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COP report shows low impact of modifications on foreclosures [ClearOnMoney]
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COP report shows low impact of modifications on foreclosures

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Commentary

COP report shows low impact of modifications on foreclosures

14 Dec 2010 by Jim Fickett.

The Congressional Oversight Panel released today a new report entitled A Review of Treasury’s Foreclosure Prevention Programs. The most important result in the report is that re-defaults of HAMP permanent modifications are likely to reach something like half of all mods, just as for other modification programs. For investors, the key takeaway is that modifications are not having much of an impact on foreclosures.

This is a long report (192 pages) with many historical and current details. In my view there are two main highlights, (1) reasons for failure, looking mostly to the past, and (2) re-defaults, looking mostly to the future.

One fundamental reason HAMP has failed is conflict of interest on the part of the banks. The big banks own the big servicers, and the latter have no real incentive to prevent foreclosure:

it is in the servicer‟s interest to keep a mortgage for as long as it is producing an income stream and, once it goes into default, to ensure that the mortgage goes through foreclosure.

Further, the big banks have a very large stake in second liens that stands as a major hindrance:

There continues to be tension between Treasury's goal of mitigating foreclosures and its goal of maintaining adequate capital levels at large banks.

… second lien holders can act as a hold out and make modification more difficult.

In general, if a second lien is modified, the loss requires immediate recognition.

… the four largest commercial banks, Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo, are both servicers of first and second liens as well as owners of large second lien portfolios. Therefore, this potential for a significant write-down of second lien mortgages creates a profound conflict of interest for these entities, putting their financial well-being at odds with their duties as first lien servicers.

Note in particular that if Wells Fargo were to write down their second lien portfolio to realistic levels, it might put them close to insolvency.

Now let's look at the second key area of results from this report – re-defaults. The Treasury provides monthly data on what happens eventually to those whose trial modifications are canceled (summary here), but does not include in the monthly report any useful information on re-defaults of “permanent” modifications. The COP report closes that gap:

Despite reassuring words from Treasury to the contrary, it looks very likely that something like half of all permanent mods are likely to eventually re-default, just as for modifications overall.

Note that if we include defaults on trial modifications, the rate is already up to half:

It is not surprising that the re-default rate is high. Here is the distribution of so-called back-end DTI (debt to income), that is, the fraction of pre-tax income that goes to all debt payments. The measurement is taken at the point of conversion from trial to permanent modification, so the fraction has the benefit of the lower modified mortgage payment:

Further, in most modifications late fees and missed payments are rolled into the principal balance, so that

Of all active permanent modifications, nearly 95 percent have an unpaid principal balance that is higher than it was before modification. …

More deeply underwater loans redefault at higher rates.

That is, even if payments have come down, debt has not, and the homeowner knows that the problem is only delayed.

Bottom line: there are not many permanent modifications to start with, and half will likely re-default. That means little impact overall on foreclosures.