Helping Borrowers Expected to Become Easier for Lenders

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August 13, 2007
By Jeff Haynes,Reporter

Homeowners facing foreclosure just got a potential lifeline from the accounting department.
A recent professional opinion on accounting standards should make it easier for lenders to restructure loans to borrowers likely headed toward foreclosure. Focusing specifically on loans that already have been sold to the secondary market, the opinion states that lenders are not required to repurchase troubled loans in order to rewrite their terms.

Changes to the loans could include lowering the interest rate, lengthening the term of the loan or other steps that would make the loan more affordable to the borrower. In addition to helping borrowers, the change may help investors in those loans, too.

For investors, “the benefit will be that they are going to lose less money,” said Robert B. Segal, chief investment officer for Danvers-based J. William Mantz Investment Advisors. Even though the yield will be less if a troubled loan’s interest rate is dropped, for example, from 8 percent to 6 percent, “investors could have a larger principal loss if that loan goes to foreclosure,” Segal said.

Eric Fischer, a partner at Boston-based law firm Goodwin Procter Inc. who specializes in banking regulations, agreed that reworking a loan can save money. “It’s more expensive to foreclose than to lower the interest rate,” Fischer said. Foreclosure, he added, is “a messy, expensive prospect.”

The green light for lenders to rewrite troubled, securitized loans without repurchasing them comes from the U.S. Securities Exchange Commission; its chief accountant, Conrad W. Hewitt; and the Norwalk, Conn.-based Financial Accounting Standards Board, whose standards are officially recognized by the SEC. The opinion was written in response to an inquiry from the House Financial Services Committee chaired by U.S. Rep. Barney Frank, D-Mass.
The request outlines the committee’s efforts to help prevent foreclosures by rewriting troubled loans, and the complications that securitizing loans creates for lenders trying to rewrite those loans.

“A number of parties have brought to our attention that [Financial Accounting Standards Board Statement No. 140], the accounting standard that guides securitizations, may not clearly state at what point a loan may be modified – when default is reasonably foreseeable or once default or delinquency has already occurred,” states Frank’s letter. “The lack of clarity may be leading some institutions to withhold making some loan modifications that may benefit borrowers – and bondholders – for fear of being found in violation of FAS 140.”

The response from the SEC was that lenders could indeed rewrite the securitized loans “when default is reasonably foreseeable,” and without having to buy them back. “Specifically, there appears to be a consensus in practice, and it is our view that entering into loan restructuring or modification activities (consistent with the nature of activities permitted when a default has occurred) when default is reasonably foreseeable does not preclude continued off-balance sheet treatment under FAS 140,” wrote Hewitt in the response.

‘A Constructive Approach’

Frank liked the SEC’s response. “This is a constructive approach that will allow mortgage lenders to provide help at the earliest possible moments to people who might otherwise be trapped in bad loans or forced into foreclosure,” the congressman said in a prepared statement.
The entity that winds up working with the borrower to restructure the loan, however, may not be the original lender, but the company with servicing rights on the loan.

Banks can sell loans without recourse, meaning there is no obligation to buy them back, said Christopher Dannen, vice president and residential lending sales manager for Bridgeport, Conn.-based People’s United Financial Inc. If the bank has sold both the loan and the servicing rights, “there’s not a lot of incentive for us to get into loan modification,” Dannen said. But People’s United does keep some of the loans it originates, and evaluates on a case-by-case basis if a loan needs to be restructured, he said. “If we own the loan, we own the asset, and it behooves us to do that,” said Dannen, who is also second vice president of the Connecticut Mortgage Bankers Association.

It’s an approach Segal understands. “Typically, banks don’t want to be property owners,” Segal said. “It’s just expensive to go through the foreclosure process. If [borrowers] can stay in the house, it’s beneficial to everyone.” “I think the more the federal government gets involved, the bigger incentive [lenders] will have,” Segal said. “Ultimately, the goal of Congress will be to help consumers stay in their homes.”

While industry observers believe the opinion rendered by the SEC will make it easier for borrowers to get their troubled loans rewritten in more manageable terms, the success the borrowers will have under those new terms remains to be seen. “Making such accommodations does not guarantee the loan won’t eventually wind up in foreclosure,” Fischer said. “So often, dropping a loan to a 6 percent interest rate isn’t a long-term solution. If the economy turns bad, or if the loan itself is bad enough, lowering the interest rate or lengthening the term of the loan is not going to solve the problem. It’s just going to delay it.”

(c)2007 The Warren Group Inc., 280 Summer Street, Boston, MA 02210. All rights reserved.