Loan Servicers Share Principal Reduction Concerns in Congressional Hearing

Representatives of four of the nation's largest mortgage lenders and servicers testified before the House Financial Services Committee yesterday on "Second Liens and Other Barriers to Principal Reduction as an Effective Foreclosure Mitigation Program." 

Prepared testimony from speakers indicates that the servicers are concerned not only with second liens but also with the concept of principal reduction as a loan modification tool.  The remarks of the four also address the level of effort their companies have put forward in addressing the current mortgage foreclosure crisis.

David Lowman, J.P. Morgan Chase's CEO for Home Lending said in his testimony 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 modifications efforts."

He said that mortgage contracts are based on a promise to repay the money borrowed and contain no provision that the lender will restore equity or reduce the repayment amount if the collateral 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?"

Lowman also voiced concern 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.  Because this would result in increased down payment requirements and higher premiums for mortgage credit, less affluent borrowers would be harmed disproportionately.

Barbara Desoer, President of Bank of American Home Loans says in her prepared testimony that, while her company "is supportive of principal reduction for customers who have high loan to value rations and are experiencing hardship, we believe solutions must balance the interests of the customer and the investor."

She said that in using principal reduction there is, from the customer perspective, a fairness issue.  86 percent of her bank's servicing portfolio is current; customers paying their mortgages every month "some of them making difficult choices and sacrifices to do so."  She said this does not mean that principal reduction should not be used for those unable to stay current, but that it must be done in a measured, responsible way so that "only customers with a legitimate hardship and genuine interest in maintaining homeownership qualify."    

She said that Bank of America's recently announced program for principal reduction is a solid start.  It includes what she called an "innovative earned principal forgiveness approach" to help customers who owe significantly more than their homes are worth.

Her bank, she said, is also looking forward to the final details of Treasury's new program to reduce principal for homeowners with an LTV ratio in excess of 115 percent.  She said Bank of America is very supportive of targeted principal reduction performed in a way that addresses the "significant moral and financial hazards but also recognizes the reality regarding the diminished future prospects for home appreciation."

Michael J. Heid, Co-President, Wells Fargo Home Mortgage said his company began using principal forgiveness as an element of its loan modification program several months before the advent of the Home Affordable Modification Program (HAMP).  While "principal forgiveness is not an across-the-board solution," he said, he has positive results to share with the House Committee.  

Wells Fargo completed more than 50,000 loan modifications using principal reduction in 2009 resulting in a total reduction of more than $2.6 billion. The bank's program granted immediate and permanent forgiveness, not an "earn out" over time.  On average, he said, customers received a 15 percent reduction in principal amounting to more than $50,000, and when combined with rate reductions and term extensions their average monthly payments dropped by 25 percent.

Heid said that Wells Fargo has found principal forgiveness is best used to help customers with certain characteristics.  Typically, they are owner occupants and are concentrated in areas with severe price declines and little prospect for full recovery of home values.  "While these customers have suffered financial hardship," he said, "they continue to have sufficient verifiable incomes to sustain homeownership with appropriately reduced payments.  Finally, they want to remain in their homes."

He said the bank is pleased with the performance of the modifications for customers with these characteristics and in fact, during 2009, the re-default rate among them was less than half the rate for similar loans in the industry. 

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

Comments from the four were, perhaps a little less defensive, when discussing the role of second liens in modification efforts.  We will look at their comments and suggestions as well as their perspectives on their overall loan modification efforts to date in subsequent articles.