Original posted on FT Alphaville by Tracy Alloway:
Just a datapoint for you, as the debate over the US Treasury’s Hamp programme rages on.
As a reminder, the Home Affordable Modification Plan aims to help keep people in their houses primarily by lowering interest rate payments. It’s not had a lot of success so far, so people are starting to look at possible ways to rejig the programme. One of those is principal forgiveness, instead of just forbearance, for underwater homeowners.
But there’s one big thing standing in the way of principal reduction; second lien mortgages, or second mortgages taken out on a property (like secured loans on mortgaged properties in the UK).
Normally second lien mortgages rank subordinate to the first mortgage (first lien). 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.
When mortgage modifications like Hamp come into play, that traditional priority order is reversed. The borrower is paying the Hamp-modified (i.e. lower) first lien amount, and the full second lien amount, so the second lien effectively becomes senior to the first.
When principal reduction comes into play, the problem becomes even starker. Current rules say that first lien mortgages can’t be written down before the second.
So second lien loans are a rather big-stumbling block in the Treasury’s mortgage programme. To make matters worse, as we’ve noted before, banks are some of the biggest holders of second mortgages.
That means they’re basically disincentivised to modify or write-down first mortgages, at the expense of second ones. Thus, Bank of America to our knowledge is the only bank to have signed up for the second lien portion of the Hamp (called 2MP) so far.
So, here’s that second lien datapoint courtesy of Laurie Goodman at Amherst Securities Group:
As Goodman puts it:
The overwhelming majority of these subordinate mortgages are on the balance sheets of depository institutions. Of the $1.053 trillion in 2nd mortgages, $767 billion are on the balance sheets of commercial banks, another $99 billion are on the balance sheets of savings institutions, and $97 billion rest within credit unions. The rest of the 2nd liens are either in securitizations ($32.5 billion) or on the books of finance companies ($69 billion). A disproportionate amount of these 2nds are the on the books of the 4 largest banks.
So the US Treasury faces an even more inordinate task.
If it wants Hamp to be a success it needs to figure out a way of overcoming the second lien problem. At the same time if it wants to start writing off second lien mortgages too, it needs to figure out a way to do so without hitting the capital positions of banks like Bank of America, Wells Fargo, Chase and Citi.
Nevertheless here’s one idea that’s being mooted, from Reuters:
The Mortgage Investors Coalition — which represents holders of some $100 billion in mortgage bonds — instead of demanding full write-downs on second liens are prepared to consider a principal reduction plan where losses are shared, said Micah Green, an attorney representing the group. This softened position on second liens could help break the impasse keeping big bank servicers from forgiving principal, he said.
Potentially softened then — but still a bit of a blow.