Is FHFA's Principal Reduction Plan 'Too Small and Too Late'?

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WASHINGTON — Federal Housing Finance Agency Director Mel Watt knew the criticism his agency would receive when it rolled out its plan Thursday to give principal reductions to help 33,000 underwater borrowers that are seriously delinquent on their mortgages.

He acknowledged that some may see the plan as "too small and too late." Indeed, many agreed with that critical assessment, arguing it would help few people while opening the door for future principal reductions.

"You kind of wonder why at this point," said Ron Haynie, an executive vice president at the Independent Community Bankers of America. "It is another diversion of revenue" from the government-sponsored enterprises. "It puts them one step closer to the draw. There is certainly a good social purpose in trying to help struggling homeowners. I understand that. But it is the safety and soundness part that concerns us."

Carrie Hunt, the general counsel of the National Association of Federal Credit Unions, agreed.

"It is extremely difficult to envision a scenario where principal reduction will do anything to strengthen the housing market," she said. "NAFCU strongly supports protecting consumers, but again, we believe that principal reduction sets a dangerous precedent."

But consumer groups and Watt himself vigorously disagreed, arguing that FHFA had made a critical first move, one that could pave the way for future actions.

"For 33,000 homeowners, it is vitally important step," said John Taylor, president and chief executive of the National Community Reinvestment Coalition. "But for rest of the 700,000 mortgages controlled by Fannie and Freddie that are underwater or delinquent, it's the tip of the iceberg."

Taylor is hoping that the experiment will produce a positive return and show taxpayers can be protected. "We have to show that this works. They are taking the worst of the worst because you have to be both underwater and delinquent by 90 days," he said.

FHFA issued guidance to Fannie and Freddie servicers Thursday that spells out the parameters of the principal-reduction program that might help an estimated 33,000 seriously delinquent borrowers. To be eligible for relief, the borrowers must have been 90 days or more delinquent as of March 1, 2016, and have mark-to-market, loan-to-value ratios that exceed 115%.

Borrowers who become seriously delinquent after March 1 are not eligible for principal relief. The maximum amount of principal forgiveness is 30% of the unpaid principal balance. If homeowners are more underwater than 30% they may not get down to a 115% loan-to-value level, an FHFA official said.

Robert Davis, an executive vice president at the American Bankers Association, said the FHFA had devised a principal reduction program that struck the right balance between benefiting borrowers and protecting taxpayers.

"It is a good analytic effort to limit this to transactions that might have an economic gain for the enterprises," he said.
But he is concerned that the agency has placed a significant burden servicers when it comes to identifying eligible borrowers.

Borrowers who meet the new principal reduction modification program's eligibility requirements will receive a solicitation letter from their servicer no later than Oct. 15 that spells out the terms for the modification.

"The national housing market has significantly improved in recent years, but there are still areas of the country where home values have not recovered and negative equity remains a real problem," Watt said.

Principal reductions have been a long time coming. Since Watt took office in early 2014, there has been widespread speculation he would finally authorize FHFA to grant principal reductions for loans owned by Fannie Mae and Freddie Mac. But Watt disappointed many of his supporters by continuing to rely on loan modifications and refinancing programs to help troubled homeowners.

The FHFA also announced Thursday changes to its nonperforming loan sales guidelines to help delinquent, underwater borrowers avoid foreclosure.

The agency will require third-party buyers of Fannie and Freddie's non-performing loans to include principal reduction as part of their loan modification programs. The guidance also tries to stop investors from abandoning homes. FHFA will require investors to sell or donate surplus properties to municipalities or nonprofit groups.

"FHFA has a difficult challenge in trying to help underwater homeowners in some of the markets that are still struggling, as they need to balance the moral hazard risk, identify loans that do not add risk to the GSEs or the communities involved, and focus on borrowers that will have the best chance to stay current," said David Stevens, president and chief executive of the Mortgage Bankers Association.

"FHFA's program design attempts to mitigate some of these concerns and the result is a narrow focus on lower loan balance and severely delinquent mortgages. Hopefully this targeted program will help some families who can meet these requirements."

Principal reduction is available for borrowers who owe $250,000 or less on their mortgage.

Taylor noted that 3 million mortgages still face potential foreclosure and principal reduction can fix the monthly payments and ensure the long-term viability of those mortgages. "There is an interest in getting these unsustainable mortgages behind us."

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Compliance Secondary market Servicing GSEs Loss mitigation Housing Risk management