Experts Say Modification Volume Is Likely to Rise
New York-Despite widespread public support and political pressure for lenders to streamline the process of modifying loans for troubled homeowners, a bevy of challenges has slowed the process of offering widespread, systematic relief.
Moreover, modified loans themselves are showing a high propensity for "redefault."
But some industry sources say pressure is mounting to take down those roadblocks. And despite historically low interest rates, many troubled borrowers have few refinancing options.
Over the next 15 months, Fitch Ratings predicts that 15% of loans backing residential mortgage-backed securities issued between 2005 and 2007 will be modified, up from virtually none today. Fitch's estimate is based on the degree to which banks are already modifying loans that they hold in portfolio, as opposed to those sold to investors via securitization.
The nation's 14 largest banks and thrifts have already modified 187,000 mortgages through the first half of 2008, according to Fitch.
That will bring about pressure for investors to make amendments or exceptions to pooling and servicing agreements that currently limit a servicer's ability to modify large numbers of securitized loans.
"There will be increases in securitized loan modifications if only to ensure that borrowers in a securitized pool are being treated equally to borrowers whose mortgages are held by a bank, as well as to fulfill the servicer's duties to maximize returns to the trust," said Huxley Somerville, group managing director for U.S. RMBS, in a news release.
He added that Fitch intends to confirm the current ratings on RMBS when deal documents are revised to give mortgage servicers broader abilities to make loan modifications.
In most cases, the original PSA documents are either silent on modifications or they limit the number or type of modifications allowed, Fitch said.
Jeff Taylor, co-founder of risk analytics provider Digital Risk, told MSN that the volume of modifications and efforts to streamline the process will have to increase in 2009, fueled in part by the estimated $1 trillion of option-ARM and alt-A loan products scheduled to adjust to fully indexed payments.
"Obviously, if someone has negative equity on their house, refinancing is not an option. So obviously we are going to see a lot of modifications," Mr. Taylor said.
"We have got a vintage of 2005 to 2007 borrowers who put no money down on the house and really don't have any skin in the game."
The trick to making mods work, however, is focusing on a borrower's total debt situation, not just their mortgage-to-income ratio. Otherwise, redefault rates will remain high and servicers will have borrowers coming back to the table again, looking for more relief, he predicts.
But not everyone is enthusiastic about the prospects for loan modifications to succeed.
Some executives, including Jon Daurio, CEO of Kondaur Capital, Santa Ana, Calif., are skeptical about the prospects for mass loan modifications. Kondaur is a buyer and servicer of scratch-and-dent loans.
Mr. Daurio is more pessimistic than some about the prospects for a housing market recovery.
He predicts that nationally, home prices will fall another 20% to 30% under pressure from rising unemployment and a weakening economy. He still believes the country faces two to three more years of falling home values.
Already, he noted that in addition to high redefault rates on modified loans, many borrowers are defaulting on products such as pay-option loans before they even adjust to become fully amortizing. He says actually modifying existing loans only makes sense for a "marginal number of borrowers," not the large volume who obtained problematic loans for homes they couldn't really afford. In most of those cases, it would be difficult to modify the loan so the borrower can afford to make payments in a way that that will exceed the net present value of the recovery from foreclosure, he said.
"The fallacy of the effort to keep people in their homes is the assumption that people are in homes they should be in," Mr. Daurio said. "I believe that by far, the vast majority of the horror stories you have been hearing involve people who are in homes that they never should have gotten in first place with loans they never should have gotten."
Consumer groups will also be stepping up pressure on lenders to expand relief efforts aimed at troubled homeowners. The Center for Responsible Lending has called on both President Bush and the incoming Obama administration to implement "new, systematic programs that will provide relief so as many families as possible can stay in their homes." The CRL has called on the Treasury Department to promote the FDIC's proposal for the government to guarantee modified home loans as a way to induce servicers and investors to embrace widespread loan modification efforts.
Mike Brauneis, associate director, regulatory risk consulting at Protiviti, said servicers are starting to benefit from an increasing body of guidance on loan modifications from the FDIC and large lenders that have announced streamlined programs.
"Clearly, this is a relatively new area or an immature area where lenders do face common challenges," he said.
The challenge now, he says, is to accumulate data about the performance of loan mods to better understand what works and how to reduce default recidivism. Protivitis early data show, not surprisingly, that borrowers who receive a larger benefit, especially if it includes principal reduction, are more likely to repay the modified loans than those who receive forbearance or a more modest reduction in payment.
So far though, he said, servicers are reluctant to grant principal reduction on loans and take a permanent loss, knowing that homeowners may eventually benefit from a housing recovery. That may change, however, if the federal government pursues a proposal to buy second liens on the loans, essentially taking the principal reduction off the hands of lenders and investors, he said.
Servicers may face resistance from some borrowers and their attorneys in pursuing mass loan mods.
According to Outreach Housing, a Fort Lauderdale, Fla.-based nonprofit, many lenders are requiring borrowers to sign agreements that release the lender from potential liability stemming from Real Estate Settlement Procedures Act or Truth in Lending Act violations at the time of loan origination.
Outreach Housing, which claims to have helped 8,500 homeowners preserve their equity interests and credit since January of this year, urges consumers to be wary of waiving their rights against lenders for past violations.