A Bloomberg story gives the not-heartening news that the government-prodded mortgage modifications are producing higher failure rates as the economy decays:
Mortgages modified in the third quarter failed at a faster pace than those revised in the first, and the delinquency rate on the least risky loans doubled, signs of deteriorating credit quality, U.S. regulators said.
Loans modified in the first quarter to help borrowers keep their homes fell delinquent 41 percent of the time after eight months, and second-quarter loans had a 46 percent default rate, the Office of the Comptroller of the Currency and Office of Thrift Supervision said in a report today. Third-quarter trends “are worsening,” the agencies said.
“For the year and this quarter, we saw the same trend that we saw last time: quite high re-default rates, no matter how we measured them,” John Dugan, the U.S. Comptroller of the Currency, said in a conference call with reporters.
Lenders including Citigroup Inc. and loan-servicing companies are adjusting mortgages by lowering interest rates or crafting longer-term payment plans. The Obama administration is acting to help as many as 9 million struggling homeowners by using taxpayer funds to pay lenders such as bond investors, mortgage servicers for reworking the mortgages.
Dugan said higher re-default rates are likely related to stressful economic conditions and new loan plans are not producing significant reductions to make mortgages sustainable.
It's important to notice what kinds of mods were offered: interest rate reductions and lengthening maturities. These are not very deep mods, in other words.
Mods that offer principal reduction have higher success rates. And Wilbur Ross, a well known investor in distressed companies, is not exactly the charitable sort. As reported in HousingWire:
[Wilbur] Ross has plenty of skin in the mortgage servicing game, as he owns Irving, Tex.-based American Home Mortgage Servicing, Inc., which recently became the nation’s largest third-party servicer with the acquisition of a large portfolio from Citigroup Inc....
Last week, Ross told HousingWire in an interview that he thinks the best way to motivate lenders, servicers, and homeowners work together on modifications requires far more than what’s been proposed so far. In particular, he believes that what’s needed is aggressive principal modifications for borrowers most in need. He has said that his American Home servicing shop has seen six-month recidivism rates below 20 percent — compared to the 50 or 60 percent standard in the industry — because the servicer has been aggressively looking to cut principal balances.
“The price of housing needs to be cleaned out. The Obama administration could right-size every underwater home and reduce principal to fit the current market value of the home. If they are going to deal with it they have to deal with it in a severe way,” Ross told HousingWire. “They also really need to consider all borrowers who are underwater, and not just the ones that have gone into default.”
The Homeowner Affordability and Stability Plan does some of that, but doesn’t go far enough, Ross suggested. “The have to reduce the principal amount of loan, not just nonperforming loans, but also performing ones,” he told CNBC. “Why should a guy who’s not paying benefit, while some poor citizen who’s struggling to make the payments gets stuck with the mortgage?”
His own plan looks something like this:1. The lender takes a write-down in principal, and the servicer takes a similar hit on any servicing strip on the newly-reduced UPB.
2. After principal reduction, the government guarantees half of the remaining principal the lender now holds.
3. This guarantee of half the principal can now be sold into the securitization market, which will give the lender an income stream on the home again and offset some of the losses the owner of the loan has to take when they write down the principal.
4. When the house is sold, if the value of the home has gone up at the point of sale, the homeowner and the lender share in the profits earned on the gain.
Ross isn’t the first to suggest an home equity sharing plan, and there are clearly strong complexities in how any such plan would be put together, particularly as it relates to second lien holders and/or investors in junior bond classes. But the fact that a large investor with such a strong hand in the servicing business is suggesting it’s possible at all to accomplish is something that perhaps bears more attention than the idea has been getting as of late.
We've been arguing for some time that with housing in many market trading at well below peak levels, the bank can offer a principal reduction and still come out ahead. In normal times, the cost of foreclosure means recovery rates of 70% at best. So assuming 50-60% (and that is probably still high), the bank can reduce principal 25% and still come out ahead.
It isn't simply that a principal reduction lowers monthly payments more (but let us not kid ourselves, that's a biggie) but it also changes the owner's perspective. Why should he struggle to make payments on a house that is unlikely to be worth more than the mortgage? Odds are that he is still looking at a foreclosure or short sale as his endgame. That also means he has zero reason to make repairs or routine investments. Conversely, if the mortgage is written down to something much closer to the current value of the house, he has much greater reason to persevere.
Why isn't that happening? Ah, those pesky securitizations. Although investors litigating to block mods is the oft-given reason for not taking this course of action (a presumed to be high number of securitizations either bar or restrict mods), my impression is servicers simply have not wanted to fight this fight (they have clearly defined compensation in the case of foreclosure versus no rewards for mods, save the fees under new government programs). Paying legal fees to fight investors is an even more dubious business proposition (it's a near certainty they can't charge those expenses to the securitization trust, and it would thus come out of their bottom line).
That is a long winded way of saying I doubt that there has been much study by legal talent as to how to overcome mod restrictions in servicing agreements. Given the high level of fraud (in a small sample, Fitch found evidence of fraud in every loan file it examined), there might be ways to persuade investors they have more to lose than gain by pursuing this line of legal action.