Servicer Options Often Inhibited

Credit risk analysts told a Senate banking subcommittee that mortgage servicers are in the best position to stave off foreclosures while a Florida law professor suggested that it’s time for an extensive overhaul of mortgage lending laws.

Mortgage servicers can act as a first responder to default, panelists suggested.

“They have flexibility to work with borrowers so that loan payments will be made, while exercising the right to foreclosure only as a last resort,” said David Sherr, Managing Director and Global Head of Securitized Products at Lehman Brothers Inc.

The servicers can offer borrowers loan modifications, forbearance agreements, extending amortization terms, adding balloon payments or restructuring or decreasing mortgage interest rates, panelists told the Senate securities subcommittee.

Susan Barnes, Managing Director of Residential Mortgage-Backed Securities for Standard & Poor’s Ratings Services, told lawmakers that S&P believes that a majority of the transactions allow the servicer to forbear or restructure mortgage loans within generally accepted servicer and industry standards.

But, panelists noted, there are restrictions on a servicer’s ability to act.

Some structured finance transactions have provisions that limit a servicer’s ability to restructure the mortgage loans to a certain percentage of the loans, Barnes noted. In other instances, servicer contracts restrict loan modification.

For example, some contracts grant loan servicers significant discretion in modifying loans, others permit a few modifications and others forbid modifications altogether, said Gyan Sinha, Senior Managing Director at Bear Stearns. Further complications are presented by the fact that servicers of securitized loans often do not own the loans, he said.

Sinha said loan modifications present one of the most viable vehicles for mitigating foreclosures but pointed out that modifications involving debt forgiveness are hampered by tax laws that create a tax liability for the borrower.

Barnes indicated S&P is optimistic that the ratings on residential mortgage backed securities will not be negatively affected so long as the forbearance and restructuring of subprime mortgage loans is consistent with industry standards.

Warren Kornfeld, Managing Director for the Residential Mortgage-Backed Securities Rating Group at Moody’s Investors Service, said servicers will need to become more proactive as greater numbers of seriously delinquent borrowers become unable to refinance.

Moody’s expects creative payment plans, forbearance options and loan modifications to become more prevalent, he said.

Sherr said because borrowers’, lenders’ and investors’ interests are aligned in their desire to prevent default and delinquency, that market is rapidly adjusting to minimize foreclosures and improve the performance of securitized loans.

For example, mortgage loans to subprime borrowers are now being underwritten in with stricter guidelines and financial intermediaries are adopting new practices such as contacting borrowers early when their loans appear to be at risk for default. And, the volume of securitization has been reduced, as has the range of mortgage products being offered to consumers.

All these adjustments in the market are being driven by the fact that nobody benefits from the underwriting of loans that do not ultimately perform, he said. Sherr expressed optimism that the subprime mortgage securitization process will continue to create opportunities for a long-ignored segment of the population.

Nobody benefits when the underwriting of loans that do not perform, Sherr declared.

But the law professors disagreed.

Kurt Eggert, professor of law at Chapman University School of Law and a member of the Federal Reserve Board’s Consumer Advisory Council, said the subprime market is regulated by rating agencies and securitizers. He also said investors can make money on loans that go into foreclosure.

In 2006, 76 percent of total loan originations were securitized. Meanwhile, adjustable-rate mortgages reportedly accounted for nearly 80 percent of the subprime loans securitized in early 2006.

Securitization decreases the discretion to modify the loan in meaningful ways to prevent foreclosure, as loan servicers are restricted by pooling and servicing agreements and by their conflicting duties to different investors, Eggert said.

Loan modifications work best for borrowers whose loan problems are caused by temporary financial setbacks, rather than those who obtained loans that, once they reset, require loan payments greater than the borrowers would be able to repay even without any new financial downturns, he said.

He also pondered whether loan servicers are willing to hire the additional people needed to handle the extra work.

Eggert likened tightened underwriting standards — one of the most commonly mentioned fixes — to closing the barn door after the horse has escaped.

University of Florida Associate Law Professor Christopher L. Peterson said residential mortgage laws, most passed more than 10 years ago, have failed to account for the complex financial innovations that are a part of today’s securitized mortgage market. The secondary market has evolved out of the reach of consumer protection law, he said, adding that it’s time for Congress to consider comprehensive reform of the nation’s consumer lending laws.

But Barnes cautioned that Congress should exercise caution in crafting a legislative response to the current subprime lending situation to ensure that subprime borrowers continue to have access to mortgage loans. If Congress determines that legislation is the appropriate response, then such legislation must provide clear guidelines.

She also said S&P believes that the oft-touted suggestion of assignee liability — a lending law that imposes liability on purchasers or assignees of mortgage loans to reduce unsafe lending unsafe practices — has a significant downside as a legal action could reduce the funds available to pay investors as the mortgage loan pool could be depleted by assessed damages.

photo of U.S. Senators Menendez, Reed & Allard

Related:

Fannie, Freddie Target Subprime Refis WASHINGTON, D.C. — Fannie Mae and Freddie Mac are rolling out subprime programs for borrowers facing foreclosure. Chief executive officers of the two government sponsored housing enterprises joined regulators and consumer groups in testimony to Congress Tuesday on rising foreclosures.

Subprime Hearings Continue WASHINGTON, D.C. — Mortgage brokers Tuesday told Congress improvements are needed for federally-insured loans, while mortgage bankers expressed a commitment to minimize foreclosures and consumer advocates called all subprime lending a mistake.

Senate Subprime Hearings WASHINGTON — Subprime mortgage executives from Countrywide Financial Corp., HSBC North America, WMC Mortgage Co. and First Franklin Financial Corp. told U.S. Senators yesterday that proposed federal subprime regulations should apply to all loan originators. Most emphasized that they have already made underwriting changes and at least one warned about curtailing some valuable programs.

Lisa D. Burden is a legal analyst for MortgageDaily.com and holds a law degree from the University of Maryland. She is currently a freelance journalist who previously wrote for Institutional Investor publications and the Baltimore Daily Record.

e-mail Lisa at: burdenlisa@yahoo.com