Boston Fed: Redefault Risk And Self-Cure Risk Impede Renegotiations

[link=][u]study[/u][/link] from the Boston Federal Reserve suggests that redefault risk and self-cure risk, and not contract frictions in securitization trusts, are driving servicers' reluctance to modify loans. Approximately 30% of seriously delinquent borrowers cure without receiving a modification, according to the report, which used a Lender Processing Services data set covering about 60% of all U.S. mortgages originated between 2005 and 2007. Between 30% and 45% of borrowers who received modifications ended up in 60-day buckets within six months. The industry's awareness of redefault rates has been high for months, as a report issued by the Office of the Comptroller of the Currency and the Office of Thrift Supervision late last year highlighted the fact that many modifications, a large percentage of which featured monthly payment increases, are unsustainable. The most OCC/OTS report shows the proportion of payment-reducing modifications increased in the first quarter of 2009. The Boston Fed economists also found that private-label loans are less likely to cure, but that the gap is small. "[W]e estimate that a cure rate of around 30 percent for the typical portfolio loan and a cure rate of about two percentage points less for an otherwise equivalent private-label loan," the study says in regard to the full data sample. In its subprime subsample, which has information about documentation and debt-to-income ratios, however, the study shows that private-label loans are "significantly more likely to cure." Three implications can be pulled from the research, the authors say. Safe-harbor provisions, for one, should have little effect on the number of modifications. Second, there may be fewer preventable foreclosures than is conventionally believed to be the case. And third, although the economists' model shows reasons why investors may not want to agree to modifications, "that does not necessarily imply that modifications may not be socially optimal." "One key input to our theoretical model is the discount rate, and it is possible that investors, especially in a time when liquidity is highly valued, may be less patient than society as a whole and, therefore, foreclose when society would prefer renegotiation," the study says. "Large financial incentives to investors or even to borrowers to continue payment could mitigate this problem." SOURCE: Boston Federal


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