Wednesday, April 14, 2010

Lawler: BoA and Chase on Second Mortgages

by Bill McBride on 4/14/2010 11:06:00 PM

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!).

BoA also said that about 90% of BoA’s owned second-lien mortgage portfolio is made up of “standalone originations used to finance a specific customer need, such as education expenses or home improvements, with “(t)he remainder consists of piggy back (combo) loans originated with the home purchase.” BoA made this point to highlight that the vast bulk of its second mortgage lending was collateralized consumer credit lending, where the borrower’s ability to pay was a major factor behind extending the credit.

Here is what BoA said about their second mortgage portfolio:

“Most of our second loans continue to have collateral value, and of those where the second loan is underwater, a significant number are still performing. Indeed, out of 2.2 million second liens in Bank of America’s held for investment portfolio – only 91,000 seconds – about four percent – are (i) delinquent, (ii) behind a delinquent first mortgage and (iii) not supported by any equity.”

BoA’s spokesperson vexed a number of investors in first-lien mortgages (or securities backed by such mortgages) by saying that in cases where the first and second are held by different investors, the “logic of 2MP” (the administrations second mortgage program) where “the holder of the second lien is required to forebear a similar percentage as the first lien holder” seems “equitable” to BoA – despite the subordinate nature of the second, and despite the fact that the 2MP program does not require second mortgage holders to forgive principal, even when the first mortgage holder does!

Here is what Chase said about its Home Equity (second) mortgage portfolio:
Chase owns about $131 billion in Home Equity loans and lines as of February 28, 2010.

• Approximately $25 billion are home equity loans and $106 billion are home equity lines of credit.
• Approximately $33 billion are in first lien position and $98 billion in second lien position.
• 5% of Chase’s home equity portfolio is 30 days or more delinquent. Total home equity line, home equity loan, first lien and second lien delinquency rates are within two percentage points of the overall total.
• About 50% of the total Chase second lien portfolio is underwater, and 95% of this portfolio is performing (less than 60 days past due). 30% of second lien mortgages have combined loan-to-value ratios over 125% and 94% of this portfolio is performing.
• For $40 billion of Chase-owned second lien mortgages, Chase also services a first lien mortgage:
• 92% of these first lien mortgages are performing.
• 28% of these first lien mortgages are by themselves underwater (loan- to-value ratio of over 100%).
• 45% of first lien mortgages have a combined loan- to-value ratio of over 100%.
• About 10% of Chase’s total serviced portfolio of first lien mortgage loans has a Chase-owned second lien.
• Our best estimate is that about 20% of Chase serviced first lien mortgages may have a second lien from another lender and about 70% do not have a second lien.
And on the issue of broad-based principal reduction programs, as well as the “subordinate” nature of second mortgages, here is what Chase had to say:

“We do think that large scale, broad–based principal reduction programs raise serious policy concerns, for both first and second lien mortgage loans, and particularly for current borrowers with an ability to repay their obligations. In Chase’s view, such programs could be potentially very harmful to consumers, investors and future mortgage market conditions – and should not be undertaken without first attempting other solutions, including more targeted modification efforts.

“Like all loans, mortgage contracts are based on a promise to repay money borrowed. Importantly, there is no provision in the mortgage contract, express or implied, that the lender will restore equity or reduce the repayment amount if the value of the collateral – be it a home, a car or a stock market investment – depreciates. 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? What responsible regulator would want lenders to take such risk?

“We are also concerned that broad-based principal reduction could result in reduced access to credit and higher costs for consumers if market risk to lenders and investors materially increases. Borrowers likely will be required to increase their down payments, credit criteria will be further tightened and risk premiums for mortgage credit will increase and get passed on to consumers. Less affluent borrowers would likely be harmed disproportionately.

“The benefits of a broad-based principal reduction program are to a large degree unknown and in Chase’s view, outweighed by the risks and the facts that we do know.”

And here is Chase on why many second loan portfolios are performing better than firsts, as well as the risks involved in broad-based principal reduction plans:

“Many borrowers remain current on their home equity loans because they want to honor their obligations and protect their credit. Our data show that 97% of borrowers in Chase’s $98 billion second lien portfolio are performing on their loans (less than 60 days past due). For second liens that have a cumulative loan-to-value ratio greater than 100%, 95% of borrowers are performing. 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 cash flow to investors have value."

“Additionally, a broad-based second-lien principal reduction plan would be forgiving past consumption by borrowers rather than housing investment. According to both internal Chase and Federal Reserve data, over 50% of borrowers used home equity loan proceeds for repayment of debt or personal consumption. No more than 15-20% used home equity proceeds to purchase a home. A broad-based program of principal reduction would be very expensive. To bring underwater borrowers “even” to a loan to value ratio of 100%, we estimate:
• It would have an industry-wide cost of $700 billion to $900 billion.
• The cost to Fannie Mae, Freddie Mac and FHA alone would be in the neighborhood of $150 billion.
• The Federal Reserve and Department of Treasury would have additional exposure through their ownership interests and risk guarantees of AIG, GMAC, and other institutions.
• Mortgage lenders would incur a significant reduction in capital now, potentially impairing their ability to extend future credit – mortgage or otherwise.
• And if house prices decline further, the costs would be even higher, representing the implicit “put” at 100% CLTV. “
And on the issue of LIEN priority, here is what Chase had to say:

“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.”

The banks’ testimony, of course, was in response to a letter from Barney Frank, who has been heavily lobbied (and influenced) by the Mortgage Investors Coalition to get second mortgage holders to write down their loans. In that letter Congressman Frank incorrectly argued that because many borrowers with second mortgages have total mortgage indebtedness that exceeds the value of their homes, these second mortgages “have no real economic value,” and he urged banks “in the strongest possible terms to take immediate steps to write down these second mortgages.”

Here, by the way, are some residential mortgage servicing statistics as of the end of last year for the top four mortgage servicers:
12/31/2009Delinquency Stats: Q4/09
Company NameNumber of Loans Serviced130-day60-day90+-dayIn ForeclosureTotal Past Due
Bank of America 14,011,029 3.4%1.7%6.5%3.3%14.8%
Wells Fargo 12,168,836 2.4%1.2%3.5%1.9%9.0%
Chase 9,689,312 3.0%1.4%4.6%3.2%12.2%
CitiMortgage, Inc. 5,118,563 2.3%1.4%4.9%1.7%10.4%

1 includes first liens and subordinate liens

These “mega” servicers were, through the economies of scale in processing payments, able to charge a pretty small fee to service loans and still make what appeared to be a decent amount of money. However, as problem loans mounted it became clear that the companies were woefully understaffed to deal with these problem loans effectively, leading to extremely poor loss mitigation efforts, poorly designed foreclosure prevention/modification programs.

All of these companies finally began materially increasing the size of their staffs devoted to troubled loan management, and the administration’s HAMP effort helped prompt them to do so by providing hefty premiums to servicers. However, it took companies quite a while to get staff and board and train them, as was clearly evidence in last year’s overall servicing performance.

NOTE: This was from housing economist Tom Lawler.