In a one-two punch for industry prognosticators, self-styled experts and finger pointers, loan modifications are not performing well. Recently styled as the cure du jour for economic recovery, the news is not promising; however, before these teaspoon deep thinkers run for the next “sure bet” for salvation, it is important to remember that the facts aren’t all in and the data is skewed – we are only talking three months of data. I have no evidence suggesting that modifications ARE, in fact, the answer…just a sober recognition that policy should be long term in scope rather than some “will o’ the wind” reaction to mere weeks of data. (/cough Paulsen and Bernanke.)
In the first real assay of loan mod performance during the first quarter of 2008, over a third of all modified loans were delinquent again within first three months and over half within six months. That is truly bad performance. It means that these borrowers are RE-defaulting on their loans after a work-out has been reached often within weeks of completing the transaction. But does that mean that loan mods are a waste of time? The only real answer is maybe.
While I am unsure of the true makeup of the loan modifications during the first quarter of 2008, it seems reasonable that many of these mods were offered to a specific subset of the mortgage market – subprime and alt-a borrowers. The timing – the first quarter – was when the industry was still trying to assess if the toxicity of subprime was going to infect the standard agency market, which seemed potentially safe. When the mortgage market began to explode, these were the fringe loans that began the cascade of delinquencies and foreclosures. Underwritten on the assumption of an eternally appreciating real estate market rather than income or credit – the notorious “liar loans” are NOT indicative of the industry’s finest hour.
The irrational optimism of these borrowers – purchasing more home and extending themselves beyond reasonable standards probably extended to their loan modifications. They want to stay in homes that they can’t afford at any cost. And it seems unrealistic in this economic climate to assume their financial position is stronger today than at origination, even with more reasonable loan terms. In addition, it seems probable that this dubious financial reasoning crept into their consumer credit, savings rates and lifestyle choices in general. I think we all know people that live well above their means in the hopes that reality will catch up with expectations. For years I have called them “Visa-nairres,” living off the sweat of their credit rather than brow. Unfortunately, no amount of Pollyanna optimism can change the cold reality of a recession, declining income and a definitively un-appreciating real estate market.
Loan modifications for more traditional agency product (Fannie and Freddie) has lagged behind subprime/alt-a. Why? The first rush of foreclosures tended to be from these loan pools… with concern that the ripple effect would be felt in agency paper. These loans were owned by Wall Street firms and hedge funds with some pretty bracing write downs on their value. Many of these loans were sold to the highest bidder, making their value and the impact on their value of a modification less onerous to investors. For example, if you purchased the distressed asset at 50 cents on the dollar… modifying the loan to 80 cents on the dollar for the borrower isn’t as devastating.
Second, from a legal standpoint, loan servicers only OWN the right to collect payments and pay taxes and insurance in exchange for a small premium… but rarely do they OWN the mortgage. This is a really important concept… In the traditional media, modification is simplified into this “common sense” transaction leaving all of the “legal” mumbo-jumbo to the scrooge set. But really, there were some significant legal hurdles for servicers when they don’t actually OWN the paper just the right to collect and manage the payments. With the murky area of pooled assets, MBSs and CDOs, where pension funds and world bank’s own interest in pools of thousands of loans – there is often not a Mr. Banker that holds the title to the house and will be ‘a-foreclosin’ if the crops fail. There are complex legal structures and the victims of the losses aren’t necessarily a “bank”… they are your mom and dad’s pension fund, their 401K etc…
With some effective regulatory hurdles being removed for servicers to start engaging in loan modifications, we are seeing the popularity and actuality of agency loan mods really grow. When the cost of foreclosure is estimated at approximately $60K per home, lenders and investors in these pools are finding strong financial incentives to avoid a huge loss in favor of a more manageable one. The difference is that these modifications are for distressed homeowners that did play by the rules. They weren’t fringe borrowers…but more of the rank and file mortgagee. It will be interesting to see the impact of loan modifications for this class of borrower over the next few months.
Read more: “Official: Re-defaults are high after mortgage modifications“