Home Loan Modifications May Still Pose Risk For Banks
by admin ~ November 20th, 2008.Banks who provide mortgage loan modifications for homeowners could potentially undermine the publically traded banking sector by masking possible losses. Historical evidence suggests that even when mortgage lenders modify mortgage terms for at-risk borrowers – cutting interest rates, principal or extending the loan’s life – a hefty portion of those borrowers default within a year or two anyway. Besides, in many cases with subprime loans, so many borrowers had so markedly inflated their income status, that even after a loan modification the borrower is still unlikely to be able to afford the mortgage payments.
Banks and politicians have been pushing the use of home loan modifications as a way of keeping at-risk borrowers out of foreclosure. They hope that will stanch the steep nationwide slide in housing values. Loan modifications can also provide some accounting and earnings relief for banks, since lenders can re-list many modified delinquent loans as current loans, so long as the borrower resumes regular payments once the loan is modified.
Many industry officials say loan modifications will help a large number of borrowers avoid foreclosure, since banks are working to identify at-risk borrowers before they default. They are focusing intensely on borrowers who have adjustable rate mortgage loans that are soon scheduled to reset higher. Just two weeks ago, for example, JPMorgan Chase & Co. (JPM) disclosed that it prevented 250,000 home foreclosures since it started to actively modify mortgage loans in early 2007.
But loan modifications have shown a glaring historical weakness: According a 2007 Fitch Ratings report, 35% to 40% of borrowers default on their modified loans within 12-24 months. Both the Fitch and Moody’s reports collected information from mortgages that lenders sold to third-party investors via mortgage-backed securities, and those pools of mortgages include both prime and subprime loans.
Dr. Joseph Mason, a banking professor at Louisiana State University’s business school, aggregated that data in a report last year that critiqued the practice of modifying loans. He puts the benchmark success rate for mortgage loan modifications at 50%. Mason says, furthermore, that there isn’t yet evidence to suggest that banks will see lower re-default rates among mortgages sitting on their balance sheets, as compared to loans sitting in mortgage-backed securities. “Unless we get into skewed outcomes,” where bank-held loans outperform securitized loans, “or vice versa,” he says, “then we wouldn’t expect to see any difference.”
But federal banking regulators, including the Federal Deposit Insurance Corp., and even Federal Reserve Chairman Benjamin Bernanke, have nonetheless been pushing banks to offer modifications to mortgage borrowers.
“The FDIC believes modifications should be systematic and sustainable,” a spokeswoman for the FDIC said. What’s more, the FDIC is itself working to modify mortgages written by IndyMac Bancorp Inc. (IDMCQ), the California bank company that the FDIC seized in July – at the time, the largest bank failure in the nation’s history. “The modified (IndyMac) loans will be underwritten to an affordable debt-to- income ratio” of 38%, said FDIC Chairman Sheila Bair, in an August statement. That means the FDIC will modify IndyMac borrowers’ loans in a way that a loan’s monthly payments are equal to 38% of a borrower’s monthly income. Read complete article >
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