Friday, January 8, 2010

A second (lien) helping of Hamp

Original posted on FT Alphaville by Tracy Alloway:

So the second lien portion of the US Treasury’s mortgage modification scheme is reportedly “on hold.”

This shouldn’t be a major surprise since the programme, called 2MP, an add-on to the Home Affordable Mortgage Modifaction Plan (Hamp), appears to have never actually got off the ground in the first place.

Indeed, Amherst MBS specialist Laurie Goodman noted in her December congressional testimony on the Hamp, that:

Second liens have thus far, under Hamp, been treated with kid gloves. While the first lien modification program is fully operational, to the best of my knowledge the second lien program has not yet been implemented.

Mortgage minutiae rarely make for interesting reading but bear with us here because the second lien issue is quite interesting, and has potential ramifications for US banks like JP Morgan and Bank of America Merrill Lynch.

Normally second lien mortgages (which are simply second mortgages taken out on a property) rank subordinate to the first loan. In principle, that means if the property is sold or the borrower defaults, the first lien lender is first in line to get the resulting money, followed by the second lien lender.

But it seems an interesting thing happens when mortgage modifications come into play.

Because the borrower is paying the Hamp-modified first lien amount, and the full second lien amount, the second lien effectively becomes senior to the first. In fact, second lien lenders might even be thought of as benefiting from the first lien mortgage since they have a better chance of getting more of their money back from the borrower.

Weird?

Yes. But it gets weirder.

Here’s Linda Lowell, of Housing Wire, to explain:

[The second lien] obstacle is not reduced by the fact that the four largest servicers (BofA, Wells Fargo, Chase and Citi) are also the largest holders of second lien residential loans. According to data compiled by Goodman last March, they own $94 billion closed-end seconds, $397 billion home equity lines of credit, and about $653 billion in first lien loans. (The report wasn’t cited in [Goodman's] testimony, but I relied on it in my November 2009 Housingwire Magazine article, “Modify Me: A Review of Loan Modification Efforts.”)

At first glance, these concentrations seem to raise the odds that the first lien servicer is owned by the bank that holds the second lien. However, in March Goodman calculated that, even if every first lien was accompanied by a 25% second lien, only about $163 billion of the top servicing banks’ second liens would be accounted for.

In other words, it should come as little surprise that mortgage servicers (banks) which also hold second lien loans are not jumping wholeheartedly into the 2MP programme.

Ironically, if the US Treasury, decides to replace the aborted-second lien portion of the Hamp with something else — principal forgiveness perhaps — you can probably expect those second liens to be extinguished entirely.

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