion can occur. It has been advised that all other aspects of the market, including completion on occupied properties, valuations, and viewings, should be paused.
To assist, U.K. Finance has indicated that mortgage lenders will give the option of up to three-month mortgage offer extension for home movers impacted by COVID-19.
The above policies and guidance (the “COVID-19 Policies”) present a number of issues to mortgage originators, investors, and administrators.
An immediate consequence of the COVID-19 Policies, in particular with respect to payment holidays and existing offers, is that mortgage administrators/servicers are having to rapidly redraw their existing policies or implement new policies.
Amongst the key points that mortgage administrator/servicers are setting out in their revised/new policies are the following:
customers who advise they may be affected by COVID-19, either directly or indirectly, and ask for a payment holiday will be offered one;
offering assessments to customers as to whether alternatives to payment holidays are more appropriate, but with a veto for the customer to choose a payment holiday;
prescribing that for a payment holiday the contractual monthly mortgage repayment will be deferred for a maximum period of three months without an administration fee being payable;
provision to the customer of the implications of a payment holiday to the customer. i.e., that the outstanding balance of the mortgage will increase given the accruing but unpaid interest, and, as part of the ongoing mortgage statements showing these deferred payments as separate identifiable amounts;
placing a moratorium on possessions; and
the considerations on what changes to customers’ circumstances at the loan application stage (both pre- and post-offer) arising from COVID-19 may impact the affordability of the mortgage loan applied for, e.g., customers working in industries particularly exposed to COVID-19 and the evidence required to show that customer income will be unaffected.
Warehouse Funding and Forward Flow Arrangements
In addition to the implementation of revised/new servicing policies, those mortgage originators relying on third-party funding arrangement with respect to their new loan originations will need to consider their existing and new funding lines. Such third-party funding is typically sourced through warehouse loan facilities (“Warehouse Financings”) secured on the pool of originated loan assets or forward flow arrangements (“Forward Flow Arrangements”) (i.e., arrangements by which involve the immediate purchase by funders of the economics of loans that are advanced by an originator in accordance with specified eligibility criteria).
An initial check that originators and servicers need to perform with respect to these transactions is whether the transaction documents require any funder consents with respect to the amendment, or implementation of, new servicing policies. Typically, one would expect that where such policies are to be amended/implemented due to government policy, then sufficient latitude has been drafted into the transaction document to allow for such amendments/implementation without consent, but care should be taken to the extent COVID-19 Policies are seen to be non-mandatory.
One of the most obvious and immediate consequence of the revised servicing policies as a result of the COVID-19 Policies on Warehouse Financing is the liquidity issues resulting from payment holidays. Depending on the liquidity support built into the structure of a Warehouse Financing, e.g. cash reserves and use of principal deficiency mechanisms, and the size of the reduction of income as a result of payment holidays granted, warehouse borrowers may struggle to meet the interest payable on the Warehouse Financing loan facilities.
A further consequence of the payment holidays is the treatment of the deferred payments. This is applicable to both Warehouse Financings and Forward Flow Arrangements. From the COVID-19 Policies, it is clear that these deferred amounts are designed not to be treated as arrears, as this would otherwise affect the borrower’s credit rating. However, the transaction documents may, notwithstanding this, treat these deferred amounts as “arrears” depending on how such term is defined. This will present issues for originators given that it is common in Warehouse Financings and Forward Flow Arrangements that mortgage loans with 90 days or more of arrears are treated as “defaulted” or “delinquent” loans. This may have a number of consequences including (i) breach of financial covenants through exceeding portfolio level criteria relating to the maximum permitted “defaulted” loans; (ii) triggering the originator’s repurchase obligations for “defaulted” loans; and (iii) causing stop funding/origination events again through exceeding portfolio level criteria relating to the maximum permitted “defaulted” loans.
The immediate response of originators to the above has, as one would expect, been to seek waivers, as necessary, under the relevant transaction documents. Given the fast pace and unprecedented nature of the effects of the COVID-19 related measures, it is likely originators will be initially seeking broad-brush general waivers to create immediately stability. Funders, if open to such general waivers, will obviously seek to limit such general waivers through appropriate limitations and carve-outs, e.g., a time limitation on such waiver and an acknowledgement that the waiver is simply a bridge to a more detailed rearrangement of the funding arrangement. Further, funders will, if such payment holidays are not to be treated as arrears, be keen to determine the economic implications the payment holidays are having on the portfolio they are funding and accordingly seek enhanced reporting, such as separate reporting on a more frequent basis as to COVID-19 payment holidays, as a quid pro quo of granting any waivers.
It would seem, at this point in time, that funders have been generally understanding as to the position of originators, but there have already been signs that certain funders are seeking to reduce or limit their exposure. A clear pinch point as a result of any such pulling of funding, beyond the larger issue of retaining access to long-term funds upon which to base future business plans, would be with respect to those post-offer loans that have yet to complete. An originator may find itself in an invidious position of being committed as a regulated entity to fund a loan to a borrower, but at the same time having had its access to funding stymied.
Of course, beyond the immediate effects of the COVID-19 policies, the general effect of COVID-19 on the economy may result in non-COVID-19 related defaults and arrears and a general shrinkage of the property market and reduced origination rates. The scale of this obviously remains to be seen.
In the context of the housing market, the policy of the government has rightly focused on the impact of COVID-19 on the ability of mortgage borrowers and tenants and to meet their mortgage and rental payments. The consequence of the COVID-19 Policies, including forbearance of payments, has consequential repercussions across the industry and particularly to the non-bank lending sector. The U.K. Government needs to introduce policies to protect these lenders from the adverse impact they may suffer as a consequence of implementing government policy designed to protect mortgage borrowers and residential tenants. This could be in the form of a statutory moratorium on any action by whole-sale funders against the non-bank lenders under their funding arrangement where the issues arise as a consequence of implementation of the COVID-19 Policies. The U.K. Government has already announced proposed changes to the U.K. insolvency framework, and whilst any such action here would not immediately fall within insolvency legislation, it should be part of the wider thinking as to the function of the market. Without such protection, this sector of the industry will suffer disproportionately and to the detriment of the customers, and it is clear from the above that immediate and continued dialogue between originators and funders is necessary to ensure that the networks of Warehouse Financings and Forward Flow Arrangements that are used to fund certain segments of the residential mortgage lending market are not irretrievably damaged from any short-term effects of the COVID-19 Policies and COVID-19 related issues.
Residential mortgage backed securitisations (“RMBS”), often utilised by originators as an exit to Warehouse Financings, will largely have the same issues as those noted above, including short-term liquidity issues and issues if payment holidays are treated as arrears. However, due to their structure, they present different problems and equally mitigants.
Typically, the debt in an RMBS transaction is more widely held than with respect to Warehouse Financings or Forward Flow Arrangements. This, combined with the more cumbersome noteholder voting process compared to the more flexible arrangements in a Warehouse Financing and Forward Flow Arrangements, means that any amendments to shore up an RMBS structure from the effects of the COVID-19 Policies on the servicing of the securitised asset pool is much more difficult. However, with this in mind, RMBS transactions are typically structured to withstand short- to medium-term liquidity issues including deeper cash reserves and, often, the availability of liquidity facilities. Therefore, depending on the precise structure of the RMBS transaction, it may prove sufficiently robust enough to withstand any short- to medium-term liquidity effects of the COVID-19 Policies. Given that the deferred amounts will remain outstanding, there will be no initial losses crystallised, and therefore, payment on the notes may become a timing point depending on the long-term economic health of the portfolio once the COVID-19 Policies are no longer in effect. Ultimately, given this, RMBS transactions may be an attractive mechanism through which to obtain funding.
Investors in RMBS transactions, like the funders in Warehouse Financing, will likely want transparency as to the effect of any servicing decisions to implement the COVID-19 Policies. However, unless such reporting is required for regulatory reasons or provided on a voluntary basis, the rigidity of the transaction documents will mean such reporting may not be forthcoming outside of any quid pro quo in relation to a noteholder amendment.
A further issue that may arise with respect to RMBS transactions is that they are typically rated. Whilst the COVID-19 Policies themselves may not initially have any effect on the ratings, depending on the scale of the payment holidays and the length of time the COVID-19 Policies are in place, COVID-19 related effects may have a number of consequences. For example, any general economic downturn may cause counterparties, e.g. swap providers, to the RMBS transaction to be downgraded. Additionally, given the fast-moving nature of the effects of the COVID-19 pandemic, any new issuances of RMBS securities may have significant execution risk given that rating agencies are continuing to stress test on a daily basis, and this may cause preliminary indicative ratings to be withdrawn at short notice prior to closing, which, in turn, may cause transactions to fail if investors pull out.