End of Forbearance Programs Puts Unprepared Banks at Risk

Any action taken in the interest of a customer in a single, perhaps pivotal, moment in time has the potential to get flipped on its head and cause difficulty down the road. 

Right now, 1.8 million Americans stand to lose a pandemic safety net that acted as a financial security blanket shortly after the public health crisis’ swift arrival. After the pandemic delivered an immediate and devastating blow to the economy last year, substantial volumes of consumers lost jobs – or found they were working fewer hours if they still had a job – and the limited financial resources they had went to basic survival, including putting food on the table and caring for their families as schools shut down.

As the federal government winds down forbearance programs that paused mortgage payments and foreclosures, banks and many consumers now need to negotiate those borrowers’ optimal exits from the program. After being extended twice over the past 18 months, acceptance into those forbearance programs ends September, but many homeowners will remain in forbearance for another year. Qualifying for this significant hardship relief initially required nothing more than asking for it, as legislators enacted streamlined action to meet a rocketing demand.

Although the mandate under the Coronavirus Aid, Relief and Economic Security (CARES) Act only applied to federally backed mortgages (even if borrowers weren’t already delinquent), the banking industry witnessed many lenders offering similar terms across their entire portfolio. Certainly, banks recognized that payment struggles wouldn’t be limited only to federal borrowers. Offering terms of this federal forbearance program to all mortgage holders was a tactic to proactively keep out of the fair lending and Unfair, Deceptive and Abusive Acts or Practices (UDAAP) regulatory crosshairs.

As the economy coughed and sputtered and tried to rebound, the government paused payments time after time in the interest of consumers. At the height of the program, 6.9 million borrowers were in forbearance. Of those still in forbearance, a fifth will not be eligible for any extensions past September.

With no hopes of additional extensions of federal forbearance, these consumers will be forced to start paying on their mortgage again as their forbearance window comes to a close. Banks need to be ready to meet those borrowers in this moment, leveraging their traditional hardship programs and ensuring fair treatment, because the public and regulators will be keeping track.

Preparing to Avoid Operational and Reputational Risk

Mortgages will exit forbearance in waves, because consumers entered forbearance at different stages and the 18-month safety net starts individually. Of the nearly 2 million mortgagees mentioned earlier, with a reminder that those are only those documented under federally backed programs, estimates indicate about half will exit forbearance by the end of 2021, with the remainder leaving through next year.

During 2020, 13% of all homeowners were in forbearance for at least one month, although, again, that number is likely higher, as many banks extended those safety nets across their full mortgage profile. As of March 31, 2021, only 35% of the homeowners who opted for the program were still in forbearance.

Bear in mind, for many individuals and families, a mortgage is the most sophisticated financial investment they will ever make. It represents their financial identity, and some borrowers might feel they’re moving by touch through a dark process that can be overwhelming to them. Customers in hardship already are struggling, and regulators will be watching to make sure banks don’t make the situation any more difficult for them. The Consumer Financial Protection Bureau (CFPB) already is aggressively working to put information in borrowers’ hands, suggesting that they should seek expert advice to reach the best resolution for their situation.

But guess what? It’s just as difficult for the banks. As customers exit forbearance, some will land on their feet. With no option to extend any more, others will face foreclosures, restructured loan packages and even personal bankruptcies. While regulators will be monitoring to ensure they do what’s right for customers, banks also have an obligation to stockholders to minimize losses from mortgages that end up in foreclosure, where the institutions stand to make only pennies on the dollar.

Time for Reckoning Has Arrived

In June 2021, the CFPB threw down the gauntlet and ended the forbearance program. And after months and months of putting out signals and guidance around how lenders should handle the transition, the CFPB finally dictated rules for implementing an orderly process.

Financial institutions need to give consumers enough time to really figure out what the best financial option is for them. Remember, the toolbox is empty: There is no additional forbearance product to offer after consumers hit the 18-month mark. Banks can work with customers to lower their interest rate or extend the length of the loan – small adjustments that translate into revamped financial obligations that consumers could manage as they regain their footing in today’s economy.

Some borrowers will decide that there’s no viable option except to sell their house, perhaps while also declaring personal bankruptcy – both of which generate their own additional operational complexities and multiple risks for banks. And banks don’t know which borrowers will make the difficult decision to walk away from their homes – unable or unwilling to negotiate an exit plan to start repaying – and push banks to foreclose.

In any case, banks haven’t been in this situation in several years, meaning their muscle memory for these experiences and processes might be weak. And that’s where the greatest risk comes from, as banks revert to their standard hardship and exit protocols.

As they brace for consumers exiting forbearance, here’s what banks must be ready to do:

1. Communicate clearly and consistently with consumers.
   Months ahead of this forbearance ending, the CFPB saw warning signs that banks might not be ready to meet consumers where they are when they reach the end of their lifeline. More than one out of every 10 complaints received by the CFPB tied directly to forbearance in the past year, with borrowers saying banks didn’t clearly communicate relief options and how forborne payments would be handled.
   
   
2. Train your agents to act with empathy and follow proven practices.
   Due to its own complaint volumes and what callers reported as issues, the CFPB will be watching for how agents interact with customers as they exit forbearance. Banks also need to look at expected customer volumes and potentially scale up to have enough employees available to deliver the required service levels.
   
   Whether you’re bringing in new staff or reassigning existing employees, you’ll need to ensure these agents are trained to offer comprehensive options to callers and not shortchange any steps, which is a sure way to raise regulatory red flags. (Re-read the point above if you don’t believe us.)
   
   
3. Treat every customer as an individual.
   By the very nature of a loss mitigation process, each customer has a unique situation. There is no one-size-fits-all solution to apply across the board and not have the regulators crying foul. Your agents – whether in house or outsourced – must present all of the options available and work with their customers to determine what’s best for them. What works for one borrower might not be right for another, and that’s where you can run into fair lending issues.
   
   
4. Analyze what you’re doing.
   Not surprisingly, customers in forbearance will bring some of the worst credit histories to these discussions, creating challenges for how banks navigate around fair lending practices. Again, banks need to turn to data analytics to identify any trends that might signal disadvantaged consumers are receiving unfair treatment.
   
   Consider that 65% of those still in forbearance weren’t making any payments as of March 2020, according to that Federal Reserve report. And CFPB reporting indicates that Black and Hispanic borrowers were twice as likely to be behind in housing payments as of December 2020. The confluence of those factors creates greater urgency around ensuring that banks monitor their actions and decisions to avoid running afoul of fair lending laws.
   
   
5. Learn from past mistakes.
   The root of the Great Recession was the collapse of the housing market and a major criticism that banks lent money to people who never should have qualified. As a result, the industry got beaten up for the volumes of borrowers who ended up in very messy foreclosures.
   
   If banks don’t look back at what happened then, the industry could stand on the brink of history repeating itself. Only a decade ago, Bank of America agreed to pay $335 million to resolve allegations that its Countrywide unit engaged in widespread discrimination against Black and Hispanic borrowers, contributing to the “foreclosure crisis” in 2008-10.
   
   Current market projections suggest a 3.8% overall delinquency rate across all mortgages, nearly triple the pre-pandemic rate. In this new pandemic era, banks need to build the right processes with the right controls to ensure they’re complying with regulatory and internal policies.

Conduct a Readiness Review Now

The most important thing banks should do right now is conduct a Readiness Review. The three key stages are fully understanding the profile of customers who will be exiting forbearance, validating that operational processes and procedures comply with internal and regulatory policies, and assessing all communications for clarity and consistency. 

Spinnaker’s Risk Management and Regulatory Compliance and Data and Analytics teams can assist you in asking the right questions or completing a comprehensive review, leading to recommendations that will ensure you enter this stage with lower strategic, reputational and operational risk – and that you’re doing right by consumers and in the eyes of your oversight agencies. Trust us: Regulators are poised to jump in at the first sign of trouble. You don’t want to be the bank that gets their attention.

Laurent Robert, a Consultant in Spinnaker's Risk Management and Regulatory Compliance practice, contributed to this blog.