Wednesday, February 18, 2009

Homeowner Aid Seen as Risky to Banks

By Dan Fitzpatrick and David Enrich (Wall Street Journal):

The rollout of the Obama administration's efforts to help U.S. homeowners set off a new round of hand-wringing about the battered banking sector.

Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. issued statements praising the plan, but banking analysts said the housing initiatives are likely to result in banks suffering a fresh round of painful write-downs, which will further depress their earnings this year.

"It accelerates some of the losses, at the very least," said Tanya Azarchs, a banking analyst with Standard & Poor's Ratings Services. She said the ultimate magnitude of those losses will remain murky until the government hammers out the final details of the plan.

The biggest negative impact of Obama's plan may be on mortgage-backed securities, said Gerard Cassidy, an analyst with RBC Capital Markets. He said tens of billions of dollars of outstanding securities could face downgrades, which could set off a chain reaction of write-downs at the banks holding these securities, due to the likelihood that the underlying loans will be modified and end up being worth less.

This could have a chilling effect on restarting the securitization markets, which largely have been at a standstill since last year, Mr. Cassidy argued. "It makes investors demand higher returns to take into account" the possibility of mortgages being modified and the government's willingness to allow contracts to be changed, Mr. Cassidy said. "That to me is the real risk."

President Obama is betting that any additional losses for U.S. banks will be a small price to pay for eventually reducing the number of foreclosures and stabilizing housing markets. If that happens, "it just may be that it will serve to limit the losses for banks in the long run," Ms. Azarchs said, noting that foreclosures tend to be more expensive for banks than losses from modifying loans.

Paul Miller of Friedman, Billings, Ramsey Group Inc. agreed, saying the Obama plan could slow down bank losses by forestalling foreclosure actions.

Ms. Azarchs cautioned that the odds of success are unclear. "There are a lot of moving parts to it in terms of the impact it's going to have," she said, noting that some rescued borrowers may end up defaulting on their modified mortgages.

In addition, some borrowers with underwater mortgages–meaning their homes are worth less than the amount the borrowers owe on their mortgages–may try to participate in the program even if they aren't in danger of defaulting. In such cases, banks would rack up losses without reducing the odds of a costly foreclosure.

"The key" to minimizing bank losses, said Wells Fargo Home Mortgage co-president Mike Heid, is to give consumers loan modification options as opposed to a straight ticket to bankruptcy court.

Such an approach "ultimately saves credit losses over time."

Wells does not favor bankruptcy cram down legislation, but if it occurs, he said, it's important it remains a "last resort."

Bank of America Corp.'s top mortgage executive, Barbara Desoer, agreed that bankruptcy should be used only as a final option and said the company has not expressed support for the cram down legislation. Bank of America is already reducing principal amounts for borrowers, but only on adjustable-rate mortgages it assumed with the July 2008 acquisition of Countrywide Financial Corp. A spokeswoman added that "directionally," the Obama initiative "appears to be consistent with the approaches we have been taking with our borrowers. After final guidelines are released, we will make adjustments to our modifications as needed."

Ms. Desoer was complimentary of certain components, noting that interest rate reductions will make payments affordable for most borrowers and arguing that any acceleration of a housing recovery is a "net positive for Bank of America."

But it's important, she said, that loans are treated according to their "net present value," which protects the interests of investors. Leaving that out "could potentially have a negative impact on the system."

President Obama's plan could be painful even for banks that didn't participate in the mortgage-lending frenzy.

Many banks, including legions of mid-sized and community lenders, are sitting on large piles of securities comprised of mortgage loans that are guaranteed by government-sponsored entities such as Fannie Mae and Freddie Mac. Now the prospect of widespread loan modifications has left some banks worried that their investments could lose value as loans' interest rates are chopped and their lifetimes are extended – both of which are aspects of the Obama administration plan.

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