One of the biggest stumbling blocks to loan modifications is the treatment of second mortgages, a resolution that could greatly impact the future of all loan restructurings. Currently, most modifications of a first mortgage leave the second lien untouched.
Nancy Mueller Handel, a managing director at MetLife, is concerned this "inversion of lien-holder rights" makes the first-lien holder pay for the modification with the second-lien owner benefiting.
What results is a borrower obligated to make full payments on the second, a situation that can leave them "underwater" regardless of what a servicer does with the first. "In order to remedy the current problem, new standards should set protocol on seconds being extinguished prior to firsts being modified," Ms. Handel told this newspaper. "That is the traditional structure of lien-holder rights in a foreclosure situation." MetLife, which owns a top 20 ranked lender/servicer, is supportive of the government's Home Affordable Modification Program and its fledgling second-lien effort known as 2MP.
Bank of America recently signed onto 2MP, which obligates servicers to restructure the second lien when the first is modified. In B of A's case, it owns nearly $150 billion of second mortgages and also happens to be the largest servicer of firsts.
Treasury Department officials are negotiating with other major banks that control large second-lien portfolios. The government's goal is to achieve sustainability on the combined mortgage payments, giving servicers the option of modifying the second or potentially reducing some of its principal.
Ms. Handel considers B of A's entry into the program an important breakthrough. "If the inversion of lien-holder rights is not remedied, we believe that mortgage rates will need to increase to compensate first-lien borrowers for the risk of a future second-lien taking priority. In short, second-lien premium pricing needs to be shared by the first in future underwriting," the MetLife structured finance director said in a written response to questions posed by National Mortgage News.
Meanwhile, Treasury officials are looking closely at principal reductions to make HAMP a more effective program, helping distressed borrowers with negative equity. "Servicers are not using payment reduction very often," according to Seth Wheeler, a senior advisor at the Treasury Department.
"When a borrower has a loan-to-value ratio above 120% and a financial hardship, they have an affordability problem," said Mr. Wheeler, Treasury's point man on loan modifications. "We are certainly taking a very serious look at how better we can achieve principal reductions in the HAMP program." (Speaking at a recent American Securitization Forum conference in Washington, he stressed that no decision has been made.)
However, Treasury officials are looking at changes to the "net present value" model to better accommodate writedowns or principal reductions. The NPV test is used to qualify borrowers for a loan modification.
Principal reductions are currently an option under HAMP, as well as principal forbearance where the servicer does not expect the borrower to make interest payments on a portion of the loan balance principal for five years or more.
The MBS pool takes a loss on principal forbearance and there is not much difference in the NPV test score for either option. Modifications with principal reduction are likely to perform better, in terms of lower redefaults, over time because it addresses negative equity.
But principal reduction is a "very sensitive subject," Ms. Handel said at the ASF conference. "We have to be mindful of moral hazard. Any time you talk about cutting principal payments as part of the waterfall in HAMP you worry that everybody is going to see their neighbor got a deal and they want a deal, too."
She stressed that servicers have to deal with second liens first before reducing the principal on the first mortgage. The rights of first- and second-lien holders need to be resolved for the private-label MBS market to recover. "Without a clear solution to lien-holder rights, it is going to be difficult to invest," the MetLife executive said. Besides owning a mortgage banker, MetLife is a major investor in MBS.
