The Federal Reserve has urged the use of loan modifications to stem the tide of defaults that could result from the current subprime mortgage troubles, and servicers appear to be responding.
But while the use of loan mods are on the rise, it still remains to be seen how much of an impact this will have on the securitization market and whether the industry will pursue longer-term solutions to the credit crisis.
Before the Fed issued a statement on Sept. 4 urging loan servicers to work with borrowers facing defaults, loan modifications were already on the rise, according to a June report by Moody's Investors Service. Moody's said that about 95% of the subprime securitizations that it rated last year permit modifications.
"Up until the dislocation in the subprime and broader housing markets, it's probably fair to say that loan modifications were not widely used or employed in connection with either a securitized, or for that matter unsecuritized loans," said George Miller, executive director of the American Securitization Forum. "The environment has changed significantly in a way that, anecdotally, modifications are much more of a focus in these deals as a loss-modification alternative. There are more modifications taking place and I think more that are likely to take place as we cycle through the current market environment."
In June, the ASF released a set of guidelines and recommendations for servicers that pursue loan modifications. Miller said that if there are contractual restrictions on loan modifications, they normally prevent the modification of a certain dollar amount without obtaining consent from a third party.
Not everyone in the securitization industry sees the path to loan modifications as being a clear one. "When we're talking about institutional lenders, they do not want your house contrary to what some people may believe," Jill Hoogendyk, a Phoenix-based broker and president of Home Point Mortgage, said.
But lenders, she said, many times do not have the ability to modify a loan because that paper has already been sold, "So it's kind of a rock and a hard place." Hoogendyk added that although these lenders would love to work it out, "They have someone on the other side that they have to work it out with as well." She said that loan modifications will occur as much as the industry is capable of doing them, but, "there are just going to be points when the industry is not capable of doing them."
A servicer's general contractual obligation is to maximize the economic recovery on that loan asset if a borrower cannot pay according to the terms of the deal, Miller said. "They should be servicing that loan as they would if they were holding it in their own portfolio," he said. This means modifying the loan in order to preserve it as a performing asset. "There certainly will be situations where foreclosure is effectively the only option, but for the most part, especially in a declining home price environment, foreclosure is usually the most costly alternative and therefore the least preferred alternative," Miller said.
Another question being raised is whether the short-term loan modifications are going to do enough to help borrowers who are struggling through the current credit environment. When the Fed urged servicers to pursue loan modifications a couple of weeks ago, Sen. Chris Dodd (D-Conn.), who is running in the 2008 presidential election, said the statement was "late in coming" and would not help enough people keep their homes.
"As I have said for many months, subprime homeowners deserve loans that are affordable in the long term," Dodd said in a statement. "We cannot tolerate short-term modifications that put off the day of reckoning until a time when the press' attention is turned elsewhere."
While the ASF's guidelines state that modifications should be sustainable over a longer-term period, Miller also said it's important that a balance is struck between helping the borrowers and permanently changing the terms of the loan. "I guess if you take the view that every subprime loan that was ever originated was somehow abusive or inappropriate to the borrower, than you might conclude that just as a matter of policy and across the board we need to modify and make some concessions on these loan terms," he said. "I think we all know the reality is that's not the case. Unless there's some clear showing of fraud or abuse, we've got to look at loan modifications as a concession."
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