I have heard many sell side analysts claim the new government rules regarding loan mods to be bullish for banks. This actually makes plenty of accounting sense, since although most mods fall back into delinquency anyway, the bank gets to reclassify the delinquent loan as current and may get a refinancing fee that goes straight to the income line item to boot. Then I took a closer look. Some banks simply are not participating. I know for a fact that Citibank has simply stop modifying loans in many, if not most, cases.
We have looked into the possibility of the loan modification program allowing for shift of losses by banks to following periods. As of now, it appears that the program has not been receiving interest from lenders due to absence of real benefits to lenders in the program. Following are our findings:
- 1. There was a study conducted by Boston Fed, the finding of which suggest that the program to solve the foreclosure crisis by giving the lending industry $75 billion to rewrite delinquent loans to more affordable levels is not likely to work. One of the reasons is that the scheme is not profitable for lenders. Even after rewriting the loan, there could be strong possibility of default going forward. As per the study, of the borrowers who received assistance under the scheme, upto 45% ended up in arrears again.
- 2. The response to the program has not been strong enough to project any situation better than that of today's. Only 3 percent of seriously delinquent borrowers - those more than 60 days behind - had their loans modified to lower monthly payments and about 5.5 percent received loan modifications that did not result in lower payments. (The study focused on 665,410 loans that were originated between 2005 and 2007 and subsequently became seriously delinquent. It also followed about 150,000 borrowers for six months after they received help, through the end of 2008).
- 3. Although the pace of loan modifications has been increasingly steadily under the program (more than 240,000 homeowners received assistance under the program), the number of foreclosure proceedings have also increased to 844,389 during the first quarter of 2009, up 73 percent from the first quarter of 2008. Thus far, the negatives are signficantly outrunning the positives!
- 4. It is largely believed that the borrowers who are in deep trouble will default anyway and again, even after they have been given assistance under the program. This disincentivizes the lenders from pushing the program.
The increase in program allocation to incentivize mortgage lenders could prove to be in insufficient given no tangible benefits visible from the program.