Banks Bite Bullet on Loans
Lenders Start to Write Off Some Principal in Modifying Terms for Troubled Mortgages
By Jame R Hagerty
The Wall Street Journal
October 01, 2009
Banks and loan investors are starting to bite the bullet and lower the principal due on home mortgages for some struggling borrowers, a new report from bank regulators shows.
That's good news for some homeowners, but may portend more write-offs over the next few years for banks and other lenders now wading through hundreds of thousands of applications for loan modifications. The tradeoff for banks is that by taking the hit now they can boost their chances of being repaid.
Banks and loan servicers modify loans primarily by reducing interest rates or extending the term of the mortgage. These methods can temporarily help borrowers struggling to make payments without requiring lenders to lower the principal owed. Now, in a small but growing number of cases, banks are going further and writing off some of the loan altogether.
Part of this is due to prodding from the Obama administration, which has made saving homeowners from foreclosure a cornerstone of its economic-rescue strategy. The administration in March announced plans aimed at helping as many as nine million households struggling with mortgage debt through loan modifications or refinancings. The plans include financial incentives for mortgage-servicing firms that modify loans.
At the same time, banks now have more flexibility to modify loans because of their success in stabilizing their balance sheets and, in some cases, raising fresh capital. Banks can afford "to take the pain up front," said Kevin Fitzsimmons an analyst at Sandler O'Neill & Partners LP in New York. "If they want a legitimate chance of salvaging something out of the loans, they are better off taking the loss now."
The portion of loan modifications in the second quarter that involved reducing the principal jumped to 10% from 3.1% in the first quarter, according to the report released Wednesday by the Office of the Comptroller of the Currency, or OCC, which regulates national banks.
Alejandro Estrella, a mail carrier in Riverside, Calif., said he was surprised when his lender, the Wachovia unit of Wells Fargo & Co., agreed recently to reduce the principal he owed on two mortgages on his home by 18% to about $237,000. That will lower his monthly payments to less than $1,500 from about $2,100. "I wasn't expecting it," said Mr. Estrella, who started out seeking just a reduction in his interest rate and got counseling from Springboard Nonprofit Consumer Credit Management.
Principal reductions are still the exception, though. Tom Kelly, a spokesman for J.P. Morgan Chase & Co., said the lender first tries to make loans affordable by lowering the interest rate for borrowers who qualify for modifications. If that doesn't result in a low enough payment, the bank may extend the term of the loan or defer repayments on part of the principal. That deferred principal would come due if the home is sold or refinanced.
But banks and loan servicers are recognizing that modifications don't always work if the borrowers aren't given a big enough break. Of loans modified in this year's first quarter, 28% were in default again within three months, the OCC said. Among those modified in last year's second quarter, 56% were in default again a year later.
Although the Obama administration programs for averting foreclosures got off to a slow start, they are starting to result in larger numbers of modified loans. The OCC report tallied 439,574 agreements to help troubled borrowers, including loan modifications and other repayment plans, in the second quarter. That was up 75% from a year earlier. Of that total, 142,362 of the agreements were classified as loan modifications, and 10% of those involved reducing the principal.
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