Realty Check

Lenders Reduce Principal? Not So Fast


This morning my boss came into my office, wondering why in my reporting yesterday on the Comptroller of the Currency's "Mortgage Metrics Report" (which gives all kinds of data on how many "home retention actions" were taken by banks in Q2), I left out a big jump in principal write-downs. This is when the bank actually reduces the amount of the loan, effectively giving the borrower more equity in a home that may have lost considerable value.

You see there is this big article in the Wall Street Journal this morning titled, "Banks Bite the Bullet on Loans." It cites a chart on P. 23 of the Mortgage Metrics Report that shows a jump in principal write-downs from 3% of modifications to 10% of modifications. The article says, "That's good news for some homeowners, but may portend more write-offs over the next few years for banks and other lenders now wading through hundreds of thousands of applications for loan modifications."

Here's why I didn't report it, and also why I don't regret not reporting it:

There are two types of home retention efforts reported, repayment plans and modifications. Repayment plans help a borrower catch up, and often result in higher monthly payments. Modifications change the terms of the loan and usually result in lower monthly payments. Right now, the government's Home Affordable Modification Program is still in its three-month trial period, so loans being modified under the plan are being lumped in the Repayment bin, despite the fact that it requires lenders to lower monthly payments. When HAMP loans pass their three-month trial, they then become Modifications and will leave the Repayment bin and go into the Modification bin. The report shows that in Q2 Repayment plans rose by 74 percent from the previous quarter and Modifications fell 25 percent. Why? Because all the banks are now doing HAMP.

The numbers that the Wall Street Journal reporter is looking at are the Modifications, which are all done by individual bank programs, not using the government's new bailout. That's 142,362 loans out of the total 439,574 home retention actions. In that much smaller subset, yes, principal write-downs went from 3 to 10 percent.

Now, I know you're asking, what about the HAMP program, where lenders could write down principal if they want? Well I called a certain government official about this on background, and here's what he said: Yes, lenders can, although they are never required to, write down principal. But the way HAMP works is through a "waterfall" kind of system: First the lender looks at the loan, capitalizes any past due interest, fees, etc. and starts at the top. 1) reduce interest rate as low as 2 percent, 2) extend the maturity of the loan up to 40 years, 3) take a portion of the principal and defer (not forgive) it as a non-interest-bearing balloon. If that doesn't get to the 31 percent debt-to-income ratio, then the lender can, again only if they want, write down principal.

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But at that point there is also the net present value test to see if the loan is really worth saving, and as home prices now are stabilizing, and investors are buying up foreclosures, it's more than likely that the lender is going to come up with a better value going to foreclosure than writing down principal. The government source tells me that all lenders are now running loans through the HAMP model before doing any of their own modifications.

True, there is no data yet on how many HAMP trial mods have principal write downs, but my guess is very very few.

Questions?  Comments?