Post by jeffolie on Jul 4, 2007 13:47:23 GMT -6
By Lingling Wei, Ruth Simon and James R. Hagerty
From The Wall Street Journal Online
As defaults on home loans mount, mortgage companies are scrambling to work out deals to help as many borrowers as possible stay in their houses.
On the surface, it seems an obvious tactic. Lenders usually end up losing money on foreclosed homes because of legal and other costs and the need to sell those properties fast, often at a knockdown price. Also, politicians are pressing mortgage companies to minimize the damages foreclosures cause to families and neighborhoods.
Still, the effort to hold down foreclosures threatens to create clashes between mortgage companies and investors in securities backed by bundles of home loans, a $6 trillion market that has been shaken recently by losses on some of the riskier types of mortgage bonds. And because of the way these securities are sold, these efforts can pit groups of holders against each other.
"It's going to create a class warfare" among different types of investors, predicts Kyle Bass, managing partner of Hayman Capital Partners LP, a Dallas hedge fund.
Foreclosures are rising fast partly because lenders in recent years rushed to make no-money-down loans to people with weak credit records and didn't always verify their income. At the same time, the decline in housing prices in much of the country makes it hard for borrowers who fall behind to sell their homes for enough money to pay off the loan.
When borrowers can't keep up, lenders typically consider whether it makes sense to offer a loan modification. Such workout deals, known as "mods," often involve lowering the interest rate or stretching out the term. Lenders have used mods for years, but the practice is expected to proliferate as defaults rise.
Sharon Greenberg, an analyst for Credit Suisse Group in New York, estimates that before this year modified loans typically accounted for less than 2% of all those outstanding. Within the next couple of years, she says, they may peak at several times that level.
Investors holding mortgage-backed bonds are watching nervously because mods may not always be in their best interest. Some investors fear that loan servicers -- the firms, often owned by lenders, that collect payments and deal with defaults -- will make too many mods. Generally, investors favor mods that ease a normally reliable borrower through a rough patch, but not those that merely buy time for deadbeats.
Investors doubt some homeowners merit a rescue plan. In some cases, says Kishore Yalamanchili, a fund manager with BlackRock Inc., New York, "by making these people current, you are pushing losses to another year or so."
Credit Suisse analysts recently examined loans that had been modified over the past few years by one nationwide lender and found that borrowers missed at least one monthly payment after a mod in nearly 40% of the cases. (That failure rate may have been skewed upward by victims of Hurricane Katrina who never returned to their homes.)
If the borrower is unlikely to keep up with payments even after a mod, many investors would prefer that servicers pursue a foreclosure quickly, especially in regions where house prices are falling, reducing the value of the collateral.
Servicers are required by their contracts to act in the interests of the investors and modify loans only when that can be expected to reduce losses. That puts servicers in the tricky position of trying to figure out which borrowers are basically sound and when it makes more sense to foreclose quickly.
One complication is that different classes of investors have different interests, reflecting the complicated mechanics of mortgage securities. Issues of mortgage-backed securities are divided into slices with various ratings, depending on the level of risk. Holders of the highest-rated slices (those with the lowest risk) are first in line to collect payments of interest and principal flowing from the loans. Many such bond issues are structured so that there is initially more than enough cash flow available to cover obligations to all the investors, leaving a cushion to cover potential losses from loan defaults. If after three years or so the loans have performed well enough to meet certain performance measures, the cushion may be reduced.
In that case, some of the excess cash available goes to holders of lower-rated securities and "residuals," the highest-risk parts of the securities that are last in line for payments.
If loan mods delay the onset of foreclosures, holders of the lower-rated securities and residuals are more likely to get those payments. But, holders of AAA and other high-rated securities may argue that the loan mods have artificially boosted the performance of the loans and that the holders of lower-rated securities and residuals are getting payments that should be preserved to protect owners of higher-rated paper against the risk of a resurgence of defaults later.
Even where there are no clashes among investors, servicers face restrictions on how they modify loans.
Moody's Investors Service, a ratings provider, recently reviewed roughly 400 subprime mortgage-security transactions issued last year: 5% of those deals prohibit any kind of loan mod; among those that allow mods, about a third stipulate that no more than 5% of the loans backing the securities can be modified. Subprime loans are those to people with spotty credit histories.
"Those restrictions may prevent servicers from doing the things they need to do," says Larry Litton Jr., chief executive of Litton Loan Servicing, a unit of C-BASS LLC, New York. Mr. Litton says his firm hasn't bumped up against any ceilings. Still, he favors eliminating restrictions in future issues of mortgage securities to give servicers more flexibility.
From The Wall Street Journal Online
As defaults on home loans mount, mortgage companies are scrambling to work out deals to help as many borrowers as possible stay in their houses.
On the surface, it seems an obvious tactic. Lenders usually end up losing money on foreclosed homes because of legal and other costs and the need to sell those properties fast, often at a knockdown price. Also, politicians are pressing mortgage companies to minimize the damages foreclosures cause to families and neighborhoods.
Still, the effort to hold down foreclosures threatens to create clashes between mortgage companies and investors in securities backed by bundles of home loans, a $6 trillion market that has been shaken recently by losses on some of the riskier types of mortgage bonds. And because of the way these securities are sold, these efforts can pit groups of holders against each other.
"It's going to create a class warfare" among different types of investors, predicts Kyle Bass, managing partner of Hayman Capital Partners LP, a Dallas hedge fund.
Foreclosures are rising fast partly because lenders in recent years rushed to make no-money-down loans to people with weak credit records and didn't always verify their income. At the same time, the decline in housing prices in much of the country makes it hard for borrowers who fall behind to sell their homes for enough money to pay off the loan.
When borrowers can't keep up, lenders typically consider whether it makes sense to offer a loan modification. Such workout deals, known as "mods," often involve lowering the interest rate or stretching out the term. Lenders have used mods for years, but the practice is expected to proliferate as defaults rise.
Sharon Greenberg, an analyst for Credit Suisse Group in New York, estimates that before this year modified loans typically accounted for less than 2% of all those outstanding. Within the next couple of years, she says, they may peak at several times that level.
Investors holding mortgage-backed bonds are watching nervously because mods may not always be in their best interest. Some investors fear that loan servicers -- the firms, often owned by lenders, that collect payments and deal with defaults -- will make too many mods. Generally, investors favor mods that ease a normally reliable borrower through a rough patch, but not those that merely buy time for deadbeats.
Investors doubt some homeowners merit a rescue plan. In some cases, says Kishore Yalamanchili, a fund manager with BlackRock Inc., New York, "by making these people current, you are pushing losses to another year or so."
Credit Suisse analysts recently examined loans that had been modified over the past few years by one nationwide lender and found that borrowers missed at least one monthly payment after a mod in nearly 40% of the cases. (That failure rate may have been skewed upward by victims of Hurricane Katrina who never returned to their homes.)
If the borrower is unlikely to keep up with payments even after a mod, many investors would prefer that servicers pursue a foreclosure quickly, especially in regions where house prices are falling, reducing the value of the collateral.
Servicers are required by their contracts to act in the interests of the investors and modify loans only when that can be expected to reduce losses. That puts servicers in the tricky position of trying to figure out which borrowers are basically sound and when it makes more sense to foreclose quickly.
One complication is that different classes of investors have different interests, reflecting the complicated mechanics of mortgage securities. Issues of mortgage-backed securities are divided into slices with various ratings, depending on the level of risk. Holders of the highest-rated slices (those with the lowest risk) are first in line to collect payments of interest and principal flowing from the loans. Many such bond issues are structured so that there is initially more than enough cash flow available to cover obligations to all the investors, leaving a cushion to cover potential losses from loan defaults. If after three years or so the loans have performed well enough to meet certain performance measures, the cushion may be reduced.
In that case, some of the excess cash available goes to holders of lower-rated securities and "residuals," the highest-risk parts of the securities that are last in line for payments.
If loan mods delay the onset of foreclosures, holders of the lower-rated securities and residuals are more likely to get those payments. But, holders of AAA and other high-rated securities may argue that the loan mods have artificially boosted the performance of the loans and that the holders of lower-rated securities and residuals are getting payments that should be preserved to protect owners of higher-rated paper against the risk of a resurgence of defaults later.
Even where there are no clashes among investors, servicers face restrictions on how they modify loans.
Moody's Investors Service, a ratings provider, recently reviewed roughly 400 subprime mortgage-security transactions issued last year: 5% of those deals prohibit any kind of loan mod; among those that allow mods, about a third stipulate that no more than 5% of the loans backing the securities can be modified. Subprime loans are those to people with spotty credit histories.
"Those restrictions may prevent servicers from doing the things they need to do," says Larry Litton Jr., chief executive of Litton Loan Servicing, a unit of C-BASS LLC, New York. Mr. Litton says his firm hasn't bumped up against any ceilings. Still, he favors eliminating restrictions in future issues of mortgage securities to give servicers more flexibility.