Servicers will likely avoid extending modifications as part of the $26 billion AG settlement since they will not be indemnified against investor lawsuits, according to a JPMorgan Securities report.
The AG Settlement includes $17 billion dedicated to principal reduction on both first and second liens mortgages that are owned and held by the nation‘s largest bank servicers. However, to extend principal forgiveness on securitizations, banks would need to infuse cash into the mortgage trust to cover the principal reduction.
"There are more than enough delinquent, underwater borrowers in bank portfolios, and servicers may be concerned with investor backlash and violating pooling and servicing agreements," JPMorgan analysts explained in the report.
In October of 2008, Bank of America/Countrywide agreed to settle a lawsuit from 11 states totaling $8.6 billion. In the settlement, analysts said, Countrywide modified roughly 400,000 subprime, adjustable rate, loans originated prior to December 31, 2007.
However, Countrywide did not buy the modified loans out of trusts, even in the case of principal forgiveness.
"This was in stark contrast to common language in Countrywide's pooling and servicing agreements, stating that modified loans must be bought out at par," analysts stated.
Soon after, Countrywide was sued by an investor group that argued that Countrywide was violating its contractual obligation under the pooling and servicing agreements.
The analysts also noted that servicers have plenty of mortgages on the banks' portfolios they can look at to complywith the AG settlement terms. According to JPMorgan, about two thirds of delinquent loans are underwater and, in many cases, the LTVs are as high as 200.
"In total, we estimate about 1.8 million delinquent borrowers are underwater, with a total underwater amount of roughly $125 billion. This is well in excess of the settlement‘s 1 million targeted borrowers and $10 billion plus in forgiveness. Of course, the settlement is aimed only at the top five servicers, but even then we expect there will be plenty of loans to work from without having to go to securitizations."