For a homeowner in financial distress, there are multiple strategies for dealing with a second mortgage: Chapter 13 lien avoidance is one option, Chapter 7 followed by a short pay is another. Its rare that a second lien holder will foreclose. For a borrower, playing "kick the can" is not a bad idea either. The big banks will eventually have to shallow huge losses on this debt.
Jan. 19 (Bloomberg) -- The U.S. Treasury Department has failed to win agreements to get struggling borrowers' home- equity debt reworked, among the biggest roadblocks to reducing foreclosures that may reach a record 3 million this year.
None of the lenders holding a combined $1.05 trillion of the debt has signed contracts requiring participation in the second-mortgage modification plan announced eight months ago. The largest banks remain "committed" to joining, Meg Reilly, a department spokeswoman, said in an e-mail.
President Barack Obama in February announced a $75 billion program to cut first-mortgage payments. The Treasury detailed a plan on April 28 in which second-mortgage owners modify or retire debt when the first lien is changed, saying it would be running in a month. The near-record level of home-equity debt held by lenders including Bank of America Corp. and Wells Fargo & Co. may lead to foreclosures that threaten housing stability after the worst slump since the 1930s.
"The issue of the second liens has to be escalated," said Richard Neiman, New York's banking superintendent and a member of the Troubled Asset Relief Program's Congressional oversight panel. The government should consider forcing banks to participate and to recognize the "true value" of second liens, he said.
Bank of America, Wells Fargo, JPMorgan Chase & Co. and Citigroup Inc. carry such mortgages at about $150 billion more than their value, according to estimates by Joshua Rosner, an analyst at Graham Fisher & Co. in New York.
Equity lines and other second mortgages rank junior to typical mortgages, meaning they get wiped out in a foreclosure unless sale proceeds from a seized home exceed the first debt.
Still Struggling
As Obama's Home Affordable Modification Plan, or HAMP, lowers first-mortgage payments, some borrowers are still left with bills they can't afford, according to Newport Beach, California-based Pacific Investment Management Co.
"Modifying the first mortgage doesn't necessarily get the homeowner to good shape," Scott Simon, head of mortgage-bond investing at Pimco, manager of the world's biggest fixed-income fund, said in a telephone interview.
About 25 percent of homeowners who received trial loan modifications are failing to keep up with their reduced payments, the Treasury said Jan. 15.
Loan Modifications
Of an estimated 3.36 million U.S. homeowners with delinquent payments eligible for loan modifications under the Obama plan, 66,465 received permanent changes, according to Treasury data. That group saw its total median debt burden -- mortgage, junior liens, alimony, car payments and other bills -- reduced to 55 percent of gross income from 72 percent.
Rosner said overvalued home-equity debt prevents residents from getting the aid likeliest to keep them in their homes: principal forgiveness.
First-mortgage owners usually won't agree to the deeper principal reductions needed to reduce the loan to at or below the home's value when home-equity holders aren't willing to make sizable cuts, said John Taylor, chief executive officer of the Washington-based National Community Reinvestment Coalition.
Three million U.S. homes will be repossessed this year as high unemployment and depressed values leave borrowers unable or unwilling to make their payments or sell, RealtyTrac Inc. forecast on Jan. 14. Almost 10.7 million, or 23 percent, of residential properties with mortgages were in negative equity as of Sept. 30, according to First American CoreLogic.
Targeting Principle
Policy makers may be able to reduce re-defaults on modified debt from an average of 57 percent within a year "significantly" more by getting mortgages lowered rather than by spurring larger payment cuts, New York Federal Reserve Bank researchers wrote in a December paper.
The government is considering changes to permanently cut balances on which borrowers owe more than the property is worth, said Michael Barr, the assistant Treasury secretary for financial institutions.
"We are in the process of reviewing that now as we have been continually," Barr said on a conference call last week. "You have to be very careful not to design a program that would change people's behavior across the country."
Bank of America CEO Brian Moynihan "recommitted" to participating in the Treasury program this month as part of "our aggressive efforts to help customers," Rick Simon, a company spokesman, said in an e-mail.
Awaiting Final Guidelines
"We are waiting for final guidelines," Simon said.
Citigroup is "actively engaged with the U.S. Treasury in finding a workable solution," Mark Rodgers, a spokesman, said in an e-mail.
Wells Fargo is working with the government "to understand the program specifics," Mary Berg, a spokeswoman for the San Francisco-based bank, said in a phone message.
Tom Kelly, a spokesman for New York-based JPMorgan, declined to comment.
Banks' reluctance to write down second mortgages also hampers short sales, when homeowners sell a house for less than they owe, minimizing the damage to themselves, their communities and their lenders.
"If I had to name one sticking point, it's the second mortgage," said Ethan W. Gregory, an agent with First Coast Realty Associates in Jacksonville, Florida, who specializes in short sales.
'Nuisance Value'
Holders of home equity loans often hold up loan workouts to extract money from deals when their junior liens are technically worthless, said Dave Walker, chief credit officer of PennyMac Mortgage Investment Trust, a Calabasas, California-based company managing $2.85 billion in distressed mortgage debt.
"The typical focus of a second lien investor is to extract a 'nuisance value' out of the second lien rather than rehabilitate the loan," Walker said. "If the second lien is entirely underwater, they have little or no potential recovery through liquidation of the property and their interest is wiped out at foreclosure. However, they can often demand a small payment -- $1,000 to $3,000 -- to release their lien."
Americans tapped home equity as values more than doubled between the start of 2000 and the market's apex, and took "piggyback" loans in lieu of down payments.
Home prices rose in each of the six months through October, increasing 5.3 percent, after a record 33 percent plunge from the 2006 peak, an S&P/Case-Shiller index for 20 metropolitan areas showed. Gains were driven by a decline in the share of sales involving "distressed" properties that will reverse this year as foreclosures climb, Deutsche Bank AG said Dec. 18.
The government's Home Affordable program offers subsidies to lenders, bond investors, loan servicers and consumers to rework first mortgages so that payments, insurance and taxes don't exceed 31 percent of a borrower's income.
Lender Relief
The Treasury said in April that home-equity lenders would receive a subsidy to reduce interest rates to as low as 1 percent. Lien holders could get as much as 12 cents on the dollar to retire debt. Officials said on a conference call that within about a month its program would start helping borrowers, and that as many as half of "at risk" homeowners had second mortgages.
The Treasury "has been working to create program infrastructure and technology, including a new platform that matches second liens to first liens modified under HAMP," Reilly said Jan. 7. "Because there has not been a systematic method of notification to second lien holders when a first lien on the same property is modified, ramp up has taken some time."
Fink's View
BlackRock Inc. CEO Laurence Fink, who oversees the world's largest asset manager, has called the government's effort flawed because of its treatment of second mortgages, which he said should be wiped out before first liens are touched.
"There is modification going on protecting our banks, protecting their balance sheets," Fink said in a September interview. With the right types of changes, he said, "the homeowner is better off, America is better off, and you could say the first lien holder is better off."
The Federal Deposit Insurance Corp. last year urged lenders to consider whether borrowers' housing debt exceeds the value of their properties and whether first mortgages have been reworked when determining loss allowances.
Bank of America's allowance for home-equity losses equaled 6.4 percent of its $152 billion portfolio as of Sept. 30, according to a slide from an earnings presentation posted on its Web site. Half the portfolio was tied to borrowers with debt exceeding 90 percent of their property's value.
TARP Approach
U.S. officials should force banks to sell their home-equity loans at current market prices of pennies on the dollar to a government-run entity, which would then forgive the debt, said Taylor, whose community-reinvestment group represents 600 organizations that work with banks on lending in low-income neighborhoods.
"When they were handing out all this TARP money, this would be a very easy conversation, but they still have the ability to do this, if they have the willingness," he said, referring to capital injections under the $700 billion TARP.
That's not a reasonable point of view because many banks can't afford to take the hits to their capital, Rosner said.
If the U.S. were to overpay for the debt, it would allow the lenders to remain solvent, he said, "but for the government to have to subsidize those writedowns, arguing it's in the best interest of the borrowers, would be merely a backdoor bailout of the banks that brought us to this crisis."
Loan Servicers
Spokespeople for Fannie Mae and Freddie Mac, the largest owners of first-mortgage risk, declined to comment. The companies were seized by the U.S. in September 2008 and are being supported by unlimited taxpayer capital through 2012, after drawing $111 billion so far.
While Home Affordable allows loan servicers to reduce borrowers' principal instead of just their payments, such steps aren't required and decisions are designated to the servicers.
The four largest U.S. banks, which own almost $450 billion of home-equity debt, are also the biggest servicers handling payments and collections on loans held by others.
"If they can get the first to eat it, why would they want to on the second?" said Pimco's Simon, who added that his firm would support principal reductions being done on a "loan-by- loan" basis.
