Big Four Testify On Principal Reductions

Despite prodding from lawmakers to write down second-lien mortgages and new guidance from the Treasury Department that incentivizes such reductions, representatives from the nation's four largest servicing operations will tell a House panel today that cutting principal balances is a drastic move that should be reserved for select borrowers and products.

Executives from Bank of America, JPMorgan Chase, CitiMortgage and Wells Fargo will testify today before the House Financial Services Committee, whose chairman, Rep. Barney Frank, D-Mass., has been among the most outspoken politicians to advocate principal reductions. In March, Frank wrote a letter to the CEOs of the four mega-servicers, stating that the problem of second mortgages standing in the way of principal-reduction modifications had reached a "critical stage."

‘I urge you in the strongest possible terms to take immediate steps to write down these second mortgages and allow principal-reduction modifications of the underlying first liens to take place," Frank's letter said.

First-lien investors often balk at reducing principal on loans for borrowers whose second liens are not fully extinguished. Though Frank's letter insinuated that many seconds have no economic value, the servicers appearing before his panel today will explain that subordinate liens perform relatively well and argue that across-the-board principal reductions carry hefty risks that have the potential to inflate future lending costs.

Ninety-seven percent of borrowers in Chase's second-lien portfolio are current or less than 60 days past due, according to prepared testimony from David Lowman, CEO of home lending at JPMorgan Chase. Of the second liens that have a combined loan-to-value ratio above 100%, 95% of borrowers are current or less than 60 days delinquent.

"Regardless of loan to value, as long as borrowers continue to do the right thing and fulfill their contractual obligations, second liens that are current and producing cashflow to investors have value," Lowman says. Nearly two-thirds of borrowers who are between 30 and 59 days delinquent on their Chase-serviced first liens are current on their second liens.

The majority of home equity loans are used by consumers to finance specific needs outside of housing. No more than 20% of borrowers use home equity proceeds to purchase a home, Lowman says, citing internal research and Federal Reserve data. Barbara Desoer, Bank of America's president of home loans, will tell the committee that only 10% of the bank's home equity portfolio consists of piggyback loans.

Together, Bank of America, Citi, Wells Fargo and Chase account for about half of the nation's second-lien mortgages. All four companies have committed to the Obama administration's Second Lien Modification Program (2MP) in recent months. Last week, Bank of America, the first shop to sign on to the program, began mailing trial modification offers to its home equity borrowers.

Principal reductions, long pushed by consumer advocacy groups, have slowly been woven into servicing practices. Democratic lawmakers failed last year in their efforts to resuscitate bankruptcy cramdown legislation, which would have essentially permitted judges to cut principal for borrowers in bankruptcy.

But last month, the Obama administration announced new monetary incentives under the Home Affordable Modification Program (HAMP) that encourage such write-downs. Bank of America has announced a similar "earned" principal reduction program for borrowers who qualify for assistance under the bank's multi-state settlement concerning certain Countywide loan products.

But whether or not second liens are the reason investors rarely agree to forgive principal on first mortgages remains a question in debate. Lowman's testimony references Chase data that show the company's HAMP first-modification completion rate is "virtually the same," regardless of if Chase is aware of the existence of a second lien. Bank of America's Desoer says in her remarks that only 4% of the bank's 2.2 million second liens held in portfolio are delinquent, behind a delinquent first mortgage and not supported by any equity. The company has written down more than $10.5 billion over the last two years on its home equity portfolio.

"For those situations where first and second liens are held by different investors and it is difficult to reconcile their economic interest, we believe a compromise solution on principal reduction is contained within the logic of 2MP," Desoer says. Later in her testimony, she explains that Bank of America would advocate working on a "similar industry-wide process that would require the second-lien holder to take a principal-balance reduction proportionate to the first-lien holder."

Most, if not all, of the companies appearing before Congress today have used principal reductions on a limited basis. Wells Fargo began cutting principal on its portfolio loans in January 2009. Unlike the new initiatives announced last month by the administration and Bank of America, Wells Fargo's principal reductions do not feature an "earn out" over time, according to Mike Heid, co-president of Wells Fargo Home Mortgage.

The company uses principal reductions for customers who share certain characteristics. Specifically, the borrowers are owner-occupants who have suffered financial hardships and whose homes are concentrated in areas with severe price declines.

"Principal forgiveness is not an across-the-board solution," says Heid. "Not every homeowner with a loan balance that exceeds the value of their home falls behind in their payment. Payment affordability continues to be the key."

Chase is working to obtain regulatory approvals for a principal-reduction program that targets certain option adjustable-rate mortgage customers in its portfolio. The company also plans to offer a Hope for Homeowners refinance option this summer. But Lowman's testimony clearly reflects the company's view that large-scale principal reductions are potentially harmful.

"If we re-write the mortgage contract retroactively to restore equity to any mortgage borrower because the value of his or her home declined, what responsible lender will take the equity risk of financing mortgages in the future?" he asks. "What responsible regulator would want lenders to take such risk?"


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