Thursday, April 2, 2009

Homeowner-Aid Plan Caught in Second-Loan Spat

From the Wall Street Journal by RUTH SIMON and MICHAEL M. PHILLIPS:

The Obama administration's $75 billion effort to help troubled homeowners avoid foreclosure has hit a stumbling block: a fight over how to aid borrowers who have more than one home loan.

The Treasury Department, scrambling to address the problem, is trying to persuade lenders to forgive or greatly reduce so-called second liens. But that effort has sparked a fight between investors who own securities backed by first mortgages and banks that hold second mortgages over how losses should be shared.

A failure to resolve the impasse could blunt the impact of President Barack Obama's housing plan, which is designed to tackle one source of the financial crisis -- the spiral of foreclosures and falling home prices. About half of seriously delinquent borrowers have a second mortgage debt, according to Credit Suisse.

Administration officials had hoped to announce a plan this week with the support of bankers, homeowner advocates and investors, who include pension funds, insurance companies and hedge funds. Instead, they find themselves shuttling proposals between warring parties.

"If everybody wants to play chicken and hold out, it's not going to serve anybody," said Janneke Ratcliffe, a housing expert at the University of North Carolina at Chapel Hill.

The administration unveiled its foreclosure-prevention plan early last month. One part of the plan is designed to help as many as four million homeowners by encouraging lenders and their agents to rewrite mortgage terms to make them more affordable.

The administration left vague, however, a plan to pay loan-servicing companies to help extinguish second liens, such as home-equity lines of credit and down-payment loans. Government officials said at the time such an effort would reduce the borrower's indebtedness and make it more likely that the homeowner would stay current on the modified mortgage.

The Treasury is "actively working" on the second-lien issue and will announce "something within the next few weeks," said department spokesman Andrew Williams.

One proposal would require lenders to cap monthly payments on second loans at a set percentage of the borrower's gross income. The lender would be expected to "eat the vast majority" of the cost, with the government subsidizing a small portion, according to an administration official. Treasury still hasn't settled on the level of the cap or the size of the government contribution.

Delinquencies on home-equity loans climbed to a record 3.03% in the fourth quarter from 2.39% a year earlier, the American Bankers Association said Thursday. Delinquencies on home-equity lines of credit climbed to a record 1.46% from 0.96%.

One problem is that first and second mortgages are often owned by different parties and may be handled by different mortgage servicers, the companies that collect checks from the borrowers. Lenders who provide home-equity loans and other second liens are normally expected to take a loss before the holder of the first mortgage does so.

"If you sign up for the first loss, you should take the first loss," said Jeffrey Gundlach, chief investment officer of TCW Group Inc., which manages roughly $52 billion in residential mortgage-backed securities.

Mortgage investors, who typically own first mortgages, say they are willing to take some losses in an effort to resolve the housing crisis. But they add that rewriting their contracts without touching the second liens violates their rights. They also complain that banks -- which as loan servicers have great influence in the Obama plan -- have a conflict of interest that may lead them to modify first mortgages and do nothing about second liens.

The implication is that angry investors might gum up the works with lawsuits and refuse to help the administration resolve first mortgages if they feel badly treated on second liens.

Banks and other financial institutions own as much as 90% of the $1.08 trillion in home-equity loans and lines of credit in the marketplace, according to SMR Research Corp., a market-research firm in Hackettstown, N.J. Bank of America Corp., Wells Fargo & Co., J.P. Morgan Chase & Co. and Citigroup Inc. have the largest home-equity portfolios, SMR said.

Banks say they are willing to write down the value of troubled home-equity loans, but they want to limit their losses.

"We are going to have to take a haircut on the second" lien, said one bank executive. "But we don't think we should get wiped out."

Write-downs of second mortgages are likely to mean higher losses for banks, which typically don't mark down the value of these loans until they are 180 days past due, said Fred Cannon, an analyst with Keefe, Bruyette & Woods.

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