Litton Warns of Potential Pitfalls in Mortgage Recovery

Larry Litton, CEO of nonprime servicing specialist Litton Loan Services, knows a thing or two about "scratch and dent" loans.

Mr. Litton has been a strong advocate of loan modifications and forbearance to keep as many borrowers in their homes as possible in these troubled times, but he is also realistic enough not to put too rosy an outlook on the prospects for a quick recovery in the mortgage sector.

In fact, Mr. Litton said that even as loan defaults skyrocket in the nonprime sector, servicers face some continued threats down the road that could complicate efforts to modify loans.

Speaking at SourceMedia's Mortgage Outlook 2008 Conference here, Mr. Litton said advances that servicers make to cover insurance and tax payments on behalf of their customers could threaten to push more borrowers into default. Many scratch-and-dent loans do not have escrow accounts to cover insurance payments.

He notes that Litton, which makes some $1 billion of advances a month, has seen a growing number of borrowers who are current on their home loans neglect to make property tax and homeowners insurance bills.

If the borrower can't make insurance and tax payments on their current loan, how are they going to make these obligations on a modification? Mr. Litton asked. Requiring borrowers to repay delinquent tax and insurance bills right away could "explode" the loan and create a bigger problem, he said.

In addition, the growing volume of advances on defaulted and current loans is a burden for servicers.

"Servicing advances are a much more difficult asset to finance in today's environment," he said.

Servicers face a quandary in seeking repayment of insurance and tax bills from these consumers. Get too aggressive and loans may go into default. But they can't let back tax and insurance liabilities pile up either.

"I think servicers are going to have to be very balanced about this," Mr. Litton said.

In today's difficult market, servicing costs are rising dramatically, Mr. Litton said, acknowledging that servicing costs are up 35% year-over-year in his company's portfolio, which has significantly increased its loss mitigation staff. That makes the business tough, but it can still be profitable, he said. Another loan modification challenge is dealing with loans where there is a second mortgage held by a different party than the one who holds the first mortgage. To modify that "bifurcated" home loan debt into a single mortgage will require cooperation and negotiations between the first- and second-lien holders, he noted.

"We created a nightmare scenario, No. 1 by doing the product, and No. 2, by letting them be split off," Mr. Litton said. Despite these challenges, participants at the conference believe there will be a growing market for scratch-and-dent loans. Servicing capacity issues and risk tolerance may force banks to sell, and already hedge funds have been aggregating capital to look for deals in the nonprime mortgage arena. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com/ http://www.sourcemedia.com/

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