By Chris Bennett and Jeff Bode
There is much to celebrate regarding Ginnie Mae’s recent announcement that it will begin accepting eNotes (or digital collateral) from its approved issuers. Even though the program is initially being limited to a handful of applicants for a limited number of transactions, the move provides a vital source of eNote liquidity that, combined with eNote acceptance by Fannie Mae and Freddie Mac, finally tips the ROI scales in favor of eNote adoption.
Ginnie Mae has also long been a source of liquidity and diversification for lenders’ secondary execution strategy in the form of custom or specified (a.k.a. spec) pools. While on the surface Ginnie Mae’s digital collateral program would seem to have little to no impact on the creation of these spec pools – or lenders’ execution strategies in general – there are certain things lenders will need to bear in mind when issuing eNotes for Ginnie Mae securities.
For the uninitiated, spec pools are loans that have been grouped together based on common characteristics (FICO scores, product type, loan balance, etc.). Depending on demand, investors typically pay a premium (or pay up) for these pools because the grouping of similar loans helps investors more accurately predict future loan performance and mitigate risks, such as pre- payments, to extend the life of the pool.
For lenders already active in spec pools (or those that may be interested in the future), the presence of an eNote is not a meaningful basis for forming a spec pool, as this has no bearing on the expected performance of the pool. Furthermore, Ginnie Mae does not allow issuers to co-mingle eNotes and paper notes within the same security. The impetus for this decision lies in ensuring the long-term ability to transfer loan pools between servicers, given that not all servicers possess the ability to service eNotes. Thus, when forming spec pools, lenders will need to keep their eNotes and paper notes separate for the foreseeable future.
In addition to servicing considerations, lenders preparing to issue eNotes for Ginnie Mae loans also need to evaluate their document custodians’ readiness to store said eNotes. There is no denying that eNotes would eliminate many of the challenges lenders face in working with their document custodians. One need only take a look at the havoc wreaked by COVID-19 – delays due to staff working remotely, lost/misplaced documents, etc. – to see how the switch to a digital promissory note would vastly improve lenders’ operational relationships with their document custodians.
However, many document custodians are not currently equipped to handle eNotes, largely due to cost considerations. While the industry’s two largest investors – Fannie Mae and Freddie Mac – have accepted eNotes for several years, industry adoption has been slow-going at best for a variety of other reasons (warehouse capacity, regulatory requirements, etc.), making the economics of investing in the infrastructure to support eNotes for only a handful of lenders simply unfeasible.
That certainly changes with Ginnie Mae’s digital collateral program, and as the industry has largely overcome the outside factors impacting adoption, eNote issuance has increased. MERSCORP Holdings, Inc. recently reported a 1,300% increase in the number of companies kickstarting the transition to eNotes, as well as record growth in eNote registrations over the past nine months.
However, as Ginnie Mae made clear in its Digital Collateral Program Guide, Ginnie Mae’s previous approval of a document custodian does not automatically qualify that same entity to provide custodial services for eNotes as part of the digital collateral program. Instead, interested custodians will need to apply and receive approval to act as an eCustodian before accepting any Ginnie Mae loans or pools that contain eNotes.
Thus, Ginnie Mae issuers that make the switch to eNotes will need to ensure their current document custodian is an approved eCustodian or establish a new relationship with an approved eCustodian. These lenders should also bear in mind any adjustments it will need to make to comply with Ginnie Mae’s stringent document custodian audit requirements, which include annual on-site reviews and loan-level pool reviews.
In the event that an issuer works with more than one document custodian, the issuer must review at least one of its custodians each year and conduct an on-site review of all custodians within a three-year window. Furthermore, lenders may need to reassess their loan selection process to ensure statistically relevant samples are pulled from both eNote and paper note pools.
To be clear, the launch of Ginnie Mae’s digital collateral program is cause for celebration within the industry, as it represents a significant step forward on the path to total digital mortgage adoption. However, as with any change, lenders must be crystal clear on the impact of this change to their operations, as well as the limits of what is both possible and permissible.