MIAMI - While federal regulators and, possibly, the rating agencies are advocating for loan modifications in lieu of foreclosures, some say loan modifications will only delay inevitable defaults.

Moody's Investors Service announced late last month that it might increase required credit enhancement for subprime pools that limit the proportion of loan modifications. And Standard & Poor's has said it is evaluating the effect of loan modifications. HEL deals that include caps on loan modifications generally do so by limiting changes to 5% of the pool's outstanding loans.

But depending on where one is investing in the HEL capital structure, loan modifications, especially when done en masse, can eat at excess spread, said Kishore Yalamanchili, a managing director at Blackrock. Refinancing, he said, is likely a more attractive option from an investor's point of view.

And, while market participants generally agree that loan modifications can be great - for the right borrower - some simply cannot afford the homes they are living in. A situation that makes defaults inevitable down the road.

For that reason, speakers last week at the Information Management Network Spring ABS 2007 conference held here said investors should keep track of how many loans have undergone modifications as a part of their overall performance surveillance process.

According to Jeff Humphrey, an analyst at United Capital Markets, modifications do not always show up prominently in loan performance data. From the data that is available, the success rate of such programs is not stellar, he said. "In good times, we know that 40% of these loan modifications fail. What is going to be happening in bad times?"

Although the Federal Housing Administration and GSEs Fannie Mae and Freddie Mac, among others, are devising plans to help a greater number of subprime borrowers refinance, the growing consensus throughout Congressional hearings seems to be that loan modification programs are a better fix than a so-called bailout plan for the growing tide of delinquencies.

Yet implications from the work-outs are likely to hit certain investors harder than others. Because loan workouts increase the likelihood that a deal will pass its performance triggers when it hits its stepdown date, releasing credit enhancement to residual and deeply subordinated investors, the highest risk could be shifted to mezzanine ABS investors, according to JPMorgan Securities analysts.

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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