NEW YORK - Borrowers would benefit from loan modifications that are implemented properly. While this would also maximize deal cashflow and thus benefiting investors, industry experts roundly rejected the notion of loan modification imposed by Congress.
Participants at the American Securitization Forum Sunset Seminar held here last week tilted Subprime Mortgage Loss Mitigation Strategies - What's Working?' were against legislated loan modification and did not expect Congress to impose strict, mandatory modifications.
The whole premise of loan modifications is to allow the servicer to exercise independent discretion and evaluate borrowers individually to determine appropriate options available to them, said Chris Flanagan, managing director and head of global research at JPMorgan Securities, who spoke at the seminar. Flanagan added that the point of loan modification would be defeated by moving away from basing the decision to modify a loan on economics to something that's legislated.
Agreeing with Flanagan, Stephen Kudenholdt, chair of Thacher Profitt & Wood's structured finance practice group, said that a "one size fits all approach" will only exacerbate losses. He believes that loan modifications should always result in a "net win" for investors if servicers actually comply with the "best interest of investors" standard.
Panelists said that borrowers usually have different needs and situations that have to be individually addressed. Shane Ross, a vice president at Litton Loan Servicing, said that the company always assesses the borrower's financial situation. Not all borrowers actually need to modify their loans, and some may just need to undergo counseling.
For instance, borrowers who have equity in their homes have the option of selling their property, while those who don't have equity and don't want to stay could simply short-sale their houses. However, those borrowers who want to stay in their homes but don't have the money to support this decision, can change their loan based on what they could afford. Options include reducing the interest rates, extending out loan maturities and waving part of the principle of the mortgage. Since borrower needs are different, it is important to perform modifications that are "tailor made for each borrower," Ross said.
Whether loan modifications are good for investors depends on the their place in the capital structure. However, in terms of servicers, they will look out for investor interest in the aggregate, which means always looking to maximize a deal's cashflow. "Generally, servicers are always doing what's right for the Trust to increase cashflow," said Mani Sabapathi, a principal at the structured finance group at Prudential Financial. He added that the challenge for investors when it comes to analyzing their bonds is to understand the number and nature of mods as well as the timing of losses.
Sabapathi added that the problem with mandatory modifications is that borrowers who really need to modify their mortgages would end up subsidizing those who could have paid for or refinanced their mortgages.
Another issue raised was the possibility of loan modifications actually causing servicers to increase their fees to cover the cost of loan mods, which might mean that newer deals would need to have relatively higher fees. Litton, for instance, has had to add facilities and employees such as vendors and real estate brokers.
"A servicer must monitor the markets and adjust staffing levels accordingly," Litton's Ross said.
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