Panelists at the American Securitization Forum’s (ASF) 2010’s mortgage modification session warned of two issues undermining government and private sector efforts to stem foreclosures and get the market re-started: negative equity and second lien mortgages.

By nearly any measure, the negative equity effect has been downright brutal. Already it has translated into a plummeting cure rate, said Laurie Goodman, senior managing director of Amherst Securities Group.

Amherst found that that a borrower who is six-months delinquent will start strategically re-thinking his or her finances, and if negative equity is thrown into the mix, the probability of default jumps anywhere from 75 percent to 80%. “Negative equity is the single most important driver of defaults,” Goodman said.

MetLife managing director Nancy Handal said addressing second liens is essential to dealing with negative equity. Using data from 2006, Goodman noted that the existence of a second lien boosted the probability of default.

Handal and Goodman agreed that forgiving principle is vital to restoring the mortgage sector to health. “Modifications can help, but right now as they’re structured they can only help on the margins,” Goodman said.

Interestingly enough, she said that in cases where the lending bank owns the first and second lien mortgage and is also the servicer, principal reduction is more prevalent. 

This is not to say that the current approach to modifications, with Home Affordable Modification Program (HAMP) at the helm, is on its way out. However, the sense is that its impact has been and will continue to be, limited.

“Modifications will help a subset of borrowers,” said Seth Wheeler, senior advisor to the U.S. Department of Treasury. Under HAMP, there have been about a million modifications, with permanent mods making up only about 100,000.  “Conversions are a big challenge” Wheeler said, giving a nod to critics of the program.

Colleen Hernandez, CEO of Homeownership Preservation Foundation, said a “new wave” of borrowers was being denied a permanent mod based on net present value (NPV), even though they had made their payments in trial. NPV calculates the difference between the present value of cash inflows and the present value of cash outflows. Hernandez suggested that programs be clear and specific in detailing the role of NPV to borrowers.

Some of the problems associated with mod programs are merely those of youth, panelists said. For instance, the “press noise” about the significant time it takes to execute a mod will likely die down as programs mature, according to Doug Potolosky, senior vice president at Chase Home Finance. “The timelines are prescriptive,” he said. “Three payments are needed to perfect a mod. [But] they’ll become more regular and timing will be less of a concern.”

Wheeler said that of 60-day day delinquent borrowers, a little over three million would be eligible for HAMP, with about half of them qualifying.

Potolosky said that HAMP has helped standardize mods but other programs are critical. And results so far with Chase’s programs have been heartening. “We are seeing material improvement with recidivism rates on the mods,” Potolosky said.

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