Loan Servicers Share Principal Reduction Concerns in Congressional Hearing

Representatives of four of thernnation's largest mortgage lenders and servicers testified before the House Financial Services Committee yesterday on “Second Liens and OtherrnBarriers to Principal Reduction as an Effective Foreclosure Mitigation Program.” 

Prepared testimony from speakers indicatesrnthat the servicers are concerned not only with second liens but also with thernconcept of principal reduction as a loan modification tool.  The remarks of the four also address thernlevel of effort their companies have put forward in addressing the currentrnmortgage foreclosure crisis.

David Lowman, J.P. MorganrnChase's CEO for Home Lending said in his testimony that large scale, broad-based principalrnreduction programs raise serious policy concerns, for both first and secondrnlien mortgage loans, and particularly for current borrowers with an ability tornrepay their obligations.  “InrnChase's view, such programs could be potentially very harmful to consumers,rninvestors, and future mortgage market conditions – and should not be undertakenrnwithout first attempting other solutions, including more targeted modificationsrnefforts.“

He said that mortgagerncontracts are based on a promise to repay the money borrowed and contain nornprovision that the lender will restore equity or reduce the repayment amount ifrnthe collateral depreciates.  “If wernre-write the mortgage contract retroactively to restore equity to any mortgagernborrower because the value of his or her home declined, what responsible lenderrnwill take the equity risk of financing mortgages in the future?”

Lowman also voiced concernrnthat broad-based principal reduction could result in reduced access to creditrnand higher costs for consumers if market risk to lenders and investorsrnmaterially increases.  Because this wouldrnresult in increased down payment requirements and higher premiums for mortgagerncredit, less affluent borrowers would be harmed disproportionately.

Barbara Desoer, Presidentrnof Bank of American Home Loans says in her prepared testimony that, while herrncompany “is supportive of principal reduction for customers who have highrnloan to value rations and are experiencing hardship, we believe solutions mustrnbalance the interests of the customer and the investor.”

She said that in usingrnprincipal reduction there is, from the customer perspective, a fairnessrnissue.  86 percent of her bank's servicingrnportfolio is current; customers paying their mortgages every month “somernof them making difficult choices and sacrifices to do so.”  She said this does not mean that principalrnreduction should not be used for those unable to stay current, but that it mustrnbe done in a measured, responsible way so that “only customers with arnlegitimate hardship and genuine interest in maintaining homeownershiprnqualify.”    

She said that Bank ofrnAmerica's recently announced program for principal reduction is a solidrnstart.  It includes what she called anrn”innovative earned principal forgiveness approach” to help customersrnwho owe significantly more than their homes are worth.

Her bank, she said, is alsornlooking forward to the final details of Treasury's new program to reducernprincipal for homeowners with an LTV ratio in excess of 115 percent.  She said Bank of America is very supportivernof targeted principal reduction performed in a way that addresses the “significantrnmoral and financial hazards but also recognizes the reality regarding therndiminished future prospects for home appreciation.”

Michael J. Heid, Co-President,rnWells Fargo Home Mortgage said his company began using principal forgiveness asrnan element of its loan modification program several months before the advent ofrnthe Home Affordable Modification Program (HAMP).  While “principal forgiveness is not anrnacross-the-board solution,” he said, he has positive results to share withrnthe House Committee.  

Wells Fargo completed morernthan 50,000 loan modifications using principal reduction in 2009 resulting in arntotal reduction of more than $2.6 billion. The bank's program granted immediaternand permanent forgiveness, not an “earn out” over time.  On average, he said, customers received a 15rnpercent reduction in principal amounting to more than $50,000, and whenrncombined with rate reductions and term extensions their average monthlyrnpayments dropped by 25 percent.

Heid said that Wells Fargornhas found principal forgiveness is best used to help customers with certainrncharacteristics.  Typically, they arernowner occupants and are concentrated in areas with severe price declines andrnlittle prospect for full recovery of home values.  “While these customers have sufferedrnfinancial hardship,” he said, “they continue to have sufficientrnverifiable incomes to sustain homeownership with appropriately reducedrnpayments.  Finally, they want to remainrnin their homes.”

He said the bank is pleasedrnwith the performance of the modifications for customers with theserncharacteristics and in fact, during 2009, the re-default rate among them wasrnless than half the rate for similar loans in the industry. 

Sanjiv Das, President andrnCEO, Citi Mortgage Inc., said, in very brief prepared remarks, that Citi hasrnused and continues to use principal reductions and believe that this is one ofrnmany options that must be used responsibly.

Comments from the fourrnwere, perhaps a little less defensive, when discussing the role of second liensrnin modification efforts.  We will look atrntheir comments and suggestions as well as their perspectives on their overallrnloan modification efforts to date in subsequent articles.  

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