ABS issues in mortgage modification


14 Dec 2009.

Although securitization does make a mortgage modification decision more complex – if only because there are more interested parties – it is unlikely that securitization is the main roadblock. More than one source suggests that the main contract restriction is simply maximizing the interests of investors; there is little evidence that securitized mortgages are modified less often; and there has apparently only been one lawsuit on the issue.

However securitization can, in fact, stand in the way of principal reduction. This can be a contract issue or a conflict of interest between holders of different tranches. Whatever the cause, principal reductions definitely do occur less often with securitized loans.


Clippings below covered through 20 Aug 2009.

Hard restrictions (13 Dec 2009)

  • In some cases there is a restriction on the fraction of mortgages in a security that can be modified – generally 5%.
  • Many contracts do not allow principal reduction.
  • Some (perhaps most, according to the FDIC) contracts require only that the value of the investment be maximized, which could sometimes be interpreted to mean doing a modification to avoid foreclosure.
  • Some contracts require lenders to buy back loans out of the securitization trust before they can be modified.

Soft restrictions (13 Dec 2008)

  • The division of cashflows between tranches of a CDO depends on both the level and timing of defaults. In general, modifications are likely to transfer wealth from senior to junior tranches. Also, principal reductions go against all tranches, while foreclosures go against the junior first.

Overall effect (13 Dec 2008)

  • Chase said in a 16 Jan 2009 press release (below) that securitization was not an issue: “Based on the company's review of investor agreements and its experience with investors and trustees to date, Chase believes it can legally modify the vast majority of mortgages owned by investors consistent with the relevant investor agreements and the best interests of investors, and intends to make modifications where appropriate. Chase will continue to seek investor approval in the small number of situations where investor agreements contain specific terms that may limit modification actions Chase can take.”
  • The Boston Fed reported on 6 Jul 2009 (below) that, according to their research, their was no difference in the modification rate between securitized and unsecuritized mortgages (but Credit Slips thought other factors might have confounded these results).
  • Of the 185,186 loan modifications cited in the Mortgage Metrics report for the first quarter of 2009, 3,398 involved principal balance reductions. At most 4 of these were in securitized loans.
  • There has apparently only been one suit over the legitimacy of modifications in securitized loans.

See also

Clippings below used in construction of this page

MBS restriction on fraction of loans that can be modified

7 May 2007. Business Week p32.

“Why This Slump Is Different. By Christopher Palmeri and Dawn Kopecki”

“To take advantage of the accounting and tax benefits, many lenders wrote restrictions on the mortgage-backed securities; generally just 5% of loans in such investments can be renegotiated.”

Loan modifications may transfer money from senior CDO tranches to junior

29 Jun 2007. WSJEE pC1.

“Subprime Woes Weave Tangled Web. Lingling Wei, Ruth Simon and James R. Hagerty”

“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.”

FDIC says the difficulty of modifying securitized loans has been exaggerated

18 Nov 2008.

“What Securitization Problem? The F.D.I.C. Weighs In. By JOE NOCERA”

“Sheila Bair, the chairman of the Federal Deposit Insurance Corporation, and Michael H. Krimminger, the F.D.I.C.’s special adviser to the chairman for policy. … in their opinion, whatever difficulties there are in modifying mortgages, the problem is not the fact that so many subprime mortgages are trapped in securitization pools.

As regular readers know, I have quoted a number of experts and people in the securitization business who have told me repeatedly that it is nearly impossible to modify mortgages that are trapped in toxic mortgage-backed securities. The contracts, they say, don’t really have provisions for preventing foreclosures. And the servicers face terrible conflicts if they try to modify mortgages, because inevitable some of the bond investors will do better than others — depending on where they stand along the risk continuum — and under those same contracts, servicers are obliged to treat all investors alike. Finally, I’ve heard, servicers have been unwilling to lift a finger for homeowners because they have no financial incentive to do so — and they face the prospect of being sued by one of their investors if they do.

… What the agency has discovered, said Mr. Krimminger, is that the contracts are rarely as constricting as investors and servicers have been portraying them. They do not allow principal reduction, for sure, but they almost never disallow interest rate reduction — or delaying principal payments for a short time. What’s more, Mr. Krimminger said, the servicer agreement simply says that the servicer’s job is to maximize the investment — which often means avoiding foreclosure. “One sample Pooling and Servicing Agreement provides as follows,” Mr. Krimminger wrote me in a follow-up e-mail message: “In connection with a seriously delinquent or defaulted Mortgage Loan, the Master Servicer may, consistent with the Servicing Standard, waive, modify or vary any term of that Mortgage Loan (including modifications that change the Mortgage Rate, forgive the payment of principal or interest or extend the final maturity date of that Mortgage Loan ), accept payment from the related Mortgagor of an amount less than the Stated Principal Balance in final satisfaction of that Mortgage Loan, or consent to the postponement of strict compliance with any such term or otherwise grant indulgence to any Mortgagor if in the Master Servicer’s determination such waiver, modification, postponement or indulgence is not materially adverse to the interests of the certificate holders (taking into account any estimated loss that might result absent such action) and is expected to minimize the loss on such Mortgage Loan.’” He also added that most of the agreements he has seen have similar language”

Some servicing contracts require loans to be repurchased by lenders before modification

2 Dec 2008. FTUSA p18.

“Challenge to BofA's modified mortgages. Saskia Scholtes”

“Mr Frey [Bill Frey, chief executive of Greenwich Financial Services, and an investor in mortgage securities issued by Countrywide Financial] argues contracts governing servicing of securitised Countrywide home loans require BoA to buy the mortgages back at face value before they can be modified. More than $2,000bn of mortgage loans have been sold into securities, but servicing contracts for them vary about the degree to which mortgages can be modified. Some require lenders to buy back loans they modify and almost all require lenders to repurchase loans that fall short of underwriting standards.”

Chase says it will modify even securitized loans

16 Jan 2009. Chase press release.

“Chase Extends Modification Efforts to Include the $1.1 Trillion of Investor-Owned Mortgages it Services”

“Chase announced today that it has extended its mortgage modification efforts to the investor-owned loans that it services – about $1.1 trillion of loans – significantly expanding the reach and effectiveness of its previously announced mortgage modification efforts. This effort includes investor-owned mortgages held in securitizations.

Based on the company's review of investor agreements and its experience with investors and trustees to date, Chase believes it can legally modify the vast majority of mortgages owned by investors consistent with the relevant investor agreements and the best interests of investors, and intends to make modifications where appropriate. Chase will continue to seek investor approval in the small number of situations where investor agreements contain specific terms that may limit modification actions Chase can take.

“Building on our modification efforts for Chase-owned loans, we have reviewed closely the terms of our investor agreements and have worked with investors, trustees, government officials and other interested parties to fashion an approach to foreclosure prevention efforts that will work for investors and homeowners,” said Charles W. Scharf, Chief Executive Officer for Retail Financial Services at Chase.”

Foreclosure goes against junior tranches, while principal reduction goes against all

5 Mar 2009. Naked Capitalism.

“The Treasury Mortgage Mod Program: Should We Hope It Doesn't Work? Yves Smith”

“there is a very big complication with this “gee, there is a win-win space here, so why is no one making mods?” view. The big one is the difference in treatment of a mod (well, at least the principal reduction kind) versus a foreclosure. For a foreclosure, the losses go against the lowest tranches first, and then proceed to higher tranches. However, with a principal reduction, all tranches, including the AAA (or more accurately, what was once AAA) layer. In many cases, the bank that is running the servicer holds some of that paper and would have to mark it down.”

It seems that securitization is not hindering modifications

6 Jul 2009. Boston Fed Public Policy Discussion Paper.

“Why Don’t Lenders Renegotiate More Home Mortgages? Redefaults, Self-Cures, and Securitization. Manuel Adelino, Kristopher Gerardi, and Paul S. Willen”

“Abstract: We document the fact that servicers have been reluctant to renegotiate mortgages since the foreclosure crisis started in 2007, having performed payment-reducing modifications on only about 3 percent of seriously delinquent loans. We show that this reluctance does not result from securitization: servicers renegotiate similarly small fractions of loans that they hold in their portfolios. …

we explore the renegotiation of home mortgages using a dataset from Lender Processing Services (LPS), a large, detailed sample of residential mortgages. …

of the more than 800 lawsuits filed by investors in subprime mortgages through the end of 2008, not one involved the right of a servicer to modify a loan.”

[This last statement seems to ignore Mr. Frey, above, who was suing BofA on just this matter. But perhaps that is the only case; see 20 Aug 2009 entry below.]

Other factors may be confounding the Boston Fed study

16 Jul 2009. Credit Slips.

“Is Redefault Risk Preventing Mortgage Loan Mods? by Adam Levitin”

“I don't know if LP includes data on loans held in portfolio by credit unions and community banks. If it doesn't, that might be distorting the results as the portfolio loans for large banks might well be serviced by the same servicers as securitized loans. If so, the study wouldn't be comparing securitized vs. portfolio, as much as self-serviced vs. serviced-by-others.

Irrespective, there is a major factual issue overlooked by the study: there is a difference in how a securitization servicer and a portfolio lender view redefaults and self-cures.”

Securitization makes it harder to do principal reductions

22 Jul 2009. Credit Slips.

“Does Securitization Affect Loan Modifications? by Adam Levitin”

“OCC/OTS Mortgage Metrics Data for the first quarter of 2009 indicates that very few loan modifications have involved principal balance reductions. In fact out of 185,186 loan modifications in Q1 2009, only 3,398 (1.8%) involved principal balance reductions. All but 4 of those 3,398 principal balance reductions were on loans held in portfolio. The other 4 are quite likely data recording errors. This means that there is heterogeneity in loan mods between securitized and portfolio loans.

The difficulty in doing principal reduction mods for securitized loans is quite important because to the extent that negative equity is driving foreclosures (and there is significant evidence that it is), principal reduction modifications are the tool for eliminating negative equity (with an shared appreciation clawback or not). The quality of loan modifications matters, and securitization affect the quality. …

The take-away here is that even if the Boston Fed staff is right that securitization doesn't affect the prevalence of loan modifications, it clearly affects the quality of those modifications, and that is every bit as important, not least because the performance of past modifications is the basis for servicers' calculation of the redefault risk that the Boston Fed staff emphasizes as constraining modifications. If servicers do bad mods and have high redefaults, that will make them more adverse to doing mods in the future because they will think that the mods don't work.”

Overblown fear of investor lawsuits in mortgage mods

20 Aug 2009. Credit Slips.

“Mortgage Modification Investor Lawsuit. by Adam Levitin”

“The District Court ruling in Greenwich Financial Services v. Countrywide, addressing the servicer safe harbor provision for doing loan modifications, is linked here. See here for the NYTimes story. See here for the complaint.

Quick version: the ruling went against Countrywide, but it was a procedurally based ruling about whether the case belongs in Federal District Court or state court at this point, not on the merits. (As an aside, I think the reason this case wasn't removed to the Federal District Court on diversity jurisdiction grounds is because Countrywide is a “citizen” of New York, so under the Class Action Fairness Act removal isn't possible. 28 U.S.C. 1441(b).)

What I find most fascinating about this case is that it is the only investor lawsuit related to modifications about which I know. (But please post in the comments if I'm wrong on this.) For a while the story we heard from servicers was one of avoiding loan mods due to the fear of litigation (of course, there could just have easily been litigation for not doing mods). Interesting how that litigation never materialized.”