Will Asking Mortgage Servicers to Modify More Mortgages Have Much Impact?

Bloomberg tells us that the Fed and the Treasury made a joint statement today asking mortgage servicers to take a more proactive stance, identify borrowers in danger of gong into default, and offer loan modification. Tanta at Calculated Risk provided a link to the “ Interagency Statement on Loss Mitigation Strategies for Servicers of Residential Mortgages,” and here is what we regard as the operative part:

Servicers of securitized mortgages should review the governing documents for the securitization trusts to determine the full extent of their authority to restructure loans that are delinquent or in default or are in imminent risk of default. The governing documents may allow servicers to proactively contact borrowers at risk of default, assess whether default is reasonably foreseeable, and, if so, apply loss mitigation strategies designed to achieve sustainable mortgage obligations.

Unfortunately, like other Bush Administration measures to address the growing housing crisis, there is less to statement than meets the eye.

The Fed and the banking regulators under the Treasury’s umbrella, such as the Office of the Comptroller of the Currency, have nicely asked mortgage servicers if they can use loan modifications to rescue more borrowers at risk of default. And in the good old fashioned days of banking, when the original lender held the mortgage, “mods” were the preferred way to prevent foreclosure, since in most cases a foreclosure was less attractive than keeping the borrower in place.

However, in our new world of securitized finance, what the servicer can and cannot do is determined by the servicing agreement between the legal entity that holds the mortgage assets on behalf of the various investors and the mortgage servicer. I am told that those agreements are governed by state law. Federal banking regulators have no authority to tell servicers to ignore or waive the terms of these agreements. Hence, all they can do is plead.

Most agreements restrict loan modifications, and our impression is that in many cases that extends to loss mitigation mods (it’s standard to restrict mods that aren’t related to loss mitigation; you don’t want the servicer enabling what is tantamount to refinance to take advantage of falling interest rates, for instance. The servicer would get the same fee as before, but you the investor would get less income). The Bloomberg story notes:

Even if loan-servicing companies want to make changes, their contractual obligations may block them.

Eight of the 31 subprime-mortgage deals that Credit Suisse Group bond analyst Rod Dubitsky looked at for an April report capped the amount of loan modifications that can be done at 5 percent of either the total loan number or their balances.

Banks and borrowers also may be worse off if they delay inevitable foreclosures because slumping home prices may create even lower resale prices, according to Josh Rosner, managing director at the New York investment research firm Graham Fisher & Co.

The last point, that delaying foreclosure may be a bad strategy financially, is important. Servicers would be reluctant to take actions that could easily be argued to have been to the investors’ detriment. So that is a further deterrent to mods in a falling housing price environment.

So the real reason this statement has little significance? Servicers have every incentive to keep borrowers alive. They collect handsome fees. And Tanta reports that from a servicers’ perspective, having a defaulted but not yet foreclosed borrower is an unattractive outcome:

That said, what you want to watch if you’re looking at a servicer is the category of loans that are 90+ days delinquent but not yet REO. That may not be anyone’s largest pile of delinquent loans (out of the total of 30-60-90-120-FC-REO), but it’s the one that is the expense-hole. Anyone who is letting that bucket get bigger at a faster rate than it is racking up 60-day delinquencies has a problem. Every loan that is 90 days down this month was 60 days down last month, so out-of-proportion increases in the 90+ category means that the trouble is on the liquidation (escape) side, not just the credit deterioration (entry) side: BKs or legal-document troubles are delaying foreclosure, or nobody really wants to foreclose right now because the bids are going to suck so badly. Dragging it out, though, just makes the servicer wait that much longer to get paid and eats away at what the investor will recover. It’s expensive to carry REO and market it, but you can’t list it until you own it and you can’t sell it until you list it. There are ways to win at the servicing game, but there are also many ways to lose.

Another sign of the likely lack of practical significance of the regulators’ move: servicers were looking actively, well before this announcement, as to how much they could do in the way of mods. Bloomberg provides examples:

Banks and securities firms, including JPMorgan Chase & Co. and Bear Stearns Cos., say they’ve already begun contacting high- risk borrowers.

“Earlier this year, as we saw all these resets coming, we wanted to make sure people were aware,” Tom Kelly, a spokesman for New York-based JPMorgan, said today. “As the servicer of the loan, our goal is to keep the owner paying the mortgage.”

JPMorgan, which services about $700 billion of mortgages, is presenting borrowers with options including refinancing their loans or simply modifying their interest rate, Kelly said.

Bear Stearns, the second-biggest U.S. underwriter of bonds backed by mortgages, set up a team in April to meet with homeowners having difficulty making payments.

“Wall Street banks don’t want to foreclose on properties, because we’re not in the real-estate business,” Tom Marano, head of Bear Stearns’s mortgage business, said at the time. He said the so-called “Mod Squad” would try to modify borrowers’ loan payments to help them avoid foreclosure.

I hope I am proven wrong. Loan mods are the best solution for borrowers who have the ability to make a reasonable level of payments. But my fear is that the statement by the regulators will not embolden mortgage servicers to do more than they are already doing.