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Multiple lender issues in foreclosure mitigation [ClearOnMoney]
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Multiple lender issues in foreclosure mitigation

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Multiple lender issues in foreclosure mitigation

This page is about the extent to which objections from second lienholders and MBS/CDO investors make a practical difference in large-scale foreclosure mitigation.

Summary

8 Mar 2011.

Over half of all first liens have associated second liens, and a key difficulty for mortgage modifications lies in the different interests of first and second lienholders. First lienholders typically feel that, per their senior status, they should not have to give up significant value in refinancing or modification until after second lienholders are wiped out. On the other hand, modification of the first lien puts its senior position in a position of legal ambiguity, and second lienholders use this to extract some value. The 2MP component of the Making Home Affordable program was designed to break the deadlock by requiring participating servicers to modify second liens in a parallel manner with first, or accept an extinguishment payment. However 2MP has seen essentially no uptake.

Although securitization does make a mortgage modification decision more complex – if only because there are more interested parties – it is unlikely that securitization is a primary roadblock. However securitization can 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 do occur less often with securitized loans.

Highlights

Clippings below covered through 14 Apr 2010.

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.


Second liens (8 Mar 2011) A few points in addition to the above summary:

  • In a modification or refinancing the first lien may lose senior status – the legal situation is somewhat ambiguous, but to avoid risk the first lienholder typically asks the second lienholder to explicitly resubordinate.
  • In many cases a second lienholder sees a chance to extract some value in exchange for resubordination; sometimes some relatively small compensation will gain cooperation; sometimes the second lienholder blocks changes in the first lien, on the hope the borrower will pay them off completely.
  • Four banks that own over half of the servicing market also hold over half of all HELOCs, suggesting that second liens may have an unfair advantage.
  • Principal modification is uncommon partly because any second liens would have to be settled if the first lien is no longer worth face value.
  • Although first liens have priority on the collateral, i.e. the foreclosure proceeds, second liens are normally recourse loans, and so retain some value after the first lienholder forecloses, if the homeowner has other assets.

See also

Below are clippings used in constructing this page

Second lienholder can block refinancing

7 Mar 2008. Michael Steinberg on SeekingAlpha.

http://seekingalpha.com/article/67629-banks-using-leverage-to-force-home-equity-repayments

“Banks Using Leverage to Force Home Equity Repayments”

“The Wall Street Journal's (3/6/08) “Some Borrowers Hit New Snag In Refinancing” discusses efforts by Bank of America (BAC), IndyMac (IMB), National City (NCC) and Wells Fargo (WFC) to hold first mortgage refinancing hostage to their home equity loans and lines of credit. Their second lien position would move to first unless they subordinate to the new first mortgage. The banks are using their leverage to force borrowers to either repay their home equity loans and lines, or reduce the existing lines. The WSJ gives examples of banks refusing to subordinate for borrowers with strong credit to refinance. The borrowers would get a new first mortgage with a lower interest rate and monthly payment, leaving more money available to pay the home equity loan. You would think that the banks would enthusiastically embrace this. But, it is more important for the banks to reduce their exposure to second liens. When home equity line of credit [HELOC] securitizations reach a certain delinquency level, banks are no longer reimbursed for HELOC advances to borrowers. Previously, in “Power of 2nd Place”, I spoke about banks using second liens to block short sales. (Short sales allow the property to be sold at less than the mortgage balance.) The first mortgage holder must negotiate compensation for the second lien holder in order to proceed and grant the new buyer a clean title. The same would be true in a “short” refinancing. Home equity products differ from first mortgages in that they generally have recourse beyond the property. While it is often not practical to foreclosure on a home equity loan, the banks can pursue other assets.”

Primary loan mods will often be blocked by second-lien holders

20 May 2008. Financial Times (US edition) p12.

http://www.ft.com/cms/s/0/10d0953c-2607-11dd-b510-000077b07658.html

“Washington sidesteps financing a big black housing hole. JOHN DIZARD”

“The next reason for the modest scope of the “rescue” is the second lien minefield. You can get all the servicers or holders of a first lien mortgage to agree to a modification of the terms, and a refinancing by a Federal housing agency, but unless the second lien holders agree, nothing will happen. Typically, if a homeowner is past due on their mortgage payments, they have also defaulted on a home equity loan or some other second lien obligation. Those lenders are often not the same institutions as the first lien mortgage holders. By the time the mortgage is in default, this paper has no real market value of the property backing it up. The only leverage the second lien holder has left is the ability to block a refinancing of the first lien. The second lien holder has no incentive at all to waive that right, unless they are compensated. But the proposed legislation does not have any provision for any payments to second lien holders.”

8 Sep 2008. Federal Reserve Board paper.

http://www.federalreserve.gov/pubs/feds/2008/200846/index.html

“The Incentives of Mortgage Servicers: Myths and Realities. Larry Cordell, Karen Dynan, Andreas Lehnert, Nellie Liang, and Eileen Mauskopf”

“A major impediment to refinancing and loss mitigation is the presence of junior liens, which appear to be more common among subprime than among prime mortgages. Senior lien holders generally require the holders of junior liens to affirmatively agree to substantive changes to mortgage terms. But junior lien holders are slow or reluctant to agree to changes before extracting the largest monetary concession they can because the value of their lien is often worthless in a foreclosure in today's depressed housing market. …

Significant changes to the senior lien may result in the revised lien being treated as a new lien; that is, modified loans can be treated like a refinancing. In such cases, in principle, unless the junior lien holder agrees to re-subordinate its lien, it becomes the senior lien holder. The actual extent to which senior lien holders are treated as subordinate when they modify loans without the junior lien holders' consent is unknown, but seems fairly rare. Indeed, the practice of subordinating modified senior liens appears related to state legal traditions and the applicable local case law. It may be the case that senior lien holders are overestimating the risk that courts will consider them as subordinate following a modification.

Nonetheless, given the legal uncertainties surrounding modifications, senior lien holders generally require the junior lien holder to affirmatively agree to subordinate their claim to the modified senior lien before agreeing to the modification.

  • Newer liens usually have lower priority then older liens.
  • Based on case law, courts may treat modified senior loans as newer than, and hence subordinate to, an existing junior lien. The extent of this practice depends on state legal traditions and previous findings by local courts. We have not found any instances in the current foreclosure episode of junior lien holders successfully promoting their claim over a senior lien holder, although many lawsuits have yet to work their way through the courts.
  • Given the legal uncertainty regarding the seniority of their claim following a modification, senior lien holders are reluctant to undertake a major modification of a loan and then become junior to another lien-holder. In practice, senior lien holders generally require the junior lien holder to affirmatively agree to the modification by agreeing to re-subordinate.
  • Conversations with servicers indicate that the GSEs routinely paid junior lien holders to agree to re-subordinate. These payments ranged from $1,000 to $2,000 to as much as $5,000 in some circumstances.

Junior lien holders have been slow and reluctant to agree to re-subordinate in this episode and have held up refinancings, modifications, and short sales.

  • Servicers may not have the operational controls or experience to get second-lien lenders to agree to re-subordinate quickly.
  • In today's depressed housing market, when a mortgage is being modified it is likely that the junior lien holder has essentially no equity; thus, a big part of the value of the lien is the ability to extract a payment from the senior lien holder in a workout.
  • Sources at the GSEs indicate that junior lien holders have started demanding larger payments in order to agree to re-subordinate. This may be because junior liens are no longer always the traditional piggyback, but may be HELOCs with balances of $50,000 or more.
  • Traders indicated to us that, in the past year, prices for pools of delinquent closed-end subprime second liens were around 1 to 3 cents on the dollar, and prices for lower-rated tranches of securitized subprime second liens were in the same low range, between 0 and 5 cents.
  • In the case of short sales, junior lien holders must agree to release their liens and take a loss. Servicers have reported instances where delays in resolving disputes between junior and senior lien holders results in prospective buyers of the property going elsewhere, forcing the loan into foreclosure.

The Hope Now servicer guidelines issued in June 2008 include an automatic re-subordination of second liens “when the second lien holder's position is not worsened as a result of a refinance or loan modification.”

  • “Not worsened” is understood to include: (a) a refinancing that does not increase the principal amount of the first lien by more than reasonable closing costs and arrearages, and no cash is extracted by the homeowner; or (b) a loan modification that lowers or maintains the monthly payment and no cash is extracted.
  • However, PSAs for junior liens may have additional constraints that prevent servicers from following these guidelines in some circumstances.”

Servicers have particular interest in second liens

24 Apr 2009. Financial Times (US edition) p22.

http://www.ft.com/cms/s/0/55fb37a6-303e-11de-88e3-00144feabdc0.html

“Clash looms over US mortgage aid. Saskia Scholtes, Aline van Duyn”

“second lien loans are mostly owned by banks, which also own the mortgage servicers. A “servicer safe harbour” in [proposed] legislation would shield servicers from legal action if they change the terms on people's mortgages, many of which back securities.

Investors say this would allow servicers to prioritise the [second lien loans]. …

Bank of America, Wells Fargo, JPMorgan Chase and Citibankown more than $400bn of second lien mortgages. …

Investors say they are willing to take losses by reducing mortgages, moves some had resisted until recently. But they want those banks that lent people money that was supposed to get hit first - second lien mortgages - actually to be hit first. … some investors believe a servicer safe harbour might work, as long as it came alongside requirements that second lien holders took losses before first lien holders.”

[Separate caption:] “The top four servicers [BofA, Wells Fargo, Chase, Citi] hold a 55% share of the servicing market and (as of year-end 2008) held $347bn of residential revolving lines of credit [according to the accompanying table, this was 52% of all HELOCs].”

Second lien mod cost sharing or extinguishment payout

28 Apr 2009. US Treasury Second Lien Fact Sheet

http://www.ustreas.gov/press/releases/reports/042809secondlienfactsheet.pdf

“Making Home Affordable Program Update”

“Shared Efforts with Lenders to Reduce Second Mortgage Payments: Making Home Affordable will share the cost with lenders of reducing payments for homeowners on second mortgages.

  • For amortizing loans (loans with monthly payments of interest and principal), we will share the cost of reducing the interest rate on the second mortgage to 1 percent. Participating servicers will be required to follow these steps to modify amortizing second liens:
    • Reduce the interest rate to 1 percent;
    • Extend the term of the modified second mortgage to match the term of the modified first mortgage, by amortizing the unpaid principal balance of the second lien over a term that matches the term of the modified first mortgage;
    • Forbear principal in the same proportion as any principal forbearance on the first lien, with the option of extinguishing principal under the Extinguishment Schedule;
    • After five years, the interest rate on the second lien will step up to the then current interest rate on the modified first mortgage, subject to the Interest Rate Cap on the first lien, set equal to the Freddie Mac Survey Rate;
    • The second mortgage will re-amortize over the remaining term at the higher interest rate(s); and
    • Investors will receive an incentive payment from Treasury equal to half of the difference between (i) the interest rate on the first lien as modified and (ii) 1 percent, subject to a floor.
  • For interest-only loans, we will share the cost of reducing the interest rate on the second mortgage to 2 percent. Participating servicers will be required to follow these steps to modify interest-only second liens:
    • Reduce the interest rate to 2 percent;
    • Forbear principal in the same proportion as any principal forbearance on the first lien, with the option of extinguishing principal under the Extinguishment Schedule;
    • After five years, the interest rate on the second lien will step up to the then current interest rate on the modified first mortgage, subject to the Interest Rate Cap on the first lien, set equal to the Freddie Mac Survey Rate;
    • The second lien will amortize over the longer of the remaining term of the modified first lien or the originally scheduled amortization term, with amortization to begin at the time specified in the original contract;
    • Investors will receive an incentive payment from Treasury equal to half of the difference between (i) the lower of the contract rate on the second lien and the interest rate on the first lien as modified and (ii) 2 percent, subject to a floor.

Pay-for-Success Incentives for Servicers and Borrowers:

  • The Second Lien Program will have a pay-for-success structure similar to the first lien modification program, aligning incentives to reduce homeowner payments in a way most cost effective for taxpayers.
    • Servicers can be paid $500 up-front for a successful modification and then success payments of $250 per year for three years, as long as the modified first loan remains current.
    • Borrowers can receive success payments of up to $250 per year for as many as five years. These payments will be applied to pay down principal on the first mortgage, helping to build the borrower's equity in the home.

Payment Schedule to Compensate Lenders for Extinguishing a Second Mortgage:

  • As an alternative to modifying the second lien, lenders/investors will have the option to extinguish second liens in exchange for larger payments under a pre-set formula. This will allow second lien holders to target principal extinguishment to the borrowers where extinguishment is most appropriate.
    • For loans that are more than 180 days past due at the time of the modification, the lender/investor will be paid three cents per dollar of UPB extinguished.”

FFIEC pronounces that second liens should not slow first lien mods

6 Aug 2009. FDIC press release

http://www.fdic.gov/news/news/financial/2009/fil09045.html

“Support for Responsible Loss Mitigation Activities: Servicers' Obligations to Lienholders on Modifying Loans”

“the Federal Financial Institutions Examination Council (FFIEC) [members at http://www.ffiec.gov/members.htm] continue to support responsible loss mitigation …

Regardless of any potential effect on the subordinate lien loan, servicers should modify the first lien mortgage when doing so would produce a greater anticipated recovery to the first lien owners/investors than not modifying the loan. Failure to do so may be a breach of the servicer's obligation to those owners/investors.”

Principal reduction would cause 2nds to be written off

18 Sep 2009. Bloomberg.com.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a.wV83iJI34k

“BlackRock’s Fink Says Obama Rules Threaten Markets (Update1). By Sree Vidya Bhaktavatsalam and Jody Shenn”

“Bond investors would prefer that more homeowners had loan balances reduced rather than payment terms eased, Curtis Glovier, a managing director at New York-based Fortress Investment Group LLC, told Congress in July. Such aid for consumers whose debt is greater than the value of their homes is being blocked because other loan changes allow second mortgages to be kept “on the books of the financial institution as a performing asset,” he said.”

Amherst shows second liens are too prevalent to ignore

29 Jan 2010. Amherst Mortgage Insight

No link (available in the “Long Room” at FT.com)

“2nd Liens — How Important?”

“In this article, we look at the 2nd lien issue, demonstrating that just over 50% of 1st liens in private label securitizations have a 2nd (or higher lien) behind them. This includes simultaneous 2nds, subsequent 2nds and both. The presence of a 2nd lien raises the CLTV of by over 20 points, and has a significant adverse impact on 1st lien performance. We also show the performance of simultaneous 2nds is worse than subsequent 2nds. The policy implication: 2nd liens are too important to ignore when considering loan modifications. And if modifications involving principal reductions begin to gain traction, the second lien issue moves front and center.”

Second lien recourse is a major impediment to settling 1st lien

8 Mar 2010. WSJ.com

http://online.wsj.com/article/SB10001424052748704706304575107770265900644.html

“Home-Saving Loans Afoot. James R Hagerty”

“Rep. Barney Frank, chairman of the House Financial Services Committee, last week sent a letter to the four biggest U.S. banks demanding “immediate steps to write down second mortgages.” …

Lack of cooperation from holders of second liens also can block short sales, in which the first-lien lender agrees to allow the home to be sold for less than the loan balance due to avoid a foreclosure. If the second-lien holder continues to press its claim against the borrower, the sale can fall through. …

Most first-lien home loans are held by the government-controlled mortgage companies Fannie Mae and Freddie Mac or by other investors in mortgage securities. By contrast, banks hold most of the seconds and other junior-lien mortgages. About $1.05 trillion of junior-lien home mortgages were outstanding as of Sept. 30, according to the Federal Reserve. Of those, $766.7 billion were held by commercial banks; most of the rest were owned by savings banks and credit unions.

If banks are forced to write down or write off large amounts of those second mortgages, many would suffer major dents in their capital. Laurie Goodman, a senior managing director at mortgage-bond trader Amherst Securities Group LP, said regulators may need to allow banks to recognize losses on second-lien loans over an extended period to avert a disastrous immediate hit to their capital.

One reason banks are reluctant to write off second mortgages is that some may still have value even after a foreclosure. Though the foreclosure wipes out the lien on the home, the consumer still has a legal obligation to repay the second mortgage debt in some cases. If the borrower has no significant assets remaining, banks generally don't bother trying to collect that debt. But they do retain that option and some say they will pursue it in cases where the borrower has significant assets or income, or may later have the ability to repay.”

All four of the top servicers are now signed up for 2MP

25 Mar 2010. Housing Wire.

http://www.housingwire.com/2010/03/25/citi-joins-hamp-for-second-liens/

“Citi Joins HAMP for Second Liens. by DIANA GOLOBAY”

“Citigroup (C: 4.27 0.00%) agreed to participate in the Second Lien Modification Program (2MP) within the administration’s Home Affordable Modification Program (HAMP). …

Citi is among the first servicers to sign on to the program, following days after JPMorgan Chase (JPM: 44.94 0.00%) announced it would participate. Last week, Wells Fargo (WFC: 31.06 0.00%) signed on to participate in 2MP after Bank of America (BAC: 17.74 0.00%) became the first to sign on in January.”

Some clarification on second mortgages

14 Apr 2010. Calculated Risk.

http://www.calculatedriskblog.com/2010/04/lawler-boa-and-chase-on-second.html

“Lawler: BoA and Chase on Second Mortgages. by CalculatedRisk”

“The following report is from housing economist Tom Lawler:

In a House Financial Services Committee meeting today on “Second Liens and Other Barriers to Principal Reduction as an Effective Foreclosure Mitigation Program, spokespersons from BoA, Citi, JPMorgan Chase, and Wells Fargo explained the potential dangers of broad principal reductions, as well as tried to dismiss the silly claim that many second mortgages have “virtually no value” because so many borrowers with seconds have total mortgage balances at or exceeding the value of the home collateralizing those mortgages. Below are some observations on BoA’s and Chase’s testimony.

BoA provided a few interesting stats: of the 10.4 million first lien mortgages that it services, 15% of second mortgages owned by BoA, while 16% have second mortgages with other lenders. (Thus, 31% have second liens!). …

[Chase said] “It is important not to confuse payment priority with lien priority. In almost all scenarios, second lien holders have rights equal to a first lien holder with respect to a borrower’s cash flow. The same is true with respect to other secured or unsecured debt, such as credit cards or car loans. Generally, consumers can decide how they want to manage their monthly payments. In fact, almost 64% of borrowers who are 30-59 days delinquent on a first lien serviced by Chase are current on their second lien. It is only at liquidation or property disposition that first lien investors have priority.” ”